Performance Measurement and Pay Dispersion

Abstract

Prior research suggests that pay dispersion among employees can cause lower-paid employees to feel unfairly treated and thus lower their effort. Recently, some firms have reduced pay dispersion by raising lower-paid employee’s wages in an attempt to mitigate this effect. However, popular press articles suggest that reducing pay dispersion could also cause higher-paid employees to leave the firm. We conduct a series of experiments to examine the effect of reduced pay dispersion on lower-paid employees’ effort and higher-paid employees’ turnover intentions. In Experiment 1, we find that reducing pay dispersion can increase lower-paid employees’ effort by increasing their perceived pay fairness. We also show that it is the reduction in pay dispersion rather than merely the increase in the lower-paid employees’ wages that yields these results. In Experiment 2, we replicate the results of our first experiment without collecting data on perceptions of pay fairness to ensure that the results of the first experiment were not the result of demand effects. Finally, in Experiment 3 we find that, contrary to concerns expressed in the popular press, higher-paid employees indicate that they are not more likely to leave the firm for a comparable job when lower-paid employees’ wages are increased, and may even be less likely to leave. Our results suggest that firms should consider whether the benefit of increased effort from the lower-paid employees is worth the extra cost they incur by increasing their wages.