When Changing from Merit Pay to Variable/Bonus Pay: What Do Employees Want?

Abstract

This study examines potential responses to a change in an employee reward system from permanent merit pay increases to one-time bonus payments. Removing long term risks associated with escalating pay is an increasingly common compensation strategy. Often overlooked, however, are employee perceptions of reward fairness under such conditions of change. Receiving lump sum payments in lieu of permanent merit pay increase may de-motivate employees. There has been little or no research conducted on this topic. In this study, using samples of practicing HR managers and university students, an equity questionnaire gathered data on the perceived equivalence between a permanent merit pay increase and what might be demanded by employees as a single payment in its replacement. An analysis of the data collected indicate an approximate 1:2 ratio is needed, such that a proposed lump-sum payment of $2400 would be perceived as a fair replacement for a permanent merit pay allocation of $1200 per year. Our research indicates that this 1:2 ratio holds for both high and low job satisfaction levels.