Core readings

18.1  High Pay as a Worker Discipline Device—Theory

Shapiro, Carl and Joseph E. Stiglitz,  "Equilibrium Unemployment as a Worker Discipline Device”. American Economic Review, vol. 74, no. 3, June 1984, pp. 433-44.

Develops the basic efficiency wage model by showing how dismissal threats can discipline workers when their current employer pays ‘above the market’.  When many firms compete for the same workers, however, it is logically impossible for all of them to pay above the market. In this situation, the authors argue that the only labor market equilibrium that prevents workers from shirking is one that exhibits some involuntary unemployment.  Thus the principal-agent problem –i.e. the problem of inducing workers to supply an efficient level of effort inside firms— can have effects on the entire labor market by necessitating a minimum level of involuntary unemployment overall.  

18.2 High Pay as a Worker Discipline Device—Evidence

Raff, Daniel MG and Lawrence H. Summers, (1987). "Did Henry Ford pay efficiency wages?" Journal of Labor Economics 5, 4(2): S57-S86.

Examines Henry Ford’s introduction of the five-dollar day in 1914 in an effort to evaluate the relevance of efficiency wage theories of wage and employment determination.

Cappelli, Peter and Keith Chauvin, (1991). "An interplant test of the efficiency wage hypothesis," The Quarterly Journal of Economics 106, no. 3: 769-787.

Tests the shirking model of efficiency wages by examining the relationship between rates of employee discipline and relative wage premiums across plants within the same firm. 

Jacob, Brian A. “The Effect of Employment Protection on Worker Effort: Evidence from Public Schooling,” Journal of Labor Economics Vol. 31, No. 4 (October 2013)

In 2004, the Chicago Public Schools and the Chicago Teachers Union signed a new collective bargaining agreement that gave principals the flexibility to dismiss probationary teachers for any reason and without the hearing process typical in many urban districts. Results suggest that the policy reduced annual teacher absences by roughly 10% and reduced the incidence of frequent absences by 25%.  Thus, increasing the threat of dismissal reduced shirking.  

Furgeson, Joshua., Moira McCullough, Clare Wolfendale, and Brian Gill, (2014). "The equity project charter school: Impacts on student achievement," Cambridge, MA: Mathematica Policy Research.

Dramatically raising teachers' salaries while reducing their job security appears to have led to large gains in student achievement.  

Lazear, Edward P.,  Kathryn L. Shaw, and Christopher Stanton. “Making Do With Less:  Working Harder During Recessions”. Journal of Labor Economics 34, no. S1 (Part 2, January 2016): S333-S360.

Uses data from 2006 to 2010 on individual worker productivity from a large firm to separately measure the two possible factors that lead to rise in productivity during recent recessions: quality increases or gains in productivity. For this firm, most of the gain in productivity during the recession was a result of increased effort. Essentially, workers worked harder to keep their jobs, because losing a job in a deep recession is much more painful than losing a job during more normal times. 

Dahl, Gordon and Matthew M. Knepper. 2021 “Why is Workplace Sexual Harassment Underreported? The Value of Unemployment Amid the Threat of Retaliation” NBER working paper no. 29248

The authors show that workers are more reluctant to report sexual harassment when their outside labor market opportunities deteriorate.  To measure ‘reluctance’, they use the mean quality of sexual harassment claims:  if workers are very reluctant to claim, they will only file claims that are of the highest quality.  When there are few jobs in the local labor market, workers accept lower levels of harassment without reporting them.  Thus, in addition to working harder, workers may also accept worse working conditions, including more sexual harassment, when their outside earnings opportunities deteriorate. 

18.3 Deferred Compensation

Lazear, Edward P. “Why Is There Mandatory Retirement?” Journal of Political Economy, vol. 87, no. 6, December 1979, pp. 1261-84

When firms use deferred compensation (combined with a threat of dismissal) to prevent shirking, their older workers (who are overpaid relative to what they produce) will want to postpone their retirement dates beyond the efficient time to take advantage of their high salaries.  Thus, to be economically efficient, a deferred-compensation system needs to find some way to induce older workers to retire at the efficient age. Employment contracts that stipulate a mandatory retirement date are one possible solution.

Fama, Eugene F. “Agency Problems and the Theory of the Firm”, Journal of Political Economy, vol. 88, no. 2, April 1980, pp. 288-307

In a widely cited article, Fama makes the provocative argument that explicit performance pay schemes for CEOs and other high-level managers are unnecessary. That’s because these managers are incentivized by their own labor market:  high-performing CEOs will receive lucrative offers to run other companies, which are likely to raise their pay whether or not they actually accept the offer. Low-performing CEOs will not receive such offers.  Thus, at least when a worker’s job performance is visible to other potential employers, the labor market for workers provides strong incentives to supply effort, even in firms that offer no incentive pay at all.  Put another way, workers are disciplined by their own reputationsin the labor market.  

Shleifer, Andrei and Lawrence H. Summers. (1988) “Breach of Trust in Hostile Takeovers”  in Alan J. Auerbach, ed. Corporate Takeovers: Causes and Consequences, University of Chicago Press  (also available as NBER working paper no. 2342). 

When firms use deferred compensation (combined with a threat of dismissal) to prevent shirking, firms with a lot of older workers will be tempted to renege on their wage promises to those workers (who are being paid more than they produce).  One way to accomplish this, Shleifer and Summers argue, is for an outside entity to make a hostile takeover; this new entity arguably has no obligations to the older workers because it did not make the initial wage promises. Because they facilitate this opportunistic transfer of wealth from workers to shareholders, hostile takeovers may occur even when they are economically inefficient.  Empirical evidence suggests that the redistribution associated with takeovers can be large, and that some takeovers are economically inefficient.

Oyer, P., and S. Schaefer, 2005, Why do some firms give stock options to all employees? An empirical examination of alternative theories Journal of Financial Economics 76, 99–133.

Standard principal-agent models make it hard to understand why some firms issue stock options to all employees, because free-rider problems are enormous in this context. The authors address this puzzle by considering three potential economic justifications for firm-wide stock options: providing incentives to employees, inducing employees to sort, and employee retention. They reject an incentives-based explanation for broad-based stock option plans, and conclude that sorting and retention explanations are the most likely explanations.

Downsizing

Bewley, Truman. 1999 Why Wages Don't Fall during a Recession Harvard University Press,

A deep question in economics is why wages and salaries don't fall during recessions. This is not true of other prices, which adjust relatively quickly to reflect changes in demand and supply. Although economists have posited many theories to account for wage rigidity, none is satisfactory. Eschewing "top-down" theorizing, Truman Bewley explored the puzzle by interviewing―during the recession of the early 1990s―over three hundred business executives and labor leaders as well as professional recruiters and advisors to the unemployed.  Concerns that wage cuts would reduce morale and productivity are among the most frequent explanations for ‘sticky’ wages. 

Keum, Dongil Daniel and Stephan Meier 2023 License to Layoff? Unemployment Insurance and the Moral Cost of Layoffs Organization Science, published 27 Jul 2023.

The authors study how managers’ use of layoffs responded to expansions in unemployment insurance that reduced laid-off workers’ economic hardship.  They find that these expansions ‘licensed‘ larger layoffs. The effects are stronger for chief executive officers (CEOs) with stronger prosocial preferences who dismiss fewer workers despite low performance, such as non-Republican, internally promoted, small town, or family firm CEOs, and weaker for CEOs who face shareholder or financial pressures.

Newer Resources

Sections 18.1 and 18.2:  Shirking, Dismissals, and Pay

Irwin, Neil, (2016). “How Did Walmart Get Cleaner Stores and Higher Sales? It Paid Its People More,” New York Times, October 15.

In early 2015, Walmart announced it would actually pay its workers more.  That set in motion the biggest test imaginable of a basic argument that has consumed ivory-tower economists, union-hall organizers and corporate executives for years on end: What if paying workers more, training them better and offering better opportunities for advancement can actually make a company more profitable, rather than less?

de Ree, Joppe, Karthik Muralidharan  and Menno Pradhan, and Halsey Rogers, (2018). “Double for Nothing? Experimental Evidence on an Unconditional Teacher Salary Increase in Indonesia.” The Quarterly Journal of Economics, 122(2):993-1039.

Results from a large-scale randomized experiment across a representative sample of Indonesian schools show that large teacher pay increases led to no improvement in student learning outcomes.  The pay increase did, however, significantly improve teachers' satisfaction with their income, reduced the incidence of teachers holding outside jobs, and reduced teachers' self-reported financial stress.

Lusher, Lester, Geoffrey Schnorr and Rebecca L.C. Taylor. 2022. Unemployment Insurance as a Worker Indiscipline Device? Evidence from Scanner Data AEJ:Applied 14(2): 285–319 

Matching high-frequency productivity measures from individual supermarket cashiers to plausibly exogenous changes in UI benefit duration during the Great Recession, the authors find a modest but statistically significant negative relationship between UI benefits and worker productivity:  Consistent with the efficiency wage model, better outside options (higher UI) reduce worker productivity.  

Ku, Hyejin. 2022. Does Minimum Wage Increase Labor Productivity? Evidence from Piece Rate Workers  Journal of Labor Economics, forthcoming.

The author shows that the productivity of Florida tomato-pickers increased in response to sudden increase in their minimum wage.  After eliminating other possible channels, an increase in worker effort appears to be the main cause of this change. Similar to Lazear, Shaw and Stanton’s results during the Great Recession, the main cause seems to be a reduction in the value of workers’ outside options:  The higher minimum wage increased a worker’s risk of not being picked up for daily employment in this casual labor market, where daily employment is decided on an ad hoc basis.

Section 18.3:  Deferred Compensation

Caplin, Andrew, Minjoon Lee, Søren Leth-Petersen, Johan Saeverud & Matthew D. Shapiro 2022 How Worker Productivity and Wages Grow with Tenure and Experience: The Firm Perspective NBER working paper no 30342.

This paper uses direct measures of worker productivity to study the effects of a worker’s within-firm versus total experience on their productivity growth.  They find that on-the-job productivity growth exceeds wage growth, which is inconsistent with Lazear’s ‘deferred compensation’ model.   While the patterns vary across types of work, they also find overall previous experience is far less than perfect substitute for experience in the current job.

Downsizing

Bertheau, Antoine, Marianna Kudlyak, Birthe Larsen, and Morten Bennedsen, 2023 Why Firms Lay Off Workers instead of Cutting Wages: Evidence from Matched Survey-Administrative Data Unpublished paper, University of Copenhagen.

The authors survey Danish employers about how they prefer to respond to adverse business shocks.  Consistent with Bewley (1999), the employers report that they try to avoid cutting workers’ wages because of anticipated reductions in morale and productivity.  The Danish employers’ responses also shed new light on why wage cuts are a poor substitute for layoffs:  Because wage cuts raise turnover, both layoffs and wage cuts have similar employment effects, but with layoffs employers get to choose who departs.  Consistent with the idea that employers’ motivations matter for worker morale, firms say that “a recession is an opportune time to lay off workers”.  In recessions, employers can blame the layoffs on factors outside the firm’s control. 

Moral hazard over time

Sliwka, Dirk and Peter Werner, (2014). “Wage Increases and the Dynamics of Reciprocity,” Journal of Labor Economics, 35(2):299-344.

Conducts a real-effort experiment: agents earn the same wage sum in all treatments, but wage increases are distributed differently over time. It shows that agents work harder under increasing wage profiles if they do not know these profiles in advance. 

Green, Brett and Curtis R. Taylor, (2016). “Breakthroughs, Deadlines, and Self-Reported Progress: Contracting for Multistage Projects,” American Economic Review, 106(12):3660-99.

Studies the optimal incentive scheme for a multistage project in which the agent privately observes intermediate progress. Shows that the principal benefits by imposing a small cost on the agent for submitting a progress report or by making the first stage of the project somewhat "harder" than the second.

Cohen Alma., Nadav Levy and Roy Sasson, (2018). “Termination Risk and Agency Problems: Evidence from the NBA,” NBER, Working paper no. 24708.

Uses NBA data to study how risk of termination in the short term affects the decision of coaches. Results show that, during the period of the NBA’s 1999 collective bargaining agreement (CBA) and controlling for the characteristics of rookies and their teams, higher termination risk was associated with lower rookie participation and that this association was driven by important games.  

Frederiksen, Anders and Colleen Flaherty Manchester (2021) Personnel Practices and Regulation: How Firm-Provided Incentives Respond to Changes in Mandatory Retirement Law forthcoming, Journal of Labor Economics.  

By prohibiting mandatory retirement clauses in employment contracts, the Age Discrimination and Employment Act reduced firms’ ability to use deferred compensation to incentivize workers.  Using internal data from a large U.S. services company, the authors show that the firm responded with increased use of pay-for-performance. This was especially true for older workers, whose promotion prospects dimmed significantly when the law allowed their supervisors to lengthen their careers.

Employers’ Reputations

Benson, A. A Sojourner and Akhmed Umyarov, (2018). ”Can reputation discipline the gig economy? Experimental evidence from an online labor market,” IZA Discussion Paper no. 9501.

Builds a theoretical model for the value of employer reputation systems and test its predictions in on Amazon Mechanical Turk, where employers may decline to pay workers while keeping their work product and workers protect themselves using third-party reputation systems (such as Turkopticon). 

Marinescu, Ioana., Nadav Klein, Andrew Chamberlain and Morgan Smart, (2018). “Incentives Can Reduce Bias in Online Reviews,” NBER working paper number 24372.

Data from one of the leading employer review companies, Glassdoor, shows that voluntary reviews have a different distribution from incentivized reviews. A randomized controlled experiment on MTurk suggests that when participants’ decision to review their employer is voluntary, the resulting distribution of reviews differs from the distribution of forced reviews.

Bassanini, Andrea, Eve Caroli, Bruno Chaves Ferreira and Antoine Rebérioux 2020 Don't Downsize This! Social Reactions to Mass Dismissals on Twitter  IZA discussion paper No. 13840. 

The authors use Twitter posts to study the effect of downsizing on firms’ reputations in the labor market.  Job-destruction announcements immediately elicit numerous and strongly negative reactions. These reactions are systematically more important than reactions to job creations. Thus, job destructions appear to generate reputational costs in the form of a strong negative buzz involving the company name.

Benson, Alan,  Aaron Sojourner and Akhmed Umyarov. 2020. Can Reputation Discipline the Gig Economy? Experimental Evidence from an Online Labor Market Management Science, 66(5): 1783-2290.

The authors use three experiments to assess the value of MTurk’s reputation system for employers.  They find that “good” employers (who do not decline to pay workers while keeping their work product) pay 40 percent more than other employers, and attract twice as many workers (of the same quality) as other employers.  Using natural experiments provided by periods when the reputation system was down, they find that the reputation system attracts work to small, good employers who would otherwise be hard for workers to identify.