In the United States, the wage and compensation structure of firms underwent significant change during the 1980s and 1990s. The wage structure changed from fixed to variable based on output, earnings inequality and returns to skill increased, and there was a very dramatic rise in pay at the top of the corporate ladder. Inequality and job mobility between executives and workers in general increased, and CEO pay rose disproportionately. During this time we saw the simultaneous change within firms the growing use of incentive and performance-related pay. Pay on commission, piece rates, bonuses, and stock options made their début.
There is much research that shows that product market competition can directly affect the amount of incentives programs utilized by a firm because of the positive effects on overall profit and individual productivity. Logic dictates that if you offer incentive for higher performance, then the individual will be motivated to enhance their productivity. However, one must also take into account the extra effort on part of the company and the difficulties within the workplace that arise in this type of variable pay system, specifically through inequality within the workplace. Globalization of economic activity and trade have led to higher imports, reductions in trade barriers, lower costs of transport, and information diffusion, which although positive for the consumer, also increase the degree of competition that firms face. Today firms are faced with global competition, rather than on a regional or national scale. Therefore, standards of performance are continuously increasing, and firms must either evolve to meet the demands or be washed away by the rising tide of the global marketplace.
In the United States, this has caused for firms, through a series of reviews and changes, to adopt a type of internal work structure alien to that which dominated until the 1980s. Focal points were the manager position, which are now the victims of incentives to exert effort and to improve their contribution of productivity to the firm, although for many in such positions this was rather a blessing than a curse, if they were actually good at what they did, that is. More work was required, but based on the level of effort given, the compensation is linear. For example, discretionary bonuses may be accorded by the firm to its employee as their branch or area shows positive growth. Also, positive performance in the workplace might cause another company to offer this same executive a better job.
In their essay, Cuñat and Guadalupe find that higher competition substantially changed the structure of compensation from non-performance-related pay to an incentive-performance-based method. The sensitivity of this pay to performance is most pronounced as one climbs the corporate ladder, and as the incentive provision rises at the rate of increase in foreign competition, wage differentials between the executives and top-paid officials also increases. Faced with more competition, firms are hiring more talented executives at the top, and paying accordingly.
Globalization and the Provision of Incentives inside the Firm: The Effect of Foreign Competition
By Vicente Cuñat and Maria Guadalupe
Journal of Labor Economics, Vol. 27, No. 2 (April 2009), pp. 179-212