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The importance of teacher quality in achieving good educational outcomes for children, and discussing the potential for a well designed compensation contract to improve the performance of teachers

Home Free essays Economics The importance of teacher quality in achieving good educational outcomes for children, and discussing the potential for a well designed compensation contract to improve the performance of teachers



The Importance of Teacher Quality in Achieving Good Educational Outcomes for Children, and Discussing the Potential for a Well-Designed Compensation Contract to Improve the Performance of Teachers

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Institution of Learning

Teacher Compensation Contracts

Teachers, like all other workers, are expected to respond to incentives inherent in compensation structure (Hanushek & Rivkin, 2006, p. 1062). As such, general theories suggest that output-based pay is best used when output is well determined and easily measured (Lazear, 2003, p. 179). Performance-related pay is a possible tool for the improvements of productivity and accountability of the public sector (Hasnain, Manning, & Pierskalla, 2012, p. 1). The idea of performance-based salaries is well thought out. If people work harder and more efficiently, they will be able to make more money (Lazear, 2003, p. 179). Encouragement of employee effort is a central issue in personnel economics, and, as with much of economics, has lots of benefits (Lazear & Oyer, 2013, p. 480).

There exists a strong link between the fixed base salary and workers participation constraint. In fact, it is possible to set a base salary to meet this constraint and let the worker keep all the marginal fruits of his effort. It practically means that the worker will actually pay the firm for the right to work there (Lazear & Oyer, 2013, p. 482). Relative performance evaluation will vary from a group of people competing for a single promotion to a large set of prizes that diminish in value as a persons relative performance diminishes (Lazear & Oyer, 2013, pp. 484-485). In the absence of incentive issues and any firm-specific productivity, the compensation will be just enough to keep employees from leaving the firm (Lazear & Oyer, 2013, p. 498).

Contract theory suggests that performance-based pay can help address the problem of adverse selection by encouraging high ability individuals and discouraging low ability individuals (Hasnain, Manning, & Pierskalla, 2012, p. 2). According to the contact, a fixed wage will be a form of periodic payment from an employer to an employee. Employment contracts usually specify wages with little or no importance given to incentives (Holmstrom & Milgrom, 1991, p. 24). The good performance can be rewarded through a variety of mechanisms, including increases in base salary, subjectively determined bonus payments, or promotions (Lazear & Oyer, 2013, p. 483). Mortensen and Vishwanaths model on personal shows proposes that the wage offered by the employer will be higher if the employee applies for the position through the contract. In this case, the wage will be determined by information signals and contract probability. Accordingly, it means that if the agent is hired through a contract, the amount of effort to be put into the task will be much higher (Holmstrom & Milgrom, 1991, p. 24). In situations when effort is unobservable, fixed pay contracts provide little ability for employers to influence employee effort. Individual rewards are a good method to create the clear plan for the employee, and a way to define what is expected of this employee. Individual motivation is considered as a stronger motivational factor than a compensation of a group level. Individual reward creates healthy competition at the work-place. Subjective evaluation is subject to the evaluators various personal biases, and the feedback from them is often vague and uninformative (Gibbs, Merchant, Van Der Stede, & Vargus, 2005, p. 27). Particularly important is a significant level of trust between the employees and their supervisors. The supervisors subjective assessment may be done in not a far manner, as supervisors incentives depend on the employees performance. Moreover, when evaluations are subjective, some employees may attempt to inappropriately influence or unduly swat supervisors to obtain better evaluations. Obviously, this will cause incentive for supervisor to evaluate subordinates generously as it directly affects their bonus (Gibbs, Merchant, Van Der Stede, & Vargus, 2005, p. 31).

It was estimated that teachers with performance-based pay have around 35% more students than those with fixed pay. The systemic observational studies and experimental evaluations have generally found that explicit performance standards are linked to the form of bonus incentives. Bonus incentive schemes can improve, sometimes dramatically, desired services outcomes. As a matter of fact, 46 of the 68 high quality studies of craft and coping jobs showed a positive effect of performance-related pay (Hasnain, Manning, & Pierskalla, 2012, p. 2). All teachers in a school are able to earn bonuses of the overall performance of students of their school surpassed the targets (Neal, 2001, p. 17). Bonus schemes should not be expected to work well unless they are a part of a larger incentive system that provides incentives for those who make subjective performance evaluations in order to make these evaluations accurately (Neal, 2001, p. 44). The bonus scheme is known to work on a very high level. Taking into consideration Brazil bonus incentives scheme, it shows that the bonuses paid under that scheme were very large and amounted over 50% of the annual salary (Kahn, Emilson, & Ziliak, 2001). Recent studies showed the substantial evidence in favour of two positions; teachers quality is an important determinant of students achievement and the teachers aptitude declined substantially over the past generations. The study concludes that the one and only effective way how the teachers quality might be improved us through altering the pay structure by the bonus incentive schemes (Leigh, 2012, p. 41). Dolton and Gutierrez (2011) showed that higher teacher salaries are associated with better test results. The connection between the salaries of teacher aptitude is positive and essential; a 1% increase in teachers payment is linked with about a 0.6-point rise in the medium percentage rank (Dolton & Gutierrez, 2011, p. 34).

The optimal compensation contract should be written in a clear and specific language. All the terms are to be defined and provide the clear payment calculation. It has to indicate position title, all compensations, vacations, benefits and performance reviews. The compensation services will be the subject to the statutory deductions by the employer. The optimal contract will consider an employer taking a risk-averse employee.

The expected payoff E (

E (image1.png ) + eH +(1-e)L – (w + eb) – 1/2pa2,

where e is effort expected by the agent, H and L are the two possible output values (High and low; H>L), w is the base salary, b is a bonus paid to the agent in case the output is high, p>0 is a cost parameter. Finally, a denotes the attention given to the agent. The probability that output is high is increasing in the teachers effort. The expected utility is

E(U) = w + eb + yea – 1/2?e2,

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where the first two terms are the expected income and the last term represents the cost of efforts. The marginal costs of effort are decreasing and the workers well-being is increasing in the attempting given by the principal. Y is the agents reciprocity parameter. The salary and bonuses provided are to be a review on the annual basis. Such an evaluation can affect different management actions, including job assignments, promotions, bonuses, and performance interventions (Gibbs, Merchant, Van Der Stede, & Vargus, 2005, p. 26).

However, bonuses may cause the Ratchet effect, which occurs when price or wage increases as a result of temporary pressure. On the other hand, it fails to fall back when the pressure is removed. The substantial ratchet effect is observed in the absence of competition, which is nearly eliminated when the competition is introduced (Holstrom & Milgrom, 1991). The efforts of workers might be allocated. Effort is homogeneous, and it can be allocated among the tasks in which way the employee likes. For example, if one task (quality) is important, but hard to measure, then adopting the incentive wage in the other easy-to-measure task (speed) will drive the employee to pay all efforts on the easy-to-measure one and neglect the hard-of-measure one (Holmstrom & Milgrom, 1991, p. 25).

It was analyzed that performance-based salary has a strong influence on the quality of teaching. The teachers quality is the key to improved schools. Recent studies of pay-for-performance incentives for teachers in Israel indicate that both group-based and individual-based incentive have positive effects on students test scores and that individual-based incentives may be more cost-effective (Rockoff, 2004). The empirical evidence shows that raising teacher quality may be a key instrument in improvement of students outcome. It became obvious that policies, which focus on recruiting and retaining teachers with particular credentials, are less effective than policies that reward teachers based on performance. It was also estimated that there is a direct impact of teacher pay on student outcome. The empirical evidence shows that higher students test results are associated with higher teachers salaries (Leigh, 2012, p. 43). If the pay is increased, employees will be more motivated to perform a better job.


Background reading

Gibbs, M., Merchant, K. A., Van der Stede, W., & Vargus, M. (2005). The benefits of evaluating performance subjectivity. Performance Improvements (44), 26-32.

Hanushek, E. A., & Rivkin, S. G. (2006). Teacher quality. Handbook of the Economics of Education (2), 1051-1078.

Hasnain, Z., Manning, N., & Pierskalla, J. H. (2012). Performance-related pay in the public sector: A review of theory and evidence. World Bank. Policy Reseach Working Paper (4.6043), 1-40.

Holmstrom, B., & Milgrom, P. (1991). Multitask principal-agent analyses: Incentive contracts, asset ownership and job design. Journal of Laws, Economics and Organization (7), 24-52.

Kahn, C. M., Emilson, S., & Ziliak, J. P. (2001). Performance-based wages in tax collection: The Brazillian tax collection reform and its effects. The Economic Journal (111.468), 188-205.

Lazear, E. P. (2003). Teacher incentives. Swedish Economic Policy Review (10), 179-214.

Lazear, E., & Oyer, P. (2013). Personnel economics. In Robert Gibbons and John Roberts (Eds.), Handbook of organizational economics (pp. 479-519). New Jersey: Princeton University Press.

Neal, D. (2001).The design of performance pay in education. Handbook of the Economics Education (4), 495-550.

Empirical evidence

Dolton, P., & Mercenaro-Gutierre, O. (2011). If you pay peanuts do you get moneys? A cross-country analysis of teacher pay and pupil performance. Economic Policy (26.65), 5-55.

Leigh, A. (2012). Teacher pay and teacher aptitude. Economic of Education Review (31), 41-53.

Rockoff, J. E. (2004). The impact of individual teachers on student achevement: Evidence from panel data. The American Economic Review (94.2), 247-252.


Current paper analyzes the current situation concerning the fixed-based salaries and performance based salaries. The paper shows that there is a strong possibility of implementing a performance-based salary, as it shows many benefits for both sides.

It was estimated that teachers with fixed-based salaries are less interested in stimulating students to provide better results rather than teachers who are working according to the pay-for-performance scheme. The work showed that there is a strong link between the fixed wages and the participation constraint. The introduction of the performance-based payments provokes more efforts from the employees side. The paper shows a number of various empirical studies, which prove the effectiveness of bonus incentive schemes. Therefore, they show the interconnection between the performance-based salaries of teachers and the higher test results of students. The paper also provides the optimal incentive contract, which pays attention to possible outcomes, bonuses and the attention paid to the agent. The contract confirms that the outcome and the attention dedicated are interconnected. Moreover, there are a pros and cons of the scheme when the individual rewards are higher than group rewards. Despite the fact that individual rewards motivate employees more than team rewards, there is the strong subjectivity concerning supervisors. Supervisors salaries depend on the employees performance and salaries that is why they are interested in the high salaries of their employees. Moreover, high salaries and cap wages may cause Ratchet effect, which occurs when the wages increase as the result of temporary pressure and fails fall back when the pressure diminishes. Nevertheless, the efforts might be allocated from the internal to external. The allocation helps to provide higher productivity and payoff, as the effort, which cannot be evaluated are substituted by those that are easily estimated.

The general performance of teachers may be improved with the usage of pay-for-performance scheme, and it will definitely help to achieve better educational outcome for learners.

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