Sorting into Performance Pay

We investigate the observable determinants of sorting between salary and performance pay jobs, the extent to which wage functions differ between the two, and the magnitude of the unobserved ability differential between salary and performance pay workers. We find that several observables - in particular age, education, job complexity and tenure - have a large impact on both the likelihood and the magnitude of performance pay. The returns to performance pay are large, and wage functions differ markedly between salary and performance pay jobs. In particular, the earnings premia associated with several observables - age, job
complexity and managerial position - are much larger for performance pay jobs than for salary jobs. A separate analysis of the base pay and bonus components of performance pay workers' earnings reveals the presence of insurance in these earnings - workers with high base pay also have large bonuses - and shows that base pay primarily rewards observables, while bonuses reward unobserved heterogeneity. The difference in unobserved ability between salary and performance pay workers is large, accounting for about half of the wage differential between both groups. Thus, unobserved ability appears to be the key driver of sorting between salary and performance pay jobs