Profit Related Pay and the U.K. Small Firm Labour Market

Abstract

This paper critically examines the relevance of profit related pay (PRP) for the U.K. small firm sector. Since 1986, the U.K. government has actively encouraged PRP, which attracts generous tax breaks, because it believed that PRP would make pay more flexible downwards and would significantly improve employee identification, morale and productivity. An analysis of the theoretical arguments and the assumptions made regarding the nature of the U.K. small firm sector that underlay these claims suggests, however, that the likelihood of achieving either of these alleged benefits is small. An appraisal of the available empirical evidence on the practical implementation and operation of PRP schemes suggests that the tax relief simply encourages firms to introduce ‘cosmetic’ schemes that have no appreciable impact upon the behaviour of either firms or employees. Moreover, the experience of some firms that adopted PRP schemes indicates that, far from increasing morale and productivity, PRP often creates new tensions and conflict between owners and employees. These and other unintended consequences illustrate the inherent difficulties of government attempts to use the tax system to alter the behaviour of agents engaged in a wide variety of complex and very heterogeneous bargaining situations.