Performance-Based Compensation in Professional Service Firms

Abstract

The purpose of this paper is to extend our understanding of theoretical agency considerations in the choice of compensation contracts by examining the use of performance-based compensation in professional service firms. We focus on compensation practices for physicians in medical group practices because this setting has several distinctive features that enhance our ability to study a wide variety of agency issues. Our sample covers 16,659 individual physicians in 778 practices. Consistent with agency theory, we find that the extent to which individual physicians are compensated using performance-based pay increases with the informativeness of standard clinical productivity measures. Monitoring serves as substitutes for performance-based compensation, but only in member-owned firms. The use of a common salary/bonus mix for all physicians is greater in smaller practices with little diversity in practice specialties. Member-owned firms also tend to use a common compensation mix when surgeons represent a greater proportion of members and when physicians staff hospitals, but tend to tailor the mix when there is greater variation in physician experience and in the amount of time physicians spend on non-clinical activities. Finally, equal-share arrangements tend to be used instead of salaries and/or bonuses in more technical practices where physicians have similar specialties and experience levels.