Incentive Pay and Performance : Insider Econometrics in a Multi-Unit Bank

We analyze the impact of differentiated incentives on performance. While the literature has studied workers with relatively homogeneous tasks, we study teams with heterogeneous tasks and differentiated outputs that cannot be perfectly distinguished – a situation common in manufacturing or organizations that combine sales and services and for which it is difficult to design optimal compensation schemes. Using data from a foreign-owned bank in Central-East Europe, we find that the differentiated incentive pay raises productivity, especially in the larger branches of the bank. However, it has mixed benefits for the quality of sales in terms of product mix and profitability. Our analytical approach falls within “insider econometrics” and we extend this literature to account in two complementary ways for the endogeneity of firm-specific reforms – a major outstanding issue in this field. In particular, we exploit the characteristics of our data to implement both instrumental variable estimation and generalized propensity score estimation. Our results underscore (a) the risks of quantity-based incentives and differentiation of incentives among co-workers where quality is an important consideration and (b) the importance of accounting for endogeneity