The effect of horizontal pay dispersion on the effectiveness of performance-based incentives

Isabella Grabner, Melissa A. Martin

Publication: Working/Discussion PaperWU Working Paper

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Abstract

In response to general calls for increased transparency in society, pay transparency
policies are growing in importance. Given that pay transparency unavoidably gives employees the
opportunity to make comparisons between themselves and others, in this study we address the
question of how these comparisons impact the incentive effects of performance contingent pay,
and consequently their performance outcomes. Specifically, we empirically examine whether
horizontal pay dispersion alters the effectiveness of performance-based pay contracts, which firms
typically use to incentivize effort. Exploiting our unique access to a large healthcare provider, we
document the moderating role of horizontal pay dispersion on the effectiveness of individual
monetary incentives at generating increased individual performance. To provide a more nuanced
understanding of the moderating effect of pay dispersion, we further examine the boundary
conditions of the proposed interaction. In particular, we examine the differential effect of overall
pay dispersion on employees that rank high versus low in the pay distribution and disaggregate
overall pay dispersion into performance-related versus performance-unrelated pay dispersion. Our
findings consistently show a positive moderating effect of pay dispersion when employees are
more likely to consider the observed pay dispersion as legitimate, and a negative moderation effect
when this is less likely the case. Our study strengthens the understanding of how individual level
incentives function in the context of a multi-person firm setting. Our results document that
individual incentives are effective, but also suggest that pay dispersion can have a significant
influence on the incentive-performance relation. These findings provide some evidence that
individuals are concerned not only with their own payout, but also with that of others, and that this
concern has a significant impact on individual’s effort provision, and consequently performance.
Original languageEnglish
Place of PublicationVienna
PublisherWU Vienna University of Economics and Business
Publication statusPublished - 9 Jan 2020

Publication series

NameDepartment of Strategy and Innovation Working Paper Series
No.06/2020

WU Working Paper Series

  • Department of Strategy and Innovation Working Paper Series

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