An empirical analysis of the effect of a performance-based compensation plan: Evidence from an automobile distribution company in Korea

Abstract

This study examines whether performance-based compensation plans act as effective devices for alleviating the agency problems by motivating employees and controlling moral hazard. Using large samples from an automobile sales and service firm in both pre-plan (2000-2001) and post-plan periods (2002-2004), we document that the productivity of employees increases following the implementation of a pay-for-performance plan. Both retention and effort effects contribute to performance improvements while the attraction effect does not. We conduct an additional analysis by performance in the pre-plan periods and by position. Our empirical results suggest that a performance-based compensation plan has positive effects on performance for employees who were less productive before the plan while it has no significant effects on employees who were already productive in the pre-plan period. An analysis of sub-samples sorted by positions indicates that the effect of a performance-based compensation plan for managers and assistant managers is significantly positive.