Why would the Corporation carry on a switch in the compensation scheme of its workers? Define “ε” as the outputlevel chosen by the worker and observed by the firm which depends on his ability (A) and Effort (X). In the hourly wages scheme, the firm sets a minimum level of output per hour (εₒ) anda corresponding wage. Xₒ(A) then, is the minimum level of effort necessary to satisfy the minimum level of output required (εₒ).
εₒ= ʄ (Xₒ(A) , A) ; and by taking the FOC we knowthat “higher-ability” individuals need to exert less effort in order to achieve εₒ. All workers with A > Aₒ will accept the job because they are earning rents from an employment wherethey are not giving a 100% of their potential effort (Rents are higher for those with higher abilities as able ones accomplish the task more easily)
This setting seems quiteacceptable for both parties (Company and worker) but in reality competition plays a fundamental role and workers with higher abilities may find it more attractive to work elsewhere afterhaving compared earnings among companies. Higher ability workers are more likely to perceive straight hourly wage jobs not as attractive as an alternative that demands more but pays moreas well.
This is when the company will decide to introduce a new compensation method (piece rates) in order to retain these higher-ability workers in the firm. For these, Aₒ