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Why Your Compensation Strategy Is Likely Backfiring


Wide pay gaps, pay-for-performance and pay secrecy all get in the way of thriving organizations

Construction scaffolding and the yellow sign "$" made of cogs

Today’s news is filled with stories highlighting salary figures, from sky-high CEO compensation packages to boards trying to hide CEO pay increases during periods of austerity, to governments interfering with collective bargaining over wage increases and unions securing pay hikes. 

Some provinces, including Ontario, Alberta and Nova Scotia, are also mandated to release annual sunshine lists of public sector workers who earn above $100,000 — all of which might suggest that higher pay equates to more productive, healthy and safe workplaces. But is this a correct assumption? What if the opposite is true? 

Could certain pay structures — such as wide wage disparities, pay-for-performance systems, pay secrecy and the belief that time equals money — hinder organizations from reaching their primary goals? Current research suggests it’s time to re-evaluate these potential barriers to creating thriving workplaces. 

Barrier: Wide pay dispersion 

Many organizations have significant pay gaps — also known as pay dispersion — between their highest and lowest earners. Pay dispersion is driven by variations in employee skills, performance and market demand, and can be exacerbated by systemic biases like gender and racial discrimination. 

One study, which analyzed nine years of data from 29 Major League Baseball (MLB) teams, found that teams with wider pay gaps had poorer individual and team performances and declining financial metrics such as gate receipts and television revenues.

A study on employees from German firms found that pay gaps led to job dissatisfaction because employees perceived the wage distribution to be unfair. 

Potential alternative: If pay gaps don’t make a positive difference, then what does? One solution was found by organizational psychologist Christian Resick and his colleagues. They demonstrated that transformational leadership by MLB CEOs resulted in higher levels of manager retention, improved team winning percentages and increased fan attendance. 

Barrier: Pay-for-performance 

Many organizations adopt pay-for-performance systems because they believe it highlights the importance of performance. This type of compensation model pays employees, or teams of employees, based on how well they perform their duties. 

A study conducted on industrial plants in the mid-western United States, however, showed that companies using pay-for-performance systems experienced more workdays lost to injuries and had lower labour productivity. Notably, the researchers found that increased training hours over the prior year led to fewer injuries and higher productivity. 

In another study, researchers examined the impact of pay-for-performance systems on mental health. They analyzed the pay data of more than 318,000 employees from 1,309 Danish companies between 1995 and 2006, alongside their medical prescription records. The shift to performance-based pay was associated with an increase in prescriptions for anti-depressants and anxiety medication. These pay structures often led to the departure of employees who were prone to, or currently facing, mental health issues. 

Potential alternative: In sharp contrast, a different analysis of 420,599 people across 63 countries revealed that autonomy had a more positive influence on psychological well-being and anxiety than wealth. In fact, researchers found that wealth only impacted well-being to the extent that it offered individuals more life choices. 

Barrier: “Time is money” 

Pay structures that prioritize the “time is money” concept emphasize direct compensation for hours worked. Examples include hourly wages in retail and manufacturing sectors and billable hours in law firms. Not surprisingly, “time is money” pay structures tend to result in longer working hours and other consequences. 

In this study, participants who were reminded of the “time is money” concept reported higher psychological stress levels, evidenced by a 23 per cent rise in cortisol levels — a known stress biomarker. 

A different study found that workers who were paid hourly volunteered less frequently at work than salaried workers. When participants were reminded of the “time is money” principle, it reinforced an economic-focused mindset, which was identified as the primary obstacle to employees’ volunteer behaviours.

Potential alternative: A relational mindset, grounded in a general orientation to relational information, emphasizes the importance of interpersonal relationships and interactions. In contrast to the “time is money” perspective, a series of four studies showed that promoting this relational mindset resulted in improved ethical behaviour in the workplace. 

Barrier: Pay secrecy 

In many Western societies, pay secrecy is more common than pay transparency. The British royal family — often referred to as “The Firm” — serves as a well-known example of an organization that keeps the salary of the royals themselves hidden from the country. 

Pay secrecy keeps employees in the dark about how much they earn compared to their colleagues and how pay is determined. It also discourages salary discussions among colleagues. 

Across three studies, researchers from the U.S. showed that employees perceive pay secrecy as a deliberate, negative strategy used by their employers, resulting in diminished trust in management. This distrust deepens when companies prevent employees from discussing salaries among themselves. 

Potential alternative: While transitioning to a transparent pay system demands time, effort and money, two benefits stand out. First, companies that transition do not experience a drop in profits since the costs are balanced by declining wage growth for male employees, who were already earning more than their female counterparts. Second, it results in a consistent reduction in the gender pay gap

Other ways to boost performance 

Trying to perfect compensation strategies can be a fool’s errand. As business scholar and organizational consultant Ed Lawler noted almost 30 years ago — a situation that remains largely unchanged today — many organizations invest significant time in giving minimum financial rewards to employees in hopes of improving performance. Lawler found this approach rarely yields substantial positive outcomes. 

But if pay doesn’t help organizations create better workplaces, what does? The keys to a workplace that fosters productivity, health and safety are: high-quality leadership, job autonomy, feelings of belonging and fairness, opportunities for growth, meaningful work and psychologically and physically safe work. 

This doesn’t mean, however, organizations should underpay their employees. While organizations don’t have to be the highest payers in the industry, they should aim to compensate above industry standards to avoid dissatisfaction and other negative consequences. 

Implementing all these facets might seem overwhelming, but they don’t need to be introduced simultaneously. For leaders, the challenge is breaking away from traditional norms. But, grounded in years of studies, they can be confident that even the smallest meaningful changes can result in productive, healthy and safe work. 

Julian Barling is Distinguished Professor and Borden Chair of Leadership at Smith School of Business. He is author, most recently, of Brave New WorkplaceNick Turner is a professor of organizational behaviour and Future Fund Chair in Leadership at University of Calgary’s Haskayne School of Business. Turner completed his PhD at Smith. A version of this essay was first posted on The Conversation.