A Theory of Optimal Sick Pay

Abstract

Illness significantly reduces worker productivity, yet how employers respond to the possibility of illness and its effects on work performance is not well understood. The 2003 American Productivity Audit pegged the cost to employers of lost productive time due to illness at 225.8 billion US dollars/year. More importantly, 71% of that loss was explained by reduced performance while at work. Studies of worker illness have been up to this point empirical, focused primarily on characteristics which co-vary with worker illness and absenteeism. This paper seeks to understand how employers mitigate the impact of illness on profits through a microeconomic model, elucidating how employers influence workers through salary-based incentives to mitigate its associated costs, providing firms and policy makers with a comprehensive theoretical method for formulating optimal sick pay policies.