Loyola University Chicago

From the SelectedWorks of Dow Scott

1987

Tracking the merit of merit payF S HillsR M MadiganDow Scott, Loyola University ChicagoS E Markham

Available at: https://works.bepress.com/dow_scott/23/

It is surprising that little serious attentionhas been given to auditing merit pay programs.Salary increase budgets have avengedovet 6.5percent of base payroll the past three years, andin recent years of high inflation the percentageoften has reached double digits. Expenditures ofthis magnitude need to be closely scrutinized,particularly in labor intensive organizationswhere the return on salarv dollars can be vial.

Merit payIf you ask salary administrators from 10companies with merit pay progmms to define it,you are likely to get 10 different definitions.Merit plans differ in the definition andmeasurement of "merit," the strength of the linkbetween pay and performance, the timing ofmerit increases, and the relationship of merit toseniority, inflation, or other pay criteria. Theterm "merit pay program" here is usedgenerically to refer to programs in whichincreases in base pay for specific individuals(excluding increases associated withpromotions) are gearcd to the performanceassessment of those individuals for a specifiedtime period.

'We are

not talking aboutgeneral, across-the-board increases, ofany monetary incen-t ive that does notpermanently increasethe employee's basepay, such as a one-timebonus.

Merit pay plansseldom establish payincrease decis ionssolely on perform-ance. For example,salary structures aregenerally not open-ended. A maximumpay level is specifiedfor each position, andprogression upwardthrough the pay rzrrgeis l inked to per-formance until theceiling is reached. Inpractice, most organi-zations pare the size ofincreases as pay ratesmove through the tophalf of the salaryrange. Thus, bothperformance level andposition in the salaryinf luence "meri t "

decisions. In effect, merit increases becomea function of both performance and iobtenure.

Furthermore, many otganizationsimplicitly recognize seniority or inflationarypressures by granting minimum increases to allemployees out of their merit budget. Obviouslythis practice affects an organization's ability toreflect performance differences in pay increases.The link between pay and performance isweakened, hence the probability of influencingindividual performance through merit increasesis reduced. This is not to suggest that audits ofthis type of meritprogmms are inappropriate orunnecessary. On the contrary, the probability ofan ineffective program is higher in suchsituations, making it even more imporant formanagement to evaluate the program.

Merit pay goalsW'hat's the point of merit Pay?

The initial answer to this question isstraightforward - to motivate high levels ofperformance. Merit pay functions as ?"catrot"to shape the job performance of employees. The

Pbato: Bob Dolla'rd aSSumptiOn iS thatemployees respond tomonetary rewards. Aprimary purpose ofarry merit pay auditis to test thisassumption.

Pay actions send apowerful message toemployees. Amongother things, theyconvey displeasurewith an employee'sperformance or signalpromotion potential.He nce, merit payplans provide a meansto influence employ-ee's decisions to stayor leave as well as toput forth future effort.By communicatingdesired messages tovalued employees,merit p4/ can imProvethe otganization'sability to retain topperformers. As aresult, a second goalof most merit pzyprograms is to reducedysfunctional turn-over. The extent towhich the merit pay

52 PTnSOiIIUN ADMIMSTRATOR

tests. In all cases, the purpose is to determinewhether higher performers actually receivelarger merit increases (percenage).

However, the relationship between pay andperformance is seldom this simple. Seniority orposition in the rarrge could legitimatelyinfluence the size of pay increases. Additionally,pay actions could be affected by factors, notincluded in poliry, thatarc actually illegal (e.9.,race, age, gender). The task facing theevaluator(s) is to determine to what degree payactions are affected by these other factors. Thequality of any audit of merit pay distributionsdepends upon how well this problem ishandled.

The problem of multiple criteria for payincreases can be addressed singly or incombination. First, the employee populationcan be subdivided into categories that aresimilar with respect to one or more of thefactors. For orample, if the size of merit increasesis also affected by the employees position in thesalary range, the overall distribution of payincreases should be broken down into salary-range categories, (i.e. upper 25 percent, 25percent above mid-point, 25 percent justbelow midpoint andthe bottom?5 percentof a szlary range). Aseparate analysis canthen be conducted foreach category. Thisprocedure isolates theeffect of performancedifferences on payincreases. It should benoted here that therelationship betweenperformance level andpercent of meri tincrease can also bedescribed statisticallyby the correlationcoefficient whichprovides an index ofthe strength ofrelat ionships. In a"pure" merit plan, thecoefficient theoret-ically should ap-proach 1.0. To thedegree it is lower,factors other thanmerit are enteringintowage deterrninationdecisions.

Second, the ef-fects of various factors

can be controlled and estimated statisticallyusing multiple regression. In this approach, theunique effect of various determinants of meritpay canbe estimated.2 For example, the auditorcould simultaneously assess the effect ofperformance, seniority and job tenure on thesize of pay increases. Use of regression analysishas been greatly faciliated by the developmentof numerous applications programs for wageand salary analysis on microcomputers.However, unless the auditors are well-groundedin regression analysis, experts should beconsulted regarding preparation andinterpretation of the analysis.

The specific analyses of meritpay increasesthat can or should be conducted in an audit ofmerit pay practices will depend upon factorssuch as the goals of the program, the size anddiversity of the employee groups, the number ofadministrative units and the availability of data.In most cases, audits of merit pay increasesshould include analyses of the folowing t]pes:

1. The distribution of p^y increasepercentages within each performance level, i.e.high performers, moderate performers and low

pboto: Bob Doil,ard performers. If iobtenure or position inthe salary range alsoinfluences the size ofincreases, subgroupandyses (or multipleregression) wil l benecessary as notedabove.

2. The avetagepay increase per-centage by race andgender within eachperformance ratingcategory. If seniorityor other factors alsoinfluence the relativesize of pay increases,they must also beinclude d. Mult ip leregression is particu-larly useful for thistype of check fordiscrimination.

3. The ^ver"gep^y increase bysupervisor within eachperformance category.This andysis shouldcompare increasesgiven by supervisorswithin and betweenorganizational units.Inconsistency among

54 PnnsonNn ADMIMSTRATOR

he measure ofindiuidual "merit"

or perfonnance is tbecritical cornponent of

any ftterit systeftr.

supervisors in their interpretat ion andapplication of merit program guidelines andprocedures is a common problem in meritsystems. For example, a performance ratingscore of 4 might result in a 5 percent raise onone department but only 3 percent in anotherdepartment. If consistency between supervisorsin performance ratings is also a problem, theperformance rating within departments mayneed to be standardized before polling themacross managers. This may be done manually orwith sophisticated statistical techniques, such as\fithin and Between Analysis of Variance.r

4. The distribution of performance levelsby range-position. This analysis provides asnapshot of the relation-ship between salary leveland performance level.In general, one wouldexpect to find higherperformance levels in theupper reaches of thesalary range. The analysiscan be further refined byconsidering seniority,education or any otherfactor likely to affect therelat ive level of anemployee's pay.

5. Theperformancerating and merit increasehistory of promotedemployees. If "merit"

For example, a common weakness of meritplans is the unwillingness of supervisors todifferentiate among their employees in theirappraisals andlor merit pay decisions. Theratings of such supervisors will typically beclustered near the center or top of the ratingscale. Furthermore, analysis of merit ratingsoften reveals ratet biases toward variousoccupations, job levels or types of employees.These problems with individual supervisors'ratings are compounded by the inconsistenciesbetween raters mentioned above. Analyses ofthe rating distributions of individual raters andbreakdowns of ratings to allow comparisons byunit, iob level, and occupation are a basic tool

for identifying andrectifying these types ofefrors.

Second, evidence ofthe ratings' accuracy canoften be obtained byfield checks of the ratingprocess. A field check isan actual review ofperformance appraisalforms and discussionwith supervisors todetermine the ratings'accuracy of selectedemployees. The purposeof a field check is todetermine whether (a)performance criteria are

-

-

signals promotability, the ratings of promotedemployees should reflect that fact. Promotedemployees should be predominantly from thehigher performance rating categories.

5. The relat ionship between meri tincreases and turnover. The goal of turnovercontrol is being achieved if the leavers arepredominantly from the lower end of theperformance distribution.

7. The relationship of the current to theprevious year's merit increases. Supervisorssometimes opefate under a"shate the wealth"philosophy and equalize merit increases fortheir subordinates over a multiple yeat cycle.lVhere this is happening the correlationbetween the increases for any two years will beneat zero or negative.

Performance eualuation, The measure ofindividual "merit" or performance is the criticalcomponent of any merit system. Merit must bedefined in a way that is understood andaccepted by the employee, ffid its measurementmust be accurate. First, the ratings often revealevidence of errors or other deficiencies of raters.

relevant and complete; (b) employees andsupervisors have a common understanding ofthe criteriaandtheir relative importance; (c) theinformationavzilable to raters provides a soundbasis for judgments of performance, and (d)whether performance reviews are complete andconstructive. This audit involves conversationswith employees and supervisors and reviews ofappnisal documentation relative to otherevidence of performance (attendance records,output quant i ty/qual i ty indicators, etc.) .Admittedly this is a judgmental process, butsuch field audits have the additional advantageof communicating the seriousness of the meritassessment process to all raters.

Employee attitudes. '$Thether

a merit paysystem influences motivation or retentiondepends upon employees' perceptions of thesystem. At a minimum, monetary recognitionmust be important to the employee, and he/shemust believe that individual performancede termines such rewards. Therefore,information about these beliefs, values andfeelings is a necessary part of any merit payaudit.

MARCH T987

Some of the advantages of usinganonymous questionnaires and group feedbackmethods were noted. Regardless of the methodused to collect information, employees'attitudes toward the following aspects of themerit pay program should be obained:

1. The concept of merit pay. Do employeesbelieve merit pay is a faft way to award payincreases? Do they believe it can be fairlyimplemented for their occupation or unit?

2. The definition of performance. Doemployees believe the performance standardsfor their iob arc relevant and complete? Aresupervisory expectations clear?

3, The performance measurementprocedure. Do employees believe the processused to assess their performance is adequate? Dothey trust their supervisor to be fair?

4. The size of merit increases. Is the size ofmerit pay increases large enough to bemotivational? Is the difference in the size ofincre ases between performance leve lssignificant?

5. Linkage to performance. Do employeesbelieve that the size of their pay increase isde termined pre-dominantly by theirperformance? Do theybelieve that the meritcriterion is distinctfrom seniority andcost of living?

5. The equity ofthe total system. Is thebase rate or pay rangefor the iob viewed asfair relative to that ofother iobs in theorganization and tomarket rates?

If questionnairesare used to obtain dataon employee atti-tudes, they shouldalso request personaland organizationaldata to allow analysisof responses byemployee category.For example, €ffi-ployee attitudes to-ward the pay systemcould vary by occu-pation, job level, sizeof most recent meritincrease, performancelevel, functional unitand tenure on thejob. A breakdown

of responses into categories of this typeprovides a basis for more meaningfulinterpreation of the responses. Information ofth is type can be requested withoutcompromising the anonymity of employee'sresponses.

Program cbaracteristics. A successfulformula for implementing of merit pay has notyet been developed. However, a number ofpreconditions and program requirements havebeen identified and generzlly accepted.

1. Trust in management. This applies bothto management philosophies and goals and toemployee perceptions of their particularsupervisor. If employee relations environmentsare shaky, employers are likely to be skeptical ofmerit programs.

2. Absence of performance constraints.Organizations often have jobs that are eternallycontrolled, highly interdependent or presentother barriers to individual performance. Sincemerit pay programs are based on individualability and effort, such constraints preventeffective implementation of the merit principle.

3. Trained supervisors and managers. ThePhoto: Bob Grieser qualitY of per-

formance planning,monitoring, reviewand feedback is crucialto merit pay programs.Few managers areborn with these skills.

4. Good mer6ure-ment systems. Pay-for-performance systemsshould be based asmuch as possible oncriteria that are specificto the job and focuson results achieved.Hence, the need foraccutaqt in measuringperformance goesbeyond performanceappraisals to theinformation systemsproviding the dataupon which they arebased.

5. Ability to pay.The merit portion ofthe salary increasebudget must be largeenough to providesignificant merit payincrements.

6. valid job eval-uation and externallycompetitive pay levels.

56 Pnnsonxn ADMIMSTRATOR

Merit pay plans are an attempt to introduceinterpersonal equity (based on performance)into pay systems. The effect will be negligible atbest if intemal job relationships are perceived tobe inequitable or rates are not competitive withthe market.

7. Distinction between cost of living,seniority and merit. Employees will assume apay increase is an economic or longevityincrease in the absence of strong evidence to thecontrary.

8. Open pay policy. A well-conceived andadministered merit pay plan is worthless unlessthe employees clearly understand how the toalpay system work.

9. Flexible reward schedule. Perceptionsof the linkage betv/een performance andrewards are influenced by the timing as well asthe amount of merit increases. It will be moredifficult to establish a credible meritpay plan ifall employees have the same merit date.

10. Consistent with the prevailing culture.Some employee groups regard performancedifferentials with suspicion. For example, thereare situations where cooperative rather thanindividual effort might be stressed, or a norm of"taking care of our own" might have developed.In such situations, merit pay could be effectiveasp rtof apaclcage of interventions designed tomodify the culture, but in the absence of astrategy for change, a merit pay program will berejected or subverted.

ConclusionsIn this paper we have suggested a frameworkwhich can be used to evaluate a merit payprogram. The recommendations capture someof the technical and analytical capabilitiesrequired to conduct such an audit. To the extentthat merit pay programs represent both lsignificant cost factor and a powerfulmotivational tool, it makes sense to ensure thatmerit pay is being used effectively andconscientiously. t

References1. See, for example, N. B. \Tinstanley, 'Are Merit IncreasesReally Effective?" Personnel Administratori Aprll, 1982,

37-4T.2. A errplanation of multiple regression is beyond the scopeof this papet but examples of its application to pay systemscan be found in B.B. Burkhalter et al., 'huditing the

Compensation Function for Race and Sex-Based SalaryDifferences : Further Needed Refinement s", Cornpensationand. Benefits Reaiew, July-August, 1985, 35-42, and

J. F. Sullivan, "Comparble \florth and the Satistical Audit of

Pay Programs for Illegal Systemic Discriminationl' PersonnelAd.ministrato4 March, t985, lO2 -ln.

3. See, for example, Dansereau, F., Alutto, J. A', and

Yammarionh, F. J., Tbeory Tbsting in OrganizationalBehau ior : Tbe Variant Approacb. New Jersey: Prentice-Hall,1984.

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