Literature Review

Edward Lazear’s 1996 research on Safelite Autoglass Company’s compensation scheme change remains the predominant study assessing the effects of such modifications. Safelite initially paid their workers an hourly wage; however, they gradually switched all of their workers to a piece-rate scheme. Lazear tested for significant differences in worker output before and after the compensation scheme switch. More importantly, Lazear computed the optimal piece-rate that maximizes worker output and subsequently the firm’s profit. He predicted three main effects: both productivity of workers and the variances between workers’ productivity would increase (the effort effect), low productivity workers would leave while high productivity workers would take their place (the sorting effect), and the longer a worker receives a piece-rate the more productive he or she will be (the tenure effect).

In order to predict worker output, Lazear created a model using a dummy, or indicator, variable for the type of compensation scheme used and subsequently controlled for how long the worker functioned under the new compensation scheme. Lazear found both the effort effect and the tenure effect to be positive and significant. Not only did the piece-rate scheme incentivize workers to increase productivity, but also variance in productivity increased because high ability workers improved their efforts. The sorting effect, which tested to see if low productivity workers were replaced with high productivity workers, was also proven. Thus, high productivity workers were attracted to the firm because their effort dictated their pay, and low productivity workers left because they could not compete with the higher achieving workers.

Lazear’s model also encompasses other controls —such as paid sick time—in order to measure the optimal piece-rate that dissuades workers from calling out sick. Because Safelite’s piece-rate compensation scheme incentivized workers to increase output, quality control measures became necessary. For example, if a Safelite employee failed to satisfy Safelite’s standards (i.e., the autoglass chipped soon after installation), the task would be randomly assigned to another worker at the firm for no piece-rate compensation. This created a peer pressure effect in which an employee’s fear of being ostracized from his or her work group deterred low quality workmanship. Lazear’s findings at Safelite paved the way for researchers to look for these cascading effects in other industries

A study by Lan Shi (2010) examined the effects of piecerate changes in the lumber industry. A group of workers at a tree-thinning company in Washington State were randomly assigned to receive piece-rate compensation instead of an hourly wage. The basis of the piece-rate scheme was to reward workers for removing “bad apples,” or apples of lesser quality, from trees (Shi, 2010). Following the compensation scheme change, the company had an incentive to ensure that all of the bad apples were removed. Thus, when the company switched to a piece-rate scheme, worker productivity statistically improved, as did the variance in the worker productivity. The variance in worker productivity is expected because the effort is greater for high ability workers compared to low ability workers. Similar to Lazear, Shi tested for the optimal piece-rate the business should pay workers in order to maximize productivity and profit.

Booth and Frank (1999) expand piece-rate literature by examining the wide scale effects of a compensation scheme change. Aside from supporting previous findings that piece-rates cause an increase in overall production (Lazear, 1996; Shi 2010), Booth and Frank found that companies and industries using piece-rate schemes attracted workers with higher “unobservable ability.” Higher unobservable ability means that these workers have a low cost of effort and will work more than a worker with a high cost of effort. Interestingly, Booth and Frank also found differences in gender responses to piece-rates. There was a 9% earnings increase for males compared to 6% for females. This seems to suggest that men respond to piece-rate schemes slightly more than women.

Heywood, Wei, and Ye (2011) found that even professors respond positively to piece-rate compensation, in which piecerates are given for publishing research. For example, a highly ranked research university in China greatly increased their piecerate for publishing research and tracked, with the help of Hey-word et al., the subsequent publishing rate. Heywood et al. used a similar research university in China as a control group. Different academic journals were put into tiers according to prominence and assigned appropriate piece-rates. The results were both positive and extremely significant across each tier, with increases of 55% to 76% for each tier. Most of the increases were attributed to full-time professors and professors who were already research active. Besides documenting an effort effect, Heywood et al. also found evidence of a sorting effect. For instance, professors hired after the piece-rate change were found to be more “productive” overall than the current professors.

Not all institutions find that piece-rate compensation is optimal. Freeman and Kleiner (2005) found that changing from a piece-rate compensation scheme to an hourly compensation scheme benefited a United States shoe firm. Faced with foreign competition that employed cheap labor, the US shoe firm changed its labor costs to remain profitable. Switching to an hourly compensation scheme reduced production, but firm profits improved because the reduction in wage costs offset reduced production. Freeman and Kleiner attribute this to the effects foreign competition has on domestic manufacturing industries.

Another researcher who finds support for hourly compensation schemes over piece-rate is Clemens. He focuses on the determinants of a piece-rate pay decision and argues that when output is hard to measure or there are hard to define piece-rates, industries should use an hourly compensation scheme (Clemens, 2012). Thus a piece-rate scheme is only more likely if production is dictated by endogenous factors. By using data from the Fourth European Survey on Working Conditions, Clemens controlled for such factors as workplace team pace, customer pace, target pace, automatic pace, and boss pace. He found that automated pace is not related to piece-rate schemes; however, team pace, customer pace, and target pace are. This implies that companies whose workers have more control over their production are likely to have piece-rates because the determinants of work pace are endogenous. Hence, companies whose workers have less control over their production are likely to pay with an hourly compensation scheme.