Does Performance-Based Compensation Boost Economic Growth or Lead to More Income Inequality? Does Performance-Based Compensation Boost Economic Growth or Lead to More Income Inequality?

Recent observations suggest that as performance-related pay has been increasingly used, (i) compensation has grown with labour productivity, and (ii) there has been a rise in income inequality. This study is a theoretical attempt to provide a convincing explanation of these observations. We develop an endogenous growth framework comprising a profit/revenue-sharing scheme that simultaneously governs income inequality and economic growth. Therefore, we show that a share-based scheme can cause the workers to engage in performance pay seeking and, as a result, boost economic growth. Nonetheless, the intensive use of performance pay also results in higher income inequality. Because of the increased use of performance pay, there exists a positive relationship between economic growth and income inequality. While this result contradicts the traditional notion, it is supported by recent empirical studies. Our welfare analysis indicates that a more intensive sharing scheme does not necessarily raise the level of social welfare, even though it is favourable to economic growth. [ABSTRACT FROM AUTHOR]