Academic journal article Economic Inquiry

The Payoff to Consistency in Performance

Academic journal article Economic Inquiry

The Payoff to Consistency in Performance

Article excerpt

I. INTRODUCTION

When a firm hires a worker, the firm pays the worker a salary to demand some service in return. Some workers provide consistent performance; others exhibit performance that is inconsistent, such that it is high on some days but relatively low on others. When workers vary in the consistency of their performance, an obvious question arises, regarding whether firms offer higher wages to workers who promise consistent performance, compared with those with greater performance volatility. In other words, is there a deduction for risk, as modern portfolio theory would predict (Markowitz 1952)?

Substantial literature addresses the effect of a worker's expected performance on his or her wages. Usually, the worker's level of education serves as the proxy for her or his expected ability and talent, which then should increase expectations of the worker's likely performance. Studies accordingly reveal that workers with a higher level of education receive higher wages on average (e.g., Mincer 1974; Waldman 2013a). The human capital theory originated by Becker (1964) is largely based on this observation: Workers are willing to invest in their human capital and acquire skills only if they expect this investment to later be rewarded with a higher wage. Job-market signaling theory suggests these investments to be wasteful at times without enhancing workers' productivity (e.g., Spence 1973). The intuition is simple: If workers of relatively high ability can acquire some job-market signal, such as a certain level of education at lower cost than workers of low ability, they may have an incentive to do so just to reveal their superior ability. (1)

The effect of performance consistency on wages has received little research attention though. Such an analysis is difficult, due to the lack of readily available, suitable data. Studies investigating the determinants of worker wages tend to rely only on the worker's level of education to proxy for expected productivity, but this level of education is relatively constant and cannot signal the likely consistency of a worker's performance. Whereas previous performance seemingly could help anticipate the rate of consistency, this performance is often unobservable.

With this study, we seek to explicate the effects of performance consistency on workers' wages. (2) The analysis consists of both a theoretical and an empirical part. In the theoretical model, we assume that a firm organizes production in a team and needs to fill one position in that team. To do so, it hires a worker whose ability is subject to fluctuations. The output that the team produces for the firm depends on all workers' abilities and thus is subject to fluctuations as well. A worker's wage is an increasing function of the value of the team's expected output. A final assumption is that the law of diminishing marginal product holds, such that a positive deviation of the worker's ability from the mean by x units increases output less than a negative deviation of ability from the mean by x units decreases it. Inconsistency in performance therefore reduces expected output, so the firm is willing to offer a higher wage to more consistent workers. The model delivers some other results as well. For example, a worker's wage increases with her or his expected ability.

In the empirical part, we use data from the National Basketball Association (NBA) to test the model predictions. Data sets that include the information required to address our research question are rare; in particular, information about the volatility of workers' performance is hard to derive. Professional sport settings can overcome these measurement problems, because information about salaries, individual characteristics, and continual performance measures are common and readily available (Kahn 2000; Rosen and Sanderson 2001). Our data include information from the 2007/2008 to 2010/2011 NBA seasons and contain game-by-game statistics for 259 different players and 22,520 individual performance observations. …

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