Within-Firm Pay Inequality and Productivity

Using confidential Census data, we find that aggressive performance pay practices and productivity growth have combined to increase U.S. inequality. Employees at more productive firms earn higher pay at all earnings levels; similarly, when a firm becomes more productive, pay increases across its workforce. Importantly, however, these pay-productivity relationships strengthen with seniority: within a firm, the pay-productivity elasticity more than doubles from the median-paid worker (0.04) to the top-paid worker (0.10). Moreover, this pay-performance relationship is particularly steep when there is more scope for performance-based pay, suggesting that the use of incentives can spur the growth of inequality following productivity growth.