Incentive contracts and time use

Tor Eriksson, Jaime Ortega

Incentive contracts, performance pay, time use, work and non-work activities, work-family balance

Empirical studies on incentive contracts have primarily been concerned with the effects on employees’ productivity and earnings. The productivity increases associated with such contracts may, however, come at the expense of quality of life at or outside work. In this paper we study the effect on the employees’ non-work activities, testing whether incentive contracts lead to a change in the allocation of time across work and non-work activities. In doing so, we distinguish between two effects, a substitution effect and a discretion effect. On the one hand, the introduction of explicit incentives raises the marginal payoff to work, hence employees are expected to work more and spend less time on non-work activities (substitution effect). On the other hand, employees with an incentive contract tend to have more discretion to choose their work hours. Therefore, they may choose to do the same job in less time and have more spare time for non-work activities (discretion effect). Using data from the European Working Conditions Survey, we show that performance pay has a negative effect on non-work activities and a positive effect on work hours. The substitution effect is negative for men’s leisure activities and for women’s charitable and political activities.