Compensation can take many forms. Remuneration can come as pecuniary payments, as fringes such as health and pension benefits, or as a nonpecuniary reward such as plush office furniture that costs the firm less than it benefits the worker. A significant literature has examined the trade-offs between pecuniary and nonpecuniary compensation, the modern work having been pioneered by Rosen (1974). More recently, another body of literature has examined the selection of method of total compensation, ignoring the distinction between pecuniary and nonpecuniary payment. This work has focused on risk and incentive factors. It has resulted in comparisons of compensation based on absolute output levels to that based on relative performance.' It has also led to explorations of the relation of compensation to experience over the work life.2 Little attention has been paid to what may be among the most important and obvious distinction in methods of compensation, namely, the choice between a fixed salary for some period of time, that is, paying on the basis of input and Some workers receive compensation that is specified in advance and not directly contingent on performance. Instead, it depends on an input measure, such as hours worked. For others, compensation is directly related to output. This essay is an attempt to predict a firm's choice of compensation method. Piece rates are defined more rigorously. Among the more important factors discussed are worker heterogeneity, incentives, sorting considerations, monitoring costs, and asymmetric information. One result is that salary workers tend to be of lower quality and more homogeneous than are their piece-rate counterparts. Numerous additional results are provided. * Helpful comments by Victoria Lazear and Yoram Weiss are gratefully acknowledged. Support was provided by the Department of Labor and the National Science Foundation. 1. See Lazear and Rosen (1981), Stiglitz (1981), Holmstrom (1982), Green and Stokey (1983). 2. See Lazear (1979, 1981) and Harris and Holmstrom (in press).
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