Business Psychology - Latest Findings

Article No. 217
Business Practice Findings, by James Larsen, Ph.D.

Sharing the Wealth

Researcher investigates the effects of two popular pay plans on performance.

We're going to revisit an old debate on pay, and then I'm going to ask your opinion. Next, I'm going to describe a recent study that supported one position in this debate, and finally, you're going to find out if your position matches the one found to be best. Here goes:

The debate concerns the dispersion of wages and salaries in a company. For example, in some companies the highest-paid person makes 200 times the compensation as the lowest-paid person. In other companies, the highest-paid person only makes 6 times the compensation as the lowest-paid person. The former pay dispersion system is steep or hierarchial. The latter system is flat or egalitarian.

Which system leads to superior employee performance? Which leads to superior firm performance? Which leads to the greatest creation of wealth - the greatest monetary value of the firm as a whole?

If you're inclined to favor a steep hierarchial system, then these arguments support your position:

Pay motivates performance. In order to induce enough effort to produce high performance, pay levels must differ enough to reflect differences in contribution, diligence, knowledge, skill, and training. Individuals also must see a monetary inducement to prepare for and fulfill more demanding and exacting kinds of work. They also need these inducements to be attracted to a particular firm. Finally, increasing pay with increases in performance creates a positive pay-performance link and thereby allows employers to reliably buy superior performance with their salary dollars.

These arguments sound convincing, but read on.

If you're inclined to favor a flat or egalitarian pay dispersion system, then these arguments support your position:

When the pay dispersion is egalitarian, greater emphasis is placed on cooperation and group performance. Employees have a greater sense of a common fate, and the overall importance of pay diminishes. Egalitarian pay enhances feelings of fairness and justice, common purpose, and teamwork. Management goals are more likely to be accepted because employees feel less exploited.

Egalitarian pay dispersions may fail to attract top quality people, and they may fail to hold these people, but these detriments are offset by their positive effects on cooperative effort.

A hierarchial pay system will have a preponderance of lower-end employees who will be inclined to act out their resentments in destructive ways. They may sabotage the work of others to prevent their success, and they may work toward personal goals that are contrary to company goals.

Now, given all these persuasive arguments, choose one position in the debate.

Matt Bloom, from Notre Dame, analyzed the pay dispersions and the performance of professional baseball players and their teams for the years 1985 to 1993. Bloom asked three questions: 1) Which pay dispersion leads to the best overall performance of individuals? 2) Is there a difference in individual performance depending upon one's position in the pay hierarchy, high verses low? and 3) Which pay dispersion leads to the best overall firm performance?

Overall, individual performance was best when players were paid in an egalitarian pay dispersion system. Every measure pointed to the same conclusion, and that's an impressive finding. There was a slight difference in performance according to the position of the player in the salary hierarchy. Higher-paid players did perform somewhat better than lower-paid players, but the differences weren't large enough to justify their high salaries.

All the measures of team performance, both in terms of competitive team performance and financial performance as a business enterprise, pointed to the superiority of a flat, egalitarian pay dispersal system, including wealth creation. Teams using these pay systems made more money and had a higher value as a business. This, too, is an impressive finding.

You made a guess about the best system at the beginning of this article. Were you right?

Reference: Bloom, Matt (1999) The Performance Effects of Pay Dispersion on Individuals and Organizations. Academy of Management Journal, 42 (1), 25-40.

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