I investigate the relationship between bonus payments and firm performance using Hungarian linked employer-employee data. A raw comparison shows that firms paying bonuses to 10 percentage points more of their employees are 3-5 percent more productive. Then, I construct an instrument to estimate the incentive effect of bonus payments. The IV estimates show that the incentive effect of a 10 percentage point increase in the share of employees with bonus payments increases firm productivity by 7-14 percent. Based on these results, I conclude that the raw comparison of firms with and without bonuses underestimates the incentive effects of bonus payments. Furthermore, some firms may have motivations for paying bonuses other than incentivizing employees.
