DP5301 | Making A Difference

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Publication Date

23/10/2005

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Abstract

Despite the potential for free-riding, workers motivated by `making a difference' to the mission or output of an establishment may donate labour to it. When the establishment uses performance related compensation (PRC), these labour donations closely resemble a standard private provision of public goods problem, and are not rational in large labour pools. Without PRC, however, the problem differs significantly from a standard private provision of public goods situation. Specifically, in equilibrium: there need not be free-riding, decisions are non-monotonic in valuations, and contribution incentives are significant even in large populations. When PRC is not used, the establishment tends to favour setting low wages which help to select a labor force driven by concern for the firm's output. Expected output can actually fall with the wage in this situation. For sufficiently high levels of risk aversion, performance related pay can yield less expected output than when compensation is output independent.