Flexible Wage Contracts, Temporary Jobs, and Firm Performance: Evidence From Italian Firms

• DOI: http://doi.org/10.1111/irel.12031
• Date: 01 July 2013
• Published date: 01 July 2013
• Author: Michele Battisti,Giovanna Vallanti

Flexible Wage Contracts, Temporary Jobs, and

Firm Performance: Evidence From Italian Firms

MICHELE BATTISTI and GIOVANNA VALLANTI*

This study focuses on the effects of decentralized wage schemes and temporary

forms of employment on firm performance. The effect of monetary incentives on

workers’effort and firm performance is a central topic in economics. According

to the principal-agent paradigm, firms (the principal) have to link employees’

remuneration schemes to any verifiable indicator of performance to avoid oppor-

tunistic behavior. The empirical evidence shows that financial incentives have the

potential to exert strong effects on indicators of firm performance, such as produc-

tivity and worker absenteeism, although the degree of effectiveness of such

schemes varies significantly according to the institutional/economic context in

which firms operate. From both a theoretical and empirical point of view, the pre-

diction on the effects of temporary types of employment on effort and productiv-

ity is less neat. In light of these considerations, this study uses a sample of Italian

firms to provide further empirical evidence on whether and to what extent perfor-

mance-related pay schemes and contract flexibility affect workers’effort (in terms

of absenteeism) and, in turn, firm productivity. These effects are analyzed for dif-

ferent types of workers (white collar vs. blue collar), working in workplaces char-

acterized by a different degree of uncertainty and risk and in firms operating in

different economic and institutional settings. Our results show that wage flexi-

bility has a significant effect on effort and then on firm’s productivity and that

white-collar workers are more responsive to monetary incentives than blue-collar

workers. Moreover, the presence of a large share of temporary contracts, implying

a lower dismissal probability for permanent workers and a deterioration of the

working environment, appears to reduce workers’motivation and effort.

Introduction

THE LAST TWO DECADES HAVE WITNESSED A SIGNIFICANT INCREASE IN THE LABOR

MARKET flexibility in all European countries. Rigidities in the labor market are

* The authors’affiliations are, respectively, University of Palermo, LUISS Guido Carli and RCEA,

Palermo, Italy. Email: mbattisti@luiss.it; Department of Economics and Finance and LLEE, University

LUISS “Guido Carli,”Rome, Italy. Email: gvallanti@luiss.it. We wish to thank Massimo Egidi, Francesca

Mazzolari, and all the participants of the IAB workshop Labour Market Flexibility: Boon or Bane?

—Nurmberg, 18–19 March.

INDUSTRIAL RELATIONS, Vol. 52, No. 3 (July 2013). ©2013 Regents of the University of California

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considered by the most debated strand of macroeconomic literature among the

key causes of the poor performance of the labor market both in terms of par-

ticipation and employment (among others Blanchard and Wolfers 2000;

Burgess, Lane, and Stevens 2000; Siebert 1997). In this study, we are inter-

ested in an empirical assessment of the effects of flexibility on firm productiv-

ity through workers’performance, which depends on a number of components

such as effort (one of its dimensions being absenteeism), worker cooperation,

and so on. In particular, we will focus on two forms of flexibility commonly

identified by the literature: external (numerical) flexibility and wage (financial)

flexibility.

1

The former is related to the capacity of the firm to adjust its work-

force to changes in the economic conditions and depends on the strictness of

employment protection legislation and the availability of temporary forms of

employment, while the latter concerns the responsiveness of wages to external

shocks and changes in internal productivity and largely depends on the fea-

tures of the wage setting institutions.

Temporary employment has grown in a number of OECD countries during

the past two decades raising concerns that temporary jobs may be crowding

out more stable forms of employment, becoming an additional source of inse-

curity for workers. From a theoretical and empirical point of view, the effects

of temporary forms of employment on productivity are ambiguous and depend

mainly on the reasons why employers use them. For instance, Boeri and

Garibaldi (2007) find a positive temporary effect on employment and a perma-

nent negative effect on productivity, while other authors (see for example Ichi-

no and Riphahn 2005) find a positive impact when temporary jobs have a high

probability to be transformed into permanent ones after the probation period.

Generally speaking, the use of temporary workers as buffer stocks increases

job instability and uncertainty inside the firm, reduces investment in training,

lowers workplace cooperation and workers’motivations, and harms long-run

growth prospects (Blanchard and Landier 2002). On the contrary, temporary

contracts used as screening devices generate better growth prospects due to

better learning about the quality of the match and lower incentive to shirking

for temporary workers. This may translate into better job matches and, there-

fore, more stable employer–employee relationships in the long run (Portugal

and Varejao 2009).

Considering the second dimension of flexibility, there is a large theoretical

and empirical literature on the effects of wage incentive schemes on effort and

productivity. The efficiency wage theory in the eliciting effort version (Shapiro

and Stiglitz 1984; Solow 1979) shows that firms pay higher salary to motivate

1

For a detailed classification of labor market flexibility see Beatson (1995).

738 / MICHELE BATTISTI AND GIOVANNA VALLANTI