Does pay for performance work in public organizations? Empirical evidence from Italy

The purpose of the paper is to investigate the relationship between pay-for-performance compensation and organisational performance in the setting of Italian local governments. Pay-for-performance systems have been introduced in the majority of the OECD’s countries as part of their performance management systems, but research on their effects is still in its infancy. This study contributes to filling this gap by using a sample of Italian local governments to empirically determine whether variable compensation translates into higher future performance. The research methodology uses a unique hand-collected database. The study uses the measures of the local governments’ performance defined along six key dimensions (standard of living, services and environment, employment level, law and order, population, leisure), over the period 2010-2013, provided by an independent source. Detailed data on managers’ compensation for each local government is obtained from Italy’s Treasury Department, and other variables on local governments were hand collected by official documents. A multivariate analysis is conducted on 398 observations. The main results show a positive association between future performance and the percentage of variable compensation granted to local managers. Moreover, additional analyses show that this result is not driven by managers’ total compensation but it depends on the composition of managers’ compensation. Overall, empirical evidence reported in this study suggests that public organisations might benefit from the introduction of pay for performance systems.