We develop a wage determination model in which a firm decides the pattern of compensation schemes, as well as offering a sequence of ontracts for her heterogeneous employees. Based on the theoretical analysis, we set up a random-effects regression model to explore and compare the wage determination under perform-pay and non-performance-pay jobs. Using data from the Panel Study of Family Dynamics in Taiwan, we find that firms employ high-ability workers and offer high returns to workers' ability on performance-pay jobs. We also show that the pervasive distribution of workers' ability generates higher inequality of earnings under performance-pay than non-performance-pay scheme. This implies that a shift in compensation scheme away from non-performance pay toward performance-pay will lead to an increase in wage inequality.
