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Wednesday July 25, 11:42 am Eastern Time

By Ellen Freilich

NEW YORK, July 25 (Reuters) - Collapsing U.S. stock prices have already shrunk U.S. household wealth, but the sequel to that story could come early next year when Americans collect bonuses that are leaner than they have come to expect.

Some economists think that second shock to household income expectations could dampen consumer spending at the start of 2002, spelling trouble for the U.S. economic recovery. ``A negative shock to household income expectations and confidence around the beginning of 2002 could pose an important roadblock to a sustained acceleration in demand,'' said John Youngdahl, senior economist at Goldman, Sachs & Co.

Variable pay -- through profit sharing, annual bonuses, or stock options -- has become a significant element in U.S. workers' total pay packages, according to WorldatWork, a Scottsdale, Ariz.-based group of human resource specialists, formerly called the American Compensation Association.

The group's 1999-2000 Total Salary Increase Budget Survey found that, of the 2,683 U.S. companies responding to the survey, 63 percent used some kind of variable pay. The proportion of variable pay received increased from 1998 for all categories of employees studied, with salaried employees who are not eligible for overtime being awarded 8.4 percent variable pay compared with 7.9 percent last year, the WorldatWork survey found.

VARIABLE PAY MEETS THE BUSINESS CYCLE

Two years ago, Federal Reserve economists were already studying the variable rate pay phenomenon. In a paper published by the Fed in July 1999, economists David Lebow, Louise Sheiner, Larry Slifman and Martha Starr- McCluer observed pay schemes tying compensation more closely to a company's performance ought to make compensation more flexible over time.

``When business is strong and profits are high, compensation will be higher than it would have been had variable pay been less prevalent:

when business is weak, compensation will be lower than it would otherwise have been,'' the economists said. Bonuses paid at the time of hiring or to retain valued employees in a tight labor market should also wane when the economy weakens and labor shortages ease, the economists said.

VARIABLE PAY DROP COULD HURT RECOVERY

Policymakers hope lower energy prices, Fed rate cuts and the personal income tax rebates, part of a $1.35 trillion tax cut, dropping into

Americans' mailboxes this summer will encourage higher spending and give the year-end holiday shopping season -- and the economy -- a

needed lift.

``The economy has been given rocket fuel,'' said Dana Johnson, managing director and head of research at Banc One Capital Markets. ``It

would be surprising to me if that didn't drive a pretty good recovery before the bonus season.'' But some economists believe U.S. households may face a colder-than-usual, post-holiday financial reckoning early in 2002 when bonuses and other profit or equity-based pay disappoint, putting a fresh constraint on personal spending.

That means the impact on household finances of this year's economic slowdown and corporate profit reversals could stretch well into the first half of 2002, said Youngdahl. Economists expect economic growth to pick up by the end of this year from the paltry levels seen in recent months. The Federal Reserve sees growth in 2002 accelerating up to 3 percent to 3.5 percent, still slower than the 5 percent rate seen in 2000.

Government data used to calculate average hourly earnings of private sector workers now anticipate appreciably larger pay increases during the first four months of each year than was the case five or 10 years ago, Youngdahl said. For instance, the Department of Labor's January to April seasonal adjustment for average hourly earnings was +4.0 percent in 1999-2000. In 1981-1985, it was just +1.8 percent.

This shift in timing of annual compensation reflects the fact that cash bonuses and equity-based pay awards have grown steadily as a proportion of private earnings over recent years. Such payments tend to be distributed early in the year.

The implication of this shift is that after watching the value of their stock portfolios shrink, consumers will feel their pocketbooks pinched again early next year, when bonuses and equity-based pay fall short of previous years. ``Bonuses will be far less generous this year and raises will be skinnier,'' said Mark Elzweig, president of a New York- based investment management search firm bearing his name.

Stephen Roach, chief economist at Morgan Stanley Dean Witter, said flexible compensation awards are likely to turn negative for the first time in seven years because they are driven by two factors -- earnings and share prices. ``Both of these factors have been flashing green for each of the past six years,'' he said. ``Today they are flashing red.'' Thus, rather than adding a full percentage point to real consumption growth, flexible compensation in the first quarter of 2002 could knock

consumption growth down by a full percentage point, Roach said.

'BONUS BABIES' GET READY FOR HARDER TIMES

While economists like Morgan Stanley's Roach and Goldman's Youngdahl believe the shock to household balance sheets and confidence

around the beginning of 2002 could interfere with the economic recovery, some job market experts suggest people who get variable pay are already making adjustments in anticipation of the proverbial rainy day.

``Most people are anticipating smaller bonuses this year,'' Elzweig said. ``They're steeling themselves to cope with the reality of that and hoping the downturn will be short-lived.''