OBJECTIVE: This study examined the relationship of Department of Veterans Affairs disability compensation payments and employment among veterans with psychiatric disorders and veterans whose impairments were nonpsychiatric. METHODS: Data from a 1987-1988 national survey of Vietnam-era veterans (N = 1,634) were used to evaluate the relationship between compensation payments and employment. The employment activity of veterans whose application for benefits was rejected was compared with that of veterans who were awarded benefits. Multivariate analytic techniques were used to control for health status and other factors that also influence an individual's decision to work. RESULTS: Veterans who received compensation of less than $500 a month were no less likely to work than were rejected applicants. Overall, the effect of compensation payment was significant but modest: each additional $100 a month was associated with a 2 percent decline in the number of veterans who worked, a decline of an hour a week in the number of hours worked, and a reduction of $1,000 a year in estimated employment income. No significant differences were observed in the relationship between disability payments and employment among veterans with psychiatric disorders and those with other functional impairments. CONCLUSIONS: The association of disability compensation with nonparticipation in the labor force is generally small, except at high levels of payment, and is no greater for veterans with psychiatric disorders than for those with nonpsychiatric impairments.