CReAM Applied Economics Online Seminar presented by Fabian Lange McGill

Abstract: Standard models of performance pay and incentives over the life cycle, so-called career concerns models, imply that implicit incentives for performance from workers' concerns about their future careers progressively weaken as workers age. To compensate, explicit incentives through performance pay increase with age. We show that in U.S. survey data and firm personnel records, performance pay instead declines during the last 20 years of workers' careers. The data thus rejects the standard model of performance pay over the life-cycle. We show that incorporating human capital accumulation through learning-by-doing can reconcile the model with the data. Our equilibrium model accounts for three key sources of earnings dynamics, namely, uncertainty and learning about individual ability, human capital accumulation with experience, and explicit performance pay. In the model, effort on the job affect not only contemporaneous output but also adds to the human capital stock of a worker. Then, because the returns to human capital diminish over time, the model naturally rationalizes hump-shaped profile of performance pay across the life-cycle that we see in the data. We characterize equilibrium wages and analytically decompose the sensitivity of pay to performance into four distinct terms: the standard trade-off between risk and incentives typical of moral hazard; the insurance contracts provide against uncertainty about ability; the incentives from human capital accumulation, and the incentives due to career concerns. The model is identified based on a panel of wages alone. The estimated model fits the first and second moments of the fixed and variable components of earnings over the life-cycle well. We find that incentives for performance and insurance against uncertainty about ability are quantitatively the most important determinants of the sensitivity of pay to performance. Overall, our estimation results imply that through the cumulative impact of effort on human capital acquisition, incentives for performance are a critical source of wage growth and dispersion over the life cycle.

Zoom Link: https://ucl.zoom.us/j/97724018932?pwd=V25xTVFKZmJGbzladlhxek9IWk1IZz09

Meeting ID: 977 2401 8932

Password: AS021120