Faculty of Economics and Business Administration Publications Database

Market Competition and the Effectiveness of Performance Pay

Khashabi, Pooyan
Heinz, Matthias
Zubanov, Nick
Kretschmer, Tobias
Volume: 32
Number: 2
Pages: 334 - 351
Link External Source: Online Version
Year: 2021
Keywords: pay for performance (PfP); market competition; incentives; field experiment

It is well established that the effectiveness of pay-for-performance (PfP) schemes depends on employee- and organization-specific factors. However, less is known about the moderating role of external forces such as market competition. Our theory posits that competition generates two counteracting effects—the residual market and competitor response effects—that vary with competition and jointly generate a curvilinear relationship between PfP effectiveness and competition. Weak competition discourages effort response to PfP because there is little residual market to gain from rivals, whereas strong competition weakens incentives because an offsetting response from competitors becomes more likely. PfP hence has the strongest effect under moderate competition. Field data from a bakery chain and its competitive environment confirm our theory and let us refute several alternative interpretations.