The dangers of implementing a merit pay practice
Merit pay refers to the process of distributing employee pay increases, based on how well each employee performs at work – often determined by supervisory performance appraisal.
Despite the overall popularity of merit pay practices and wide support for the principle of paying for individual performance, merit pay seems to often be ineffective in producing the desired outcomes, such as enhanced motivation and productivity.
Thus, most employees like the idea of being compensated based on their performance, but are often suspicious about whether a merit pay system has any motivational value in practice because of the numerous implementation problems.
The implementation of merit pay programmes can suffer from numerous barriers related to the performance assessment and pay allocation that may impede its intended usefulness. Both the subjective nature of performance appraisals and the use of those appraisals for administrative purposes (such as pay and promotion) can facilitate different forms of bias in performance appraisal, which results in inaccurate ratings.
These biases in performance appraisal, as well as biased pay allocations, can be viewed as violations of organizational justice, and/or as forms of organizational politics.
Organizational politics has the potential to have widespread impact on the effectiveness and efficiency of organizations through various organizational processes, such as performance appraisal, resource allocation, and managerial decision-making.
The vast majority of research on organizational politics views it as a negative phenomenon, arguing that perceptions of organizational politics stimulate negative, anxiety-provoking reactions. According to recent studies, a high level of perceptions of politics is negatively associated with job satisfaction and organizational commitment, and positively related to job stress and turnover intentions. However, organizational politics is necessary for the survival of the organization and those who operate in them, and can sometimes be perceived to be benefiting the organization as a whole.
In merit pay systems, political behaviour can enter into the performance appraisal conducted by the immediate supervisor. When conducting the performance appraisal, the supervisor may take into account its impact on many factors, such as his or her own reputation, the motivation of an individual, group dynamics, and the pay budget. In addition, politics can also enter into the actual decisions on pay. The performance appraisal scores and the level of raises are not always directly linked. In such situations, the immediate supervisor does not make the final pay decisions, but rather they are made at higher levels.
Politics in performance appraisal
When supervisors believe that appraisals are used for administrative decisions, such as promotion and pay raises, they tend to pay more attention to the performance appraisal process. Heightened attention does not, however, guarantee increased accuracy in the performance appraisals.
Performance appraisals can be considered goal-directed behaviour, where a range of characters of individuals, organizations, and performance measurement systems lead raters to adopt different sets of goals when completing a performance appraisal. When raters complete performance appraisals, they have specific goals in mind, and intend to provide ratings that are consistent with these goals. This means that raters who pursue different goals when completing performance appraisals tend to give different ratings, even when they have observed the same performance.
Adoption of a merit pay practice where performance appraisals are used as a basis for compensation decisions often enhance the (reward) power of the immediate supervisors. However, the use of performance appraisals as a basis for pay decisions can be of concern because their subjective nature presents threats to the accuracy of those appraisals, such as those stemming from affective influences, liking, and favouritism.
“… it is dangerous to implement a merit pay practice if employees perceive appraisals are based on favouritism, and pay decisions are based on political agendas.”
Viewing favouritism as a goal-directed behaviour, one could presuppose that it is likely to enter into performance appraisals especially when supervisors are motivated to protect and/or enhance their self-interests. Supervisors are likely to deliberately distort the performance appraisal scores when they have a high need for power, they are high in Machiavellianism, have low self-efficacy, are not highly committed to the organization, and purport to gain control over organizational behaviour and resources.
This, in the context of merit pay systems, can mean that supervisors ensure high performance appraisal scores for those employees they are dependent on. Thus, from the supervisor's perspective, favouritism in performance appraisals might facilitate the retention of those employees they consider the most important resources. However, generally from the subordinate's perspective, these “affective motives” present uncertain and even ineffective leadership.
Politics and fairness
A merit pay system can be considered an organizational intervention that stimulates a social marketplace, where individuals engage in several transactions to obtain a favourable return for their investment.
Merit pay creates competitions where some win (i.e. get merit increases) and some lose (i.e. don't get increases). In a highly political environment the effect of unfair pay might be emphasized. As the outcome of this competition becomes salient, those who lose, are likely to experience an even more pronounced effect from politics if they do not get a favourable return on their investment. Thus, if the employees perceive that they did not get what they deserved, they are likely to perceive that the pay system is ineffective to motivate them to achieve organizational objectives. Conversely, in situations where the employees feel they personally benefited from the situation, the association between organizational politics and pay system effectiveness may be attenuated.
Employee perception of pay system effectiveness
According to results of a study of three organizations in the central government in Finland, the higher levels of politics employees perceived in pay decision-making, the less effective the pay system was perceived in achieving its objectives. Also a high level of favouritism in performance appraisal was related to low levels of pay system effectiveness, as expected.
Taken as a whole, the results of this study suggest that some forms of organizational politics might be perceived as more detrimental than others, and that employee perceptions of pay system effectiveness depends on both politics and fairness. Individuals who perceive their organizational environments to be highly political engage in political behaviour as a mechanism of control through which their situation is made “more bearable”. Furthermore, it is possible that in a highly political environment only those employees that behave politically “win” and get pay raises.
On the whole, it is dangerous to implement a merit pay practice if employees perceive appraisals are based on favouritism, and pay decisions are based on political agendas. If employees feel that the pay decisions are based on politics instead of their performance, they are likely to become cynical as to whether the pay system would promote positive outcomes such as productivity and employee developmental opportunities.
The beliefs of an uneven social exchange can further lead to a range of unfavourable employee attitudes and behaviours, such as decreased helping behaviour and performance as well as increased employee turnover.
This is a shortened version of “Perceptions of politics and fairness in merit pay”, which originally appeared in Journal of Managerial Psychology, Volume 25 Number 3, 2010.
The authors are Aino Salimäki and Sini Jämsén.