Using Fixed Wages for Management Control: An Intra-firm Test of the Effect of Relative Compensation on Performance

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Abstract

Efficiency wage theory predicts employers can elicit better employee performance ex post by paying ex ante a higher fixed compensation relative to the market wage for a similar position. Relative compensation may, thereby, constitute an alternative control mechanism when performance-based compensation is difficult to implement. Using field data from a lodging firm, we investigate the impact of relative compensation on unit-level performance. As hypothesized, relative compensation is positively associated with performance. Moreover, increased profits offset the cost of higher compensation in our setting. Relative compensation has a larger impact on financial performance when tasks are more complex. Monitoring attenuates the impact of relative wages on non-financial performance. Finally, consistent with economic theory, relative wage-performance elasticities are the same regardless of whether workers compensated with more or less than the median wage. Overall, our observations are consistent with the claim that higher relative compensation attracts more capable candidates and mitigate adverse selection but provide little evidence of reduced moral hazard. This study contributes to the compensation literature by providing new evidence on the efficacy of relative compensation in controlling agents’ actions. This paper is under review in the Journal of Management Accounting Research (conditional acceptance)

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