Mello, A Seffrey Strategi Human Resources Management, 4th Edition, Siena College (1)

Chapter 10 Performance Management and Feedback | 483

At the forming stage, care should be taken to help the motivation, which fuels future efforts and continued success.
virtual project team establish a shared team identity to pre- Conversely, teams that struggle initially lose confidence and
vent team members from abandoning the virtual project momentum, stifling motivation and sending these teams into
when they return to their home offices. Initial communica- a spiral of failure. The importance of teams getting off to a
tions, whether face-to-face, teleconference, videoconference, fast start and building on early successes to generate momen-
or on-line, should encourage the exchange of personal infor- tum cannot be overemphasized. The virtual project team
mation about backgrounds, skills, and experiences designed members we followed consistently pointed to the need for
to help team members get to know one another and identify teams to build consensus around the team mission, work
common ground. To help the team create a unique identity, out role assignments, commit to goals, and confront conflicts.
teams might develop their own language or jargon to engage The most effective virtual teams reported the eventual devel-
members or develop logos/symbols to serve as a constant opment of greater mission clarity and higher levels of coordi-
visual reminder of the team and its mission.31 nation and agreement around monthly goals, all of which
reflected the time that these teams invested up front on
Our findings complement prior research on work teams their projects and the active, early involvement of the senior
by highlighting the importance of involving a senior sponsor sponsor. Less successful teams reported early ambiguity
early in the team’s life cycle and gaining “unequivocal sup- around the project’s purpose, unresolved coordination pro-
port from the top of the organization.”32 Indeed, the least blems, and conflict over some members’ lack of commitment,
effective sponsors we observed proceeded with their roles in a all symptoms of the self-fueling spiral of failure.
laissez-faire manner, did not proactively contact the teams,
and did not attend their final presentations. Moreover, Though sometimes costly and inconvenient, a face-
these sponsors failed to clarify their teams’ missions until to-face team-building session for virtual teams is highly
the teams had completed a considerable amount of work. recommended early in the team development process to
This created enormous frustration when midway through reduce the impact of an unsuccessful storming stage on team
the projects the sponsors expressed concern that the teams development. The senior sponsor could assign an experienced
were not meeting expectations. team facilitator or “coach” to help virtual team members focus
on building consensus around a team’s mission, differentiating
Effective senior sponsors can help virtual project teams roles, clarifying assignments, and resolving conflicts. Meeting
clarify their mission and ensure that team members have the face-to-face provides the richest possible communication con-
resources needed to accomplish their tasks, such as funding text, often proving critical for overcoming problems encoun-
travel costs for intermittent face-to-face meetings.33 Senior tered early in a virtual team’s development.37
sponsors can also be used to provide pertinent information
and an “expert opinion” on the teams’ task. For example, in In situations where early face-to-face meetings are not
the virtual teams that Lipnack and Stamps observed from possible, alternatives such as video or teleconferencing meet-
Eastman Chemical Co. and Sun Microsystems, senior spon- ings can still provide a relatively rich opportunity for
sors advised teams on their task, were invited to key meet- exchanges and can offer many, but not all, of the advantages
ings, and were included in email correspondence between of face-to-face meetings. If conflict cannot be resolved at such
team members.34 Finally, sponsors can help teams create meetings, teams may employ more overt techniques aimed at
“small wins” upfront that provide a springboard for future addressing specific points of conflict.38 For instance, a team
performance. For example, one of the more successful virtual leader or facilitator may ask conflicting team members to
teams we followed used their sponsor to help develop and work together to resolve a problem and to foster greater
administer a survey shortly after the initial meeting. The understanding and appreciation of each other’s perspective.
launch of the survey energized team members and provided In rare cases where a consensus regarding protocol or other
a confidence boost for their efforts going forward. This prac- coordination issues cannot be reached, teams may consider
tice has been used successfully at IBM where virtual team using “shuttle diplomacy” or mediation.39 Specifically, a facil-
sponsors assist teams in creating an important 30-day goal itator will communicate with team members individually to
upfront that requires full team participation. Similar to the hear issues, concerns, or ideas, and then consolidate these
team we observed, teams at IBM use these 30-day projects viewpoints to come up with a compromise solution.
as vehicles to come together and build early momentum.35
An important intervention at the forming stage requires Interventions at the Norming Stage
managers to foster a collaborative partnership between spon- Our teams reported that problems with information gathering,
sors and their virtual teams. commitment from some team members, and free riding by
others became more apparent at the norming stage of devel-
Interventions at the Storming Stage opment. Teams acknowledged that their current work pace
would make it nearly impossible to meet deadlines. The seri-
Much has been written about the self-fueling spiral of success ousness of these shortcomings led many teams to markedly
or failure experienced by many types of teams.36 In particu- increase their work efforts. For the best teams, a renewed
lar, teams that experience early success gain confidence and

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484 | Part 2 Implementation of Strategic Human Resource Management

commitment proved critical for project completion. For those virtual team members do not function in isolation. Corporate
teams hopelessly behind, norms governing commitment and and sub-unit cultures may also influence virtual team
productivity developed too late, the teams became stressed, effectiveness.
and the final results were relatively disappointing.
Virtual project team sponsors may need to intervene to
We believe that early managerial intervention will shape a more supportive corporate and sub-unit context
increase the likelihood that teams develop norms governing within which virtual teams can flourish. In most instances,
commitment, accountability, and productivity, as our suc- serving on a virtual project team is a part-time assignment.
cessful teams did. Managers who observe teams struggling Team members must balance competing local demands for
with scheduling and coordination conflicts, miscommunica- their time with commitments made to their virtual project
tions between distal team members, and gaining team mem- teams. Virtual team sponsors must be sensitive to these dual
bers’ commitment to the task can provide virtual teams with demands and, as needed, be willing to negotiate with local
templates that identify strategies for improved team coordi- executives the relative importance and time commitment
nation.40 Teams can then customize a template to include required for successful virtual project team participation.
specific task requirements, individual accountabilities,
expected completion dates, and mechanisms for collecting, One of our least successful teams reported minimal sup-
collating, and sharing information. Managers can also help port for their project activities among executives in the divi-
virtual teams identify norms regarding communication con- sions represented on this team. Team members also believed
tent, including how to share contextual information. For that their performance evaluation and compensation for their
example, managers at Intel encourage virtual team members “real (non-virtual) job” were at risk if they made more than a
to send a “face” depicting their mood on any given day so token commitment to the virtual project team. In contrast,
that team members can better understand how to interpret our most successful virtual team reported complete support
and respond to team member communications.41 for their virtual project efforts by senior managers in all of
the divisions represented by the team. By providing team
Some virtual teams may benefit from using electronic members with the necessary time and resources to work on
decision support systems to stimulate brain-storming and both their local and virtual projects, senior management sig-
group decision-making.42 Managers should provide training naled that outcomes of the virtual project team were valued.
to ensure that team members know how to use these technol- The lesson seems obvious: To thrive, virtual project teams
ogies and use them appropriately, as needed. Virtual team must be embedded in supportive corporate cultures.
leaders at Novartis recommend that training team members
in the use of more complex collaborative technologies should In addition to providing sufficient resources, managers
be incremental, allowing team members to become comfort- can use other strategies to create a supportive culture. For
able with various features of a given technology over time.43 example, virtual team leaders at ARCO reported that to sup-
port their virtual team’s efforts, team leaders “buffer” interfer-
In addition to the impact of a supportive senior sponsor, ence from on-site work demands.45 When virtual team
another possible intervention is to assign project teams “coa- members are relieved from some of their typical local
ches” skilled in virtual management to nurture virtual project demands, they may focus more energy on the virtual team
teams through the early development stages. Senior sponsors assignment without fear of reprisal from their local managers.
may not have had experience managing virtual teams and/or
may not be sufficiently accessible to team members to pro- The creation of virtual teams will likely require that
vide the type of personal suggestions a “coach” could provide. managers realign recognition and reward systems to better
In addition to providing team members with a realistic pre- assess and reward virtual team performance.46 For example,
view of the virtual team experience, coaches could counsel Sabre uses a balanced scorecard approach for tracking virtual
team members on- or off-line, model the appropriate use of team performance that provides quantitative and qualitative
communication and collaboration technologies, and reinforce information including growth, profitability, process improve-
the value of managing boundary relationships.44 Indeed, our ment, and customer satisfaction.47 Teams may wish to com-
most successful teams were particularly proactive, seeking out plement this objective performance data with 360 degree
informal sources of coaching and support. Once team mem- evaluation procedures to capture unique individual contribu-
bers experience success working virtually, they should tions. By realigning recognition and reward systems, man-
become well situated to coaching new virtual project mem- agers help their virtual teams discover how various
bers and teams. stakeholders, including customers, other team members,
and outsiders perceive the quality of their work.48
Interventions at the Performing Stage
As these results suggest, many factors contribute to virtual Conclusion: Timing the Interventions
project team effectiveness. We have emphasized how team
processes can contribute to or detract from team perfor- To mobilize virtual project teams, managers need insights
mance. However, it is equally important to recognize that into the challenges associated with each stage of the virtual
team life cycle. Based on our comparison of flourishing and

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Chapter 10 Performance Management and Feedback | 485

floundering virtual teams, it appears that managers who can commissioned a large university located in the southeastern
recognize the signs of steady progress as well as the signs of US to create an Executive Leadership Institute (ELI) that
distress associated with virtual team development will be in would (1) align organizational learning with strategic busi-
stronger positions to keep their teams on track. Similar to the ness needs, (2) establish cross-organizational networks to
concept of a “teachable moment” for introducing skills train- encourage the sharing of best practices, (3) prepare managers
ing at the point where these skills are most salient, managers for expanded organizational roles, (4) integrate new managers
must learn to time the introduction of interventions to virtual from FOODCO’s recent acquisitions, and (5) develop a unified
team life cycle challenges.49 To conclude, we suggest a num- company culture across its multiple operating companies.
ber of stage-appropriate interventions.
The 29 participants in the ELI program held positions of
In the formation stage, realistic previews, exercises sur- substantial responsibility in human resources, finance, mar-
rounding the creation of mission statements, and assistance keting, sales, and operations areas. Superiors nominated par-
in building team identity are all potentially useful strategies ticipants for the program based on their potential to
for helping virtual project teams get off to a fast start. The contribute to the company beyond their current levels of
active involvement of a senior sponsor to clarify the team’s responsibility. Fourteen participants were from the executive
mission and to ensure that the team has the resources it ranks, while the remaining participants held middle-
needs to perform can also boost early success. Because management positions.
teams typically experience frustration and conflict in the
storming stage, most teams should benefit from managerial Summary of Methodology Used to Study
interventions to help select appropriate procedures for work- Virtual Project Teams at FOODCO
ing through conflicts, pushing teams more quickly to the
norming stage of team development. Encouraging teams to To assess the factors that contributed to virtual project team
establish a strong work ethic and to create mechanisms for performance at various stages of the teams’ life cycles, we
holding members accountable for meeting deadlines are collected survey and interview data throughout the eight-
interventions particularly important at the norming stage. month project period. Specifically, during each of the four
residence sessions, ELI participants completed surveys and
At the performing stage, managerial interventions to participated in interviews designed to assess their attitudes
facilitate brainstorming, decision making, and monitoring of and behaviors during the virtual project team assignment.
progress against objectives and timelines will enhance team
performance. Finally, and perhaps most important, are ongo- Participant surveys included both quantitative and quali-
ing managerial efforts to embed virtual teams in supportive tative questions. The quantitative data we collected at each
work contexts. Similar to other virtual team experiences time period varied slightly to reflect anticipated differences in
chronicled in the literature, our six teams struggled to bal- development issues. During the first residency, participants
ance their virtual team demands with home office priorities.50 were asked about the meaning of their project, its usefulness
To combat these competing demands, managerial interven- to the firm, the impact that the project would have on the
tions could take the form of negotiating work priorities with company, how competent they felt to complete the project,
on-site supervisors and aligning reward systems to recognize and the anticipated climate for teamwork. During subsequent
virtual team contributions. residence periods, survey questions focused on team process
variables, such as perceptions of mission clarity, trust levels
Certainly, sponsors, coaches, managers, and virtual team among team members, learning capacity, extent of sponsor
leaders and members have many intervention options to assist support, and specific performance outcomes, including per-
struggling virtual teams. But, as with so many organizational centage of project completed, perceptions of team productivity,
activities, timing is everything. Introducing interventions at the and perceived efficacy of completing an outstanding project.
appropriate stage of development represents an important tool
for leveraging virtual team performance. Having the tools in Surveys also included several open-ended questions
the toolkit is only the beginning. Knowing which tool to use allowing participants to describe their views of the project,
when is the sign of the true master craftsman. the challenges associated with virtual work, and their teams’
responses to these challenges. For instance, during the first
Appendix: Descriptive Information residency, we asked participants to “Describe your expecta-
Regarding the Six Virtual Project Team tions for how you think your team will work together.” Ques-
Participants tions at the third residency focused on what individuals had
learned about working virtually and what they would do dif-
The members of the six virtual project teams that we followed ferently had they been able to start over. During the final
were employed by FOODCO. This company distributes food residency, we asked participants to reflect on their experi-
products to schools, hospitals, fast-food chains, and individu- ence, to discuss what they learned about team processes
ally owned and operated restaurants, and manufactures a lim- that they could carry over to their current jobs, and to con-
ited number of its own products. Executives at FOODCO sider what advice they might give future virtual teams.

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486 | Part 2 Implementation of Strategic Human Resource Management

At the end of the fourth residency, teams presented their Does medium matter? The interaction of task type and
analysis and recommendations to a group of FOODCO’s top technology on group performance and member reac-
executives and ELI administrators. This group rated the qual- tions. Journal of Applied Psychology, 79(1): 87–97.
ity and content of each team’s analysis of the critical business
issue they researched and the quality of the recommendations 7. Hackman, J. R. 1990. Groups that work (and those that
they provided. They also rated the quality of the presentation don’t): Creating conditions for effective teamwork. San
delivered by each team. Each observer calculated an overall Francisco: Jossey-Bass.
score for each team based on these three dimensions. We
aggregated and averaged ratings for each team and used the 8. Tuckman, B. W. 1965. Development sequence in small
result as the measure of team performance in further analyses. groups. Psychological Bulletin, 63: 384–399; Gersick, C.
J. G. 1988. Time and transition in work teams: Toward
Source: Academy of Management Executive, 18, (2), 6–20 (2004). a new model of group development. Academy of
Reprinted by permission of the CCC. Management Journal, 31: 9–41.

ENDNOTES 9. Gersick, C. J. G. 1994. Pacing strategic change: The
case of a new venture. Academy of Management Jour-
1. Townsend, A. M., DeMarie, S. M., & Hendrickson, nal, 37: 9–45.
A. R. 1998. Virtual teams: Technology and the work-
place of the future. The Academy of Management 10. See, for example, in Bordia, P., DiFonzo, N., & Chang,
Executive, 12(3): 17–29. A. 1999. Rumor as group problem solving: Develop-
ment patterns in informal computer-mediated teams.
2. Potter, R. E., & Balthazard, P. A. 2002. Understanding Small Group Research, 30: 8–28. For further evidence
human interaction and performance in the virtual of pacing differences, see Gluesing, J. C., et al. 2002.
team. Journal of Information Technology Theory and The development of global virtual teams. In C. B.
Application, 4: 1–23; Baker, G. 2002. The effects of Gibson & S. G. Cohen (Eds.), Virtual teams that work:
synchronous collaborative technologies on decision Creating conditions for virtual team effectiveness: 353–
making: A study of virtual teams. Information 380. San Francisco: Jossey-Bass. For evidence of the
Resources Management Journal, 15(4): 79–93. punctuated equilibrium model in virtual teams, see
Maznevski & Chudoba, 2000, op. cit.
3. Ahuja, M. K., & Galvin, J. E. 2001. Socialization in
virtual groups. Journal of Management, 29: 1–25. 11. Caproni, P. J. 2001. The practical coach: Management
skills for everyday life. Upper Saddle River, NJ:
4. Townsend, et al., 1998, op. cit.; Cascio, W. F. 2000. Prentice-Hall (see specifically Chapter 8, entitled,
Managing a virtual workplace. The Academy of Man- “Diverse teams and virtual teams: Managing differ-
agement Executive, 14(3): 81–90; Kirkman, B. L., et al. ences and distances,” 247–287).
2002. Five challenges to virtual team success: Lessons
from Sabre, Inc. The Academy of Management Execu- 12. Cramton, C. D. 2001. The mutual knowledge problem
tive, 16(3): 67–79. and its consequences for dispersed collaboration.
Organization Science, 12: 346–371.
5. See, for example, Banker, Lee, Potter, & Srinivasan, 1996;
Wellins, Byham, & Dixon, 1994; Cohen & Ledford, 1994; 13. Tsui, A. S., Egan, T. D., & O’Reilly III, C. A. 1992.
and Cordery, Mueller, & Smith, 1991. Being different: Relational demography and organiza-
tional attachment. Administrative Science Quarterly,
6. For studies that investigate coordination, communica- 37: 549–579.
tion interpersonal dynamics, and technology issues in
virtual or computer-mediated teams, see Straus, S. G. 14. Cramton, C. D. 2002. Finding common ground in
1996. Getting a clue: The effects of communication dispersed collaboration. Organizational Dynamics, 30:
media and information distribution on participation 356–367.
and performance in computer-mediated and face-
to-face groups. Small Group Research, 27: 115–42; 15. Shapiro, D. L., et al. 2002. Transnational teams in the
Lipnack. J., & Stamps, J. 2000. Virtual teams: People electronic age: Are team identity and high performance
working across boundaries with technology. 2nd ed. at risk? Journal of Organizational Behavior, 23: 455–467.
New York: Wiley; Daft, R. T., & Lengel, R. H. 1986.
Organizational information requirements, media rich- 16. Handy, C. 1995. Trust and the virtual organization.
ness, and structural design. Management Science, 32: Harvard Business Review, 73(9): 40–48.
554–571; and Straus, S. G., & McGrath, L. E. 1994.
17. Jarvenpaa, S. L., Knoll, K., & Leidner, D. E. 1998. Is
anybody out there? Antecedents of trust in global

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

Chapter 10 Performance Management and Feedback | 487

virtual teams. Journal of Management Information 31. Malhotra, A., et al. 2001. Radical innovation without
Systems. 14; 29–64. collocation: A case study at Boeing-Rocketdyne. MIS
Quarterly, 25: 229–249.
18. Cramton, 2002, op. cit.
32. Kossler & Prestridge, 2004, op. cit.
19. Hollingshead, A. B., & McGrath, J. E. 1995. Computer
assisted groups: A critical review of the empirical 33. Ibid.
research. In Guzzo, R., & Salas, E. (Eds.), Team effec-
tiveness and decision making in organizations, San 34. Lipnack, J., & Stamps, J. 2000, op. cit.
Francisco: Jossey-Bass: 46–78.
35. Rosen, B., et al. 2001. Is virtual the same as being
20. Hinds, P. J., & Weisband, S. P. 2002. Knowledge there?: Not really! Paper presented at the National
sharing and shared understanding in virtual teams. In Academy of Management Meetings, Toronto.
C. B. Gibson & S. G. Cohen (Eds.), Virtual teams that
work: Creating conditions for virtual team effectiveness: 36. Hackman, J. R. 1990. Groups that work (and those that
221–36. San Francisco: Jossey-Bass. don’t). San Francisco: Jossey-Bass.

21. Blackburn, R. S., Furst, S. A., & Rosen, B. 2002. 37. Joinson, C. 2002. Managing virtual teams. HR Maga-
Building a winning team: KSAs, selection, training, zine, 47(6): 69–73.
and evaluation. In C. B. Gibson & S. G. Cohen (Eds.),
Virtual teams that work: Creating conditions for 38. Gluesing, et al., 2002, op. cit.
virtual team effectiveness: 95–120. San Francisco:
Jossey-Bass. 39. Ibid.

22. Tyran, K. L., Tyran, C. K., & Shepard, M. 2002. 40. Montoya-Weiss, M. M., Massey. A. P., & Song, M.
Exploring emerging leadership in virtual teams. In C. 2001. Getting it together: Temporal coordination and
B. Gibson & S. G. Cohen (Eds.), Virtual teams that conflict management in global virtual teams. Academy
work: Creating conditions for virtual team effectiveness: of Management Journal, 44: 1251–1262.
183–195. San Francisco: Jossey-Bass.
41. Rosen, et al., 2001, op. cit.
23. Furst, S. A., Blackburn, R. S., & Rosen, B. 1999. Virtual
team effectiveness: A proposed research agenda. 42. Lam, S. S. K., & Shaubroeck, J. 2000. Improving group
Information Systems Journal, 9: 249–269. decisions by better pooling information: A compara-
tive advantage of group decision support systems.
24. Kirkman, et al., 2002, op. cit. Journal of Applied Psychology, 85(4): 565–573.

25. Jarvenpaa, et al., 1998, op. cit.; Cascio, 2000, op. cit. 43. Rosen, et al., 2001, op. cit.

26. Gluesing, et al., 2002, op. cit. 44. Jarvenpaa, S., & Leidner, D. 1998. Communication and
trust in global virtual teams. Organization Science,
27. Kossler, M., & Prestridge, S. 2004. Leading dispersed 10(6): 791–815.
teams: Ideas into action guidebook. Greensboro, NC:
Center for Creative Leadership. 45. Ibid.

28. Hackman, J. R. 2002. Leading teams: Setting the stage 46. Lawler, E. E. 2002. Pay systems for virtual teams. In
for great performances: 199–232. Boston: Harvard C. B. Gibson & S. G. Cohen (Eds.), Virtual teams that
Business School; Jiang, J. J., Klein, G., & Discenza, R. work: Creating conditions for virtual team effectiveness:
2002. Pre-project partnering impact on an information 121–144. San Francisco: Jossey-Bass.
system project, project team and project manager.
European Journal of Information Systems, 11: 86–97; 47. Kirkman, et al., 2002, op. cit.
Zhang, Q., & Doll, W. J. 2001. The fuzzy front end and
success of new product development: A causal model. 48. Blackburn, et al., 2002, op. cit.
European Journal of Innovation Management, 4(2):
95–112. 49. Ibid.

29. Wetlaufer, S., et al. 1994. The team that wasn’t. Har- 50. Reeves, M. & Furst, S. 2004. Virtual teams in an
vard Business Review, 72(6): 22–38. executive education training program. In S. H. Godar,
& S. P. Ferris (Eds.), Virtual and collaborative teams:
30. Kirkman, et al., 2002, op. cit. Process, technologies, and practice: 232–252. Hershey,
PA: Idea Publishing Group; Gluesing, et al., 2002, op.
cit.: Hackman, et al., 2002, op. cit.

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11C H A P T E R

Compensation

LEARNING Strategic Compensation at Jamba Juice
OBJECTIVES
Founded in 1990, San Francisco, California–based Jamba Juice has expanded to
• Gain an awareness of the 300 stores that employ more than 4,000 workers in 15 states. Jamba is a leading
multifaceted nature of retailer of blended-to-order fruit smoothies, fresh-squeezed juices, and healthful
compensation soups and breads. Since its inception, one of Jamba’s chief challenges has been
finding and retaining qualified managers. In a high-growth company that has
• Understand the different intense competition within the industry, Jamba is additionally challenged by its
types of equity and their location in the San Francisco Bay area, which provides many other career oppor-
resultant effects on tunities to the younger employees—Jamba recruits. A large number of these
employee behavior employers are technology based and offer more generous financial incentives
than the typical food retailer.
• Explain the nature of salary
compression and the To expand, Jamba must attract and retain these younger workers. To assist
challenges it presents to them in this objective, Jamba has developed an innovative compensation
employers policy that allows it to compete not only within the growing juice industry but
also with the technology-based employers who attract the same young employees.
• Develop an awareness Jamba’s “J.U.I.C.E. Plan” allows general managers to receive a percentage of the
of the advantages and store’s cash flow, predicated on the financial performance of their business. To
disadvantages of pay for keep good managers on board, Jamba provides opportunities for general managers
performance or incentive to share in store profits over a three-year period. When general managers increase
pay and the conditions year-to-year sales in their operation, money accrues in a retention account, which is
under which it might payable only in three-year cycles. Much like stock options that vest over three or
be most successful five years in technology companies, Jamba’s retention account not only provides
short-term performance incentives but it also provides incentives to stay with
• Describe the legal issues Jamba. On top of this, Jamba also provides all employees at the managerial level
that influence with traditional stock options. When assistant managers are promoted, their general
compensation managers also receive a cash bonus of $1,000 for their development efforts.

• Appreciate the challenges In a fiercely competitive industry characterized by high turnover, Jamba was
inherent in setting able to reduce turnover among managers during the first year of operating its
executive compensation J.U.I.C.E. Plan. Jamba has also received inquiries from Australia and Europe from
levels prospective employees, managers, and franchisees. Ironically, the company’s
strategically designed compensation program has also provided the unintended
benefit of fueling its growth.1

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490 | Part 2 Implementation of Strategic Human Resource Management

C ompensation—a key strategic area for organizations—impacts an employer’s ability to attract
applicants, retain employees, and ensure optimal levels of performance from employees in
meeting the organization’s strategic objectives. Compensation is also a key economic issue:
Compensation programs continue to assume an increasingly larger share of an organization’s oper-
ating expenses. This is particularly true in service industries, which are highly labor intensive.
A critical balancing act must occur to ensure that compensation attracts, motivates, and retains
employees; at the same time, compensation should allow the organization to maintain a cost struc-
ture that enables it to compete effectively and efficiently in its markets.

Compensation, as part of an organization’s total reward system, has been evolving relative to
the changing needs of organizations and employees in recent years in a number of ways.2 First,
greater emphasis is being placed on employee performance and contribution, rather than seniority,
in compensation decisions. Second, employers are taking a more holistic approach to compensation
in offering enhanced and flexible benefits to meet individual employee needs and preferences. Third,
greater emphasis is being placed on more immediate and intermittent rewards, rather than waiting
for the annual performance review to announce compensation decisions. Fourth, organizational
rewards are becoming more directly linked to the organization’s mission, strategy, and goals. Fifth,
compensation decisions and rewards are becoming more individualized, rather than applied equally,
“across the board,” to all employees.

An organization’s compensation system usually consists of three separate components, as
illustrated in Exhibit 11.1. The first and largest component is the base compensation or salary
system. The second is the incentive system, where employees receive additional compensation
based on individual, divisional, and/or organization-wide performance. Third is the indirect
compensation system, where employees are provided with certain benefits, some of which are
legally required and others are provided at the discretion of the employer. This chapter focuses on
the strategic and policy issues associated with compensation, as opposed to presenting details
concerning many of the components of indirect compensation.

Equity

In designing the overall compensation system, an organization needs to be concerned with the
perceived equity or fairness of the system for employees. All employees should feel that they are
being compensated fairly relative to their coworkers and to individuals who hold comparable jobs
in other organizations. The equity theory of motivation holds that workers assess their perceived
inputs to their work and their outcomes to those of others, as depicted in Exhibit 11.2.3

When individuals perceive that they are being treated inequitably relative to their peers, they
usually try to establish equity by increasing their outcomes or decreasing their inputs. Increasing
outcomes might involve asking for additional compensation or pilfering from the organization. In
the latter case, the individual might use the inequity to justify the theft. Decreasing inputs might
involve not working as hard, taking longer breaks, coming in late, leaving early, or resigning.

The design of an equitable compensation system must incorporate three types of equity:
internal, external, and individual. These perceptions of equity directly impact motivation, commit-
ment, and performance on the job, as illustrated in Exhibit 11.3. It is important to remember that
employee assessments of equity are, in fact, perceptions. They may be based, in part, on incom-
plete or inaccurate information. Few employees really know the extent of their coworkers’ inputs
unless they are together throughout the workday.

One critical policy decision employers must make is the extent to which compensation levels
will be made public or kept private. Public employers usually have no choice in this matter, as rel-
evant state laws may require full disclosure and reporting of and public access to such informa-
tion. However, privately held and publically traded organizations have the option of disclosing
the compensation of individuals and/or the compensation ranges associated with specific positions.
Even if that information is not disclosed, employers frequently have policies that forbid employees
from disclosing their compensation to others. Reading 11.1 “Exposing Pay Secrecy,” explores the
reasons for such policies as well as the advantages and disadvantages of such a practice.

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Chapter 11 Compensation | 491

EXHIBIT 11.1 Compensation System

Compensation System

Direct Indirect

Base Pay Incentive Pay Legally Required Optional

• Bonus • Social security • Paid time off
• Commission (holidays, vacation,
• Profit sharing • Unemployment sick days, etc.)
• Stock options compensation
insurance • Health insurance

• Worker’s • Retirement/
compensation pension plans

• Family and • Disability
medical leave insurance

• Life insurance © Cengage Learning

• Tuition
reimbursement

• Dependent care

• Flexible work
schedules
(telecommuting,
flex time,
compressed work
week, etc.)

EXHIBIT 11.2 Equity Theory

Outcomes/Rewards Outcomes/Rewards
self others

Inputs/Contributions Inputs/Contributions
self others

The individual senses inequity when perceiving that ratios are not equal. © Cengage Learning

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492 | Part 2 Implementation of Strategic Human Resource Management

EXHIBIT 11.3 Equity and Work-Related Outcomes

Internal Equity Motivation

External Equity Perceptions of Commitment
Fairness

Individual Equity Performance © Cengage Learning

The confidentiality of many compensation programs can also make it difficult for employees
to obtain accurate information on coworker compensation. Nonetheless, these perceptions impact
motivation, commitment, and performance and must be effectively managed. Although compensa-
tion is not the only work-related outcome employees receive, it is often the basis by which
employees conclude that they are being treated appropriately.

The Internet can provide a wealth of information to employees about comparable salary data.
A recent Google search turned up more than 28,000 hits for the search “salary comparison” sites.
The most popular of these sites, www.salary.com, averages more than 26 million hits annually and
hosts 1.7 million different visitors monthly. The Wall Street Journal even offers its own site, www.
careerjournal.com.4 Much of the salary information found by employees may be inaccurate, dated,
or based on samples that are irrelevant to the individual employee’s job. Employers, however, add
to the confusion by failing to communicate compensation policy with employees. Although 60 per-
cent of workers in one recent survey reported that their pay compares unfavorably to pay levels
elsewhere, only 43 percent of that same group reported that their employers do a good job of
explaining how pay is determined.5 Hence, with the abundance of salary information available to
employees, it is more important than ever that employers develop an equitable compensation sys-
tem and explain it to employees.

Internal Equity

Internal equity involves the perceived fairness of pay differentials among different jobs within an
organization. Employees should feel that the pay differentials between jobs are fair, given the cor-
responding differences in job responsibilities. In attempting to establish internal equity, employers
can evaluate jobs by using four techniques: job ranking, job classification, point systems, and fac-
tor comparison.

Job ranking is a relatively simple, nonquantitative means of determining equity in compensa-
tion in smaller, less complex organizations. Senior management makes judgments as to which jobs
are most challenging and ensures that the more challenging jobs receive higher compensation.
This method, which is somewhat random and nonscientific, is more concerned with the hierarchi-
cal position of jobs rather than with the differential amounts of compensation. Because it is ran-
dom, job ranking is used infrequently and usually only in small, informal organizations.

Job classification systems group jobs requiring similar effort, ability, training, and responsibil-
ity into predetermined grades or classes and compensates each job within a grade similarly. This
method is more scientific than job ranking, but it has been criticized for lack of flexibility. Organi-
zations must force each job into a specific category, and subjectivity is involved in classifying jobs,
given the nonquantitative nature of the process.6 However, job classification systems are easy to

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Chapter 11 Compensation | 493

understand and explain and can be widely administered in large organizations. The federal gov-
ernment, for example, has an elaborate system of 18 job classes, each of which is distinguished by
10 levels of job difficulty or challenge; this impacts the compensation of more than 3 million
federal employees. Exhibit 11.4 provides a sample of several of these job grades.

Point systems involve making a quantitative assessment of job content and are more scientific
than job ranking or classification. Point systems are easy to understand and explain and—although
difficult to design—are easy to implement once they are operational. The organization first creates
a list of compensable factors—things that the organization is willing to pay its employees for, such
as education, experience, specific skills, working conditions, and responsibility. Each of these com-
pensable factors is then assigned a factor scale, which describes progressive levels of mastery or
accomplishment of each factor. Points are assigned to each level of each scale, and compensation
is determined by the overall number of points that correspond to the job. A sample point system
is presented in Exhibit 11.5. Note that some compensable factors receive higher points than others.
For example, level one in technical skills receives 30 points; level one in working conditions
receives only 5 points. Employers can determine the relative worth of each compensable factor by

EXHIBIT 11.4 Grade Description and Representative Job Titles from
the Classification System used by the Federal Government

Grade Level Grade Description Jobs Included in Grade
GS 1 Typist, Messenger
Includes those classes of position the duties of which are to perform,
GS 2 under immediate supervision, with little or no latitude for the exercise Engineering aide
of independent judgment:
GS 5 Chemist, Accountant,
• The simplest routine work in office, business, of fiscal operations; or Engineer (civil),
• Elementary work of a subordinate technical character in a professional, Statistical clerk

scientific, or technical field.

Includes those classes of position the duties which are:

• to perform, under immediate supervision, with limited latitude for the
exercise of independent judgment, routine work in office, business, or
fiscal operations, of comparable subordinate technical work of limited
scope in a professional, scientific, of technical field, requiring some
training or experience; or

• to perform other work of equal importance, difficulty, and
responsibility, and requiring comparable qualifications.

Includes those classes of positions the duties which are:

• to perform, under general supervision, difficult and responsible work
in office, business, or fiscal administration, or comparable subordinate
technical work in a professional, scientific, or technical field, requiring
in either case;

• considerable training and supervisory or other experience;
• broad working knowledge of a special subject matter or of office,

laboratory, engineering, scientific, or other procedure and practice; and
• the exercise of independent judgment in a limited field;
• to perform other work of equal importance, difficulty, and

responsibility, and requiring comparable qualifications.

Source: From The Management of Compensation by Alan, N. Nash and Stephen J. Carroll. Copyright © 1976 by Wadsworth, Inc.

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494 | Part 2 Implementation of Strategic Human Resource Management

EXHIBIT 11.5 Sample Point System

Level

Factors 1 234 5
Education 15
Experience 20 30 45 60 75
Technical skills 30
Working 40 60 80 100
conditions 5
Responsibility 60 90 120 150
25
10 15 20 25

50 75 100 125

The compensable factor “technical skills” might have its five levels defined as follows:

Knowledge
This factor measures the knowledge or equivalent training required to perform the job duties.

1st Degree

Use of reading and writing, adding and subtracting of whole numbers; following of instructions; use of fixed gauges,
direct reading of instrument, and similar devices; where interpretation is not required.

2nd Degree

Use of addition, subtraction, multiplication, and division of numbers, including decimals and fractions; simple use of
formulas, charts, tables, drawings, specifications, schedules, wiring diagrams; use of adjustable measuring instrument;
checking of reports, forms, records, and comparable data; where interpretation is required.

3rd Degree

Use of mathematics with the use of complicated drawings, specifications, charts, tables; various types of precision
measuring instruments. Equivalent to one to three years’ applied traders training in a particular or specialized
occupation.

4th Degree

Use of advanced trades mathematics, together with the use of complicated drawings, specifications, charts, tables,
handbook formulas; all varieties of precision measuring instruments. Equivalent to complete accredited apprentice-
ship in a recognized trade, craft or occupation; or equivalent to a two-year technical college education.

5th Degree

Use of higher mathematics involved in the applications of engineering principles and the performance of related
practical operations, together with a comprehensive knowledge of the theories and practices of mechanical, electri-
cal, chemical, civil, or like engineering field. Equivalent to complete four years of technical college or university
education.

Source: Adapted from Compensation, 3/c by George T. Milkovich and Jerry M. Newman. Copyright © 1990 by Richard D. Irwin.

assessing its criticality for the organization’s strategic objectives. The more a compensable factor
relates to goals and objectives, the higher the values that should be present in the factor scales.

A special type of point system is often used for administrative and managerial positions.
Developed by the consulting group Hay Associates, this system is known as the “Hay Plan” and
is used by most of the Fortune 500 companies as well as over 5,000 organizations in more than

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Chapter 11 Compensation | 495

30 countries. The Hay Plan utilizes three factors, called “universal factors,” which are common to
all managerial and administrative jobs: know-how, problem solving, and accountability. Know-
how pertains to the technical knowledge required to do the job. Problem solving assesses the
amount of independent thinking and decision making required in the job. Accountability consid-
ers the direct responsibility for people, resources, and results. A brief summary of the Hay Plan is
presented in Exhibit 11.6.

Factor comparison is somewhat similar in concept to the point system. However, instead of
assessing jobs independently of each other relative to compensable factors, factor comparison uti-
lizes five standard factors in evaluating all jobs: responsibility, skills required, mental effort, physi-
cal effort, and working conditions. Jobs are evaluated relative to each other on each of these five
dimensions to determine appropriate compensation. For example, an employer would try to deter-
mine whether the job of a paralegal required more or less responsibility, skill, mental effort, physi-
cal effort, or unusual working conditions relative to the job of an accounting clerk to determine
appropriate compensation for each job. Factor comparison can be difficult to administer in orga-
nizations where job content and responsibilities change frequently. It has also been criticized for
its assumption that the five factors are universal to and equally important in all jobs. Factor com-
parison is best utilized in organizations where there is limited change and job responsibilities and
content remain somewhat stable.

EXHIBIT 11.6 Hay Compensable Factors

Know-How

Know-how is the sum total of every kind of skill, however acquired, necessary for acceptable job performance. This
sum total, which comprises the necessary overall “fund of knowledge” an employee needs, has three dimensions:

• Knowledge of practical procedures, specialized techniques, and learned disciplines.
•• The ability to integrate and harmonize the diversified functions involved in managerial situations (operating,

supporting, and administrative). This know-how may be exercised consultatively as well as executively and
involves in some combination the areas of organizing, planning, executing, controlling, and evaluating.
••• Active, practicing skills in the area of human relationships.

Problem-Solving

Problem-solving is the original “self-starting” thinking required by the job for analyzing, evaluating, creating, reason-
ing, and arriving at conclusions. To the extent that thinking is circumscribed by standards, covered by precedents, or
referred to others, problem-solving is diminished and the emphasis correspondingly is on know-how.

Problem-solving has two dimensions:
• The environment in which the thinking takes place.
•• The challenge presented by the thinking to be done.

Accountability

Accountability is the answerability for an action and for the consequences thereof. It is the measured effect of the
job on end results. It has three dimensions:

• Freedom to act—the degree of personal or procedural control and guidance.
•• Job impact on end results.
••• Magnitude—indicated by the general dollar size of the areas(s) most clearly or primarily affected by the job

(on an annual basis).

Source: Courtesy of the Hay Group, Boston, MA.

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496 | Part 2 Implementation of Strategic Human Resource Management

The consequences of having a compensation system that employees perceive to be inequitable
can be severe. Employers have a choice of four systems for developing an internally equitable com-
pensation system based on whether they wish to consider complete or specified job factors as well
as whether they wish to compare jobs to each other or to some standard. Exhibit 11.7 compares
the four techniques, noting the relative strengths and weaknesses of each technique. Regardless of
the method chosen, employees must understand and accept the system to ensure optimal motiva-
tion, commitment, and performance.

A more recent issue that has arisen relative to the management of internal equity is salary
compression. Salary compression happens when new hires earn higher salaries than employees
who have more experience and/or tenure within the organization. It is the result of rising starting
salaries in fields for which demand for employees exceeds supply. Salary compression has become
a common and particularly problematic issue for faculty in colleges and universities.

Salary compression can be exacerbated in organizations in which individual salaries are made
public. It can lead to severe morale problems due to the sense of inequity felt by long-term employ-
ees who may have shown tremendous loyalty to their employers. It can be difficult to remedy, as its
effects are often far reaching throughout the organization. Simply adjusting salaries to address salary
compression can create additional problems relative to the basis for such adjustments as well as
the availability of resources to support such adjustments. Frequently, the only solution for those
employees who are on the short end of salary compression is to leave their organization and seek
employment elsewhere on the open market at the going salary rates. When an organization realizes
that its compensation system suffers from salary compression, there is no simple answer as to how
to best remedy the situation, but action is necessary to retain top-performing employees. Chapter 13
provides some recommendations as to how to retain such individuals.

EXHIBIT 11.7 Comparison of Job Evaluation Methods

Unit of Analysis

Basis of Whole Job Selectors Factors of Job
Comparison Job Ranking Factor Comparisons

Job vs. Job • Identify jobs based on “worth” to • Define compensable factors and evaluate
organization relative to other jobs jobs on these factors relative to other jobs

Simple, inexpensive, easy to understand Ease of employee comprehension

Random, subjective, not useful in large Cumbersome and requires constant
organizations updating; universal importance of factors
in all jobs questionable

Job Classification Point Method

Job vs. Standard • Prepare job grades/classification and • Define compensable factors and levels of
assign job to appropriate class accomplishment and determine levels for
each job © Cengage Learning
Apply to large number of varied jobs;
easy to understand; flexible Simple to understand and administer; easy
Detailed and time-consuming to develop; for employees to aspire to high levels
lack of flexibility
Extremely time consuming to develop;
lack of universal applicability of
compensable factors

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Chapter 11 Compensation | 497

External Equity

External equity involves employee perception of the fairness of their compensation relative to
those outside the organization. Obviously, employees would not be thrilled to discover that those
who do similar work in other organizations receive greater compensation. Employers need to be
aware of salary structures of competitors and understand that this can impact motivation, com-
mitment, and productivity.

Assessing external equity is relatively a straightforward process. Organizations should first
collect wage and salary information to determine market wage rates. This information, which can
be collected in-house or through sources external to the organization, is usually readily available
relative to the industry and geographic area through professional associations, human resource
(HR) consulting firms, or through the organization’s own primary research. When making assess-
ments of external equity, it is important to consider not only salaries but also other forms of com-
pensation, such as bonus and incentive plans and benefits packages. Information pertaining to
these additional forms of compensation may be more difficult to obtain, but it must be incorpo-
rated into the analysis, especially for higher level managerial and executive positions that may
have a significant portion of the overall compensation based on incentive pay.

After an investigation of the market has been completed, the organization then determines its
own pay strategy relative to the market. The three strategies an employer can choose are a lead,
lag, or market policy. A lead policy involves paying higher wages than competitors to ensure that
the organization becomes the employer of choice. In other words, this strategy assumes that pay is
a critical factor in an applicant’s decision in choosing an employer and attempts to attract and help
retain employees of the highest quality. In short, the employer desires to be the first-choice
employer; that is, the organization wants first selection from available talent. However, any organiza-
tion that offers higher compensation than its competitors needs to ensure that it has a means of
remaining competitive relative to its cost structure and market prices. This requires the organization
to have operational efficiencies that its competitors lack, a higher rate of employee productivity than
its competitors, and/or a product or service for which consumers are willing to pay a premium price.

With a lag policy, the organization compensates employees below the rates of competitors. An
organization employing this strategy attempts to compensate employees through some other means,
such as opportunity for advancement, incentive plans, good location, good working conditions, or
employment security. The organization believes that work-related outcomes are multifaceted and,
more important, that employees consider more than just salary in weighing their employment
options. An organization employing a lag policy needs strong insights into the personal and lifestyle
choices of the employees it recruits to allow it to tailor compensation options for these individuals
that will allow them to accept a lower base salary than that offered by the competition.

With a market policy, the organization sets its salary levels equal to those of competitors. An
employer following this strategy attempts to neutralize pay as a factor in applicant decisions,
assuming that it can compete in the labor market in attracting employees by other means such as
those listed in the discussion of lag policy. It should come as no surprise that the majority of
employers set their salary levels at or very near market levels. Such a strategy assumes that
employees are less likely to leave if their salaries would remain the same with a new employer.

Individual Equity

Individual equity considers employee perceptions of pay differentials among individuals who hold
identical jobs in the same organization. Determining individual salary levels and pay differentials
among employees in identical jobs can be done in a number of ways. The most basic is basing
pay on seniority. Seniority-based systems determine compensation according to the length of
time on the job or length of time with the employer. Although this rewards a stable and experi-
enced workforce, it has no direct relationship to performance on the job. Seniority systems are
very common in union settings. They are also usually looked upon favorably by the court system
because they are objective in nature. However, they provide little incentive to be more productive,
and they encourage workers who may be mediocre or substandard performers to remain with the
organization.

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498 | Part 2 Implementation of Strategic Human Resource Management

Merit pay systems compensate individuals for their proven performance on the job. Ideally,
they provide an incentive for employees to work harder and accomplish more. Merit pay is gener-
ally permanently added to an employee’s base pay. However, in practice, merit pay can be quite
problematic. Because merit-based pay systems are anchored by the organization’s performance
feedback system, they can extend the subjectivity that is inherent in the feedback system. If an
employee believes that the performance feedback process is biased or unfair, a compensation sys-
tem that is based on this process can further add to the employee’s perceptions of unfairness. Any
merit-based pay plan must ensure that the performance feedback upon which it is built is under-
stood and accepted by employees.

An increasing number of organizations are using incentive pay to compensate their employ-
ees. Incentive plans allow the employee to receive a portion of his or her compensation in direct
relation to the financial performance of the individual, unit, or entire organization. Incentive pay
is provided for a given time period and is not added to the base salary. Consequently, it must be
re-earned in subsequent time periods and can have a greater motivational impact than merit pay.

The philosophy behind this compensation system is to reward higher levels of performance
by returning financial rewards to the employees who have been responsible for creating them.
Incentive pay programs also allow organizations to adjust their compensation expenses based on
organizational performance. These plans can take a variety of forms, such as commission sales
plans, profit-sharing plans, gain-sharing plans (in which cost savings are partially distributed to
those responsible for them), and stock ownership, distribution, or option plans. Incentive plans
also differ from merit pay plans in that the former are based on objective, measurable financial
performance; the latter are based on subjective, generally nonfinancial performance-related criteria.
A well-designed incentive pay plan can be the deciding factor in an applicant’s decision to accept
or reject a job offer when base compensation is set at market level and nondistinguishable from
that of competitors.7

Performance-based pay that is variably tied into an employee’s, work unit’s, or organization’s
results is popular with both employers and employees. Performance-based pay—which was until
recently offered to senior executives only—is now extended to many other employees, as organiza-
tions realize how variable compensation programs can impact individual employees’ behavior and
performance. Approximately two-thirds of U.S. companies offer some form of variable
performance-based pay, and about 10 percent of all compensation paid in the United States is var-
iable.8 More important, one survey found that employers who provide variable performance-based
pay to their top employees are 68 percent more likely to report outstanding bottom-line financial
performance than those who do not.9

Performance-based pay plans are not limited to the private sector. Pay-for-performance plans
have also been implemented successfully in the public sector, as illustrated in Reading 11.2, “The
Development of a Pay-for-Performance Appraisal System for Municipal Agencies: A Case Study,”
which further illustrates the critical link between performance management and compensation
programs.

One important consideration in the shift from straight salary to incentive compensation is the
fact that incentive compensation will usually lower the base salary an individual receives in
exchange for incentives that could significantly raise overall compensation. Not all employees,
however, will find such a trade-off attractive, as illustrated below.

Joe Torre and the New York Yankees

In October 2007, the sporting world was stunned when Joe Torre parted ways with the New
York Yankees baseball franchise. Torre had managed the Yankees for 12 seasons, and in each
of those seasons had led the Yankees to the postseason, including four World Series cham-
pionships. However, the 2007 season ended for the Yankees with elimination during the first
round of the playoffs for the third consecutive year. At the time, Torre was the highest paid
manager in baseball, having earned $7.5 million for the 2007 season.

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Chapter 11 Compensation | 499

Team owner George Steinbrenner, hungry for another World Series championship,
decided to offer Torre an incentive compensation package. Torre’s base salary for 2008
would be reduced to $5 million but with incentives of an additional $3 million possible,
with $1 million being awarded for each successive level of Yankee postseason success. The
incentive-laden, short-term contract with a 33 percent decreased in base salary caused Torre
to leave the Yankees and sign a $13 million, 3-year contract with the Los Angeles Dodgers
two weeks later.

Incentive pay is popular with employers, in part because it is self-funded. Because it is tied to
specific financial performance of a division or the entire organization and is not paid unless spe-
cific measurable financial metrics are achieved, it can and should appeal to even the most fiscally
conservative organizations. The flexibility of variable compensation programs allows them to be
tailored to organization-wide, divisional, team, or individual performance—or some combination
thereof—depending on the interdependence present in jobs as well as organizational strategy. Per-
haps their greatest value is that variable compensation programs, if well communicated and imple-
mented, allow employees to fully understand the organization’s goals and objectives as well as how
their individual jobs impact organizational performance.

Pay-for-performance plans have been identified as a means of aligning the interests of
employers and owners. One study compared pay-for-performance plans with a fixed salary com-
pensation program and found that the former resulted in significantly higher productivity and
overall financial performance.10 This is because pay for performance generally attracts higher qual-
ity applicants, which has a net effect of lowering unit cost of production or service delivery. Not
surprisingly, higher performing employees show a marked preference for pay-for-performance
compensation programs over salaried compensation without incentives. However, employers need
to monitor such programs to ensure that employees do not focus excessively on incentive-
producing tasks and behaviors that result in individual financial rewards at the expense of other
important tasks or goals.

Team-Based Incentive Pay at Children’s Hospital Boston

The accounts receivable department at Children’s Hospital Boston was suffering from low
morale and inefficiencies after an unsuccessful change to a new billing system. With an aver-
age of more than 100 days from billing to payment, the organization was facing serious cash
flow concerns in its fiscal operations. To alleviate this, the management developed a team-
based incentive plan that would allow employees to see the relationship between quarterly
cash flow and the number of days a bill spent uncollected in accounts receivable. Employee
centered, the program allowed team members to set three possible goal levels—threshold, tar-
get, and optimal—with corresponding rewards of $500, $1,000, and $1,500 for the attainment
of each. Meetings were set up with employees to explain the program and obtain employee
input and support. Employees suddenly began to feel important, empowered, and energized:
Weekly progress reports allow employees to self-monitor their progress. During the first year,
the average number of days a bill spent in accounts receivable was reduced from more than
100 days to 76, and during the second year, the average was reduced to the mid-60s—and the
satisfaction with the program has reduced employee turnover in the department.11

While performance-based rewards can be tremendous motivators and allow employees to see
a stronger connection between their performance and organizational performance, they are clearly
not for every organization. Cultural barriers, both institutional and national, can act as impedi-
ments to the successful implementation of a performance-based pay plan. Japanese conglomerate

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500 | Part 2 Implementation of Strategic Human Resource Management

Fujitsu was the first Japanese organization to implement such a compensation plan. Hailed as a
breakthrough and revolutionary when first introduced, the program ignited a trend in Japanese
organizations to abandon archaic pay systems based almost entirely on seniority in favor of
performance-based plans. After eight years, however, Fujitsu abandoned the program, calling it
“flawed” and a poor fit with Japanese culture that respects and rewards loyalty and seniority. In
addition, to maintain a positive self-image, employees fought to keep the performance standards
under the plan as low as possible for fear of falling short and being embarrassed. Innovation was
stifled, as employees resisted change, fearing that results might not accompany the change.12

Skill-based pay systems have been increasing in popularity in recent years because of the ease
of measurement of many specific skills and because skills relating to the organization’s strategy
can be readily identified. Skill-based pay involves basing the employee’s compensation on the
acquisition and mastery of skills used on the job. Skill-based pay programs not only give employ-
ees incentives to learn new skills or upgrade existing ones, but they also promote flexibility for the
organization. They can easily be linked with training programs and the strategic needs of the orga-
nization. During the strategic planning process, the organization must determine which kinds of
employee skills are most critical to its objectives and future success. Then, the organization must
hire employees either with these skills or with the capacity to learn these skills.

Despite their popularity, skill-based pay systems are not without problems. Employers should
remember that the acquisition of skills and improved performance are two different things. Skill-
based pay systems are often based on the acquisition of skills, without regard to whether the
employee has successfully transferred the training to the work setting or achieved any results
from the skill-based training. In a rapidly changing work environment, skill obsolescence may
result in a pay system that compensates employees for previously learned skills that have become
outdated and are no longer of value to the employer. Most employees would find it unfair for the
organization to reduce compensation because it no longer values certain employee skills, particu-
larly if the organization has not provided opportunities for employees to upgrade their skills.
Employers need to implement skill-based pay plans very carefully and with a clear sense of what
the future might hold for how work is performed.

Team-based pay plans are also becoming more prevalent in many organizations. With more
work and responsibility being centered on self-managed teams, such compensation plans provide
incentives to cooperate and be more flexible in working with others in achieving group and orga-
nizational objectives. Administering team-based pay systems can be less time consuming than
administering individual reward systems. However, team-based pay plans may impact group
dynamics and can adversely impact and intensify conflict within a unit, particularly if team mem-
bers feel that certain teammates are not doing their share of the work and living up to their
responsibility to the team. Such free riders can also greatly damage morale and enthusiasm for
the plan.13 Team-based pay plans present a key strategic issue for organizations in determining
the percentage of overall employee compensation that should be based on team rather than indi-
vidual performance. Consequently, team-based pay plans may require the oversight and attention
of supervisors, particularly in their early stages of implementation.14

Team-based pay systems need a decentralized decision-making system that gives the team
some autonomy and responsibility to be successful; they also need to be tied into specific measures
of accountability and results. To the extent that they foster unhealthy competition and conflict
among different teams within an organization, they can have adverse effects on overall perfor-
mance. Although team-based pay plans may make sense given the changing nature of work and
the emphasis on project teams and groups, their potential impact on both individual teams and
intra-team relations and performance needs to be assessed before the plan is implemented. Despite
the changing nature of job design, technology, and work relationships, certain organizations may
find that their culture does not support the team-based pay concept. Team-based pay plans must
be implemented within the context of an organizational culture that values sharing and collabora-
tion, cooperation, and open communication.

While many employers realize the critical role that effective teams play in the success of their
organization, few have been able to implement compensation systems that encourage and reward
team effort. The few that have done so find that three criteria influence the success of such a plan.

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Chapter 11 Compensation | 501

First, there has to be a high level of communication with employees regarding the details of the
plan. Second, employees should have a voice and provide input into the design and implementa-
tion of the plan. Third, team members need to feel that the system is fair and equitable.15

Team-Based Pay at Phelps Dodge

Phoenix, Arizona–based Phelps Dodge has a copper-mining operation that employs more
than 4,200 individuals at six North American locations. When the employees decided to
decertify their existing labor union, the management saw a golden opportunity to create a
more incentive-based compensation system. The new plan involves a base salary, with
bonuses awarded for meeting team-based goals set for a specific location or mine. Goals are
set by team members, and the compensation is constantly being evaluated through the feed-
back provided by employees.16

Legal Issues in Compensation

Those designing compensation systems must also bear in mind that compensation is a condition
of employment covered under Title VII of the Civil Rights Act of 1964. The design of any com-
pensation system that intentionally or unintentionally discriminates against any protected class
can subject the organization to legal action. The Equal Pay Act of 1963 also partially regulates
compensation and must be considered when designing and administering compensation programs.
These laws were discussed in Chapter 7.

Critics of the Equal Pay Act have noted that it has been of limited value because men and
women are often not employed in the same jobs, and the Act only requires equal pay for equal
work. To combat this limitation, the concept of comparable worth has been advanced. Compara-
ble worth argues that the standards of equal pay for equal work should be replaced with the doc-
trine of equal pay for equal value. Because many occupations, although becoming more gender
integrated, are still somewhat gender segregated, women and men generally do not hold the same
jobs or do the same work in our economy, so the Equal Pay Act does nothing to relieve the lower
wages that women receive relative to men. For example, in a warehouse, men might be working
on the loading dock, and women might be working in the office. Men will invariably be paid
more, but the Equal Pay Act cannot address this because the jobs being performed by men
and women are not the same. Comparable worth would argue that the work being done in the
office (bookkeeping, clerical, and switchboard) has as much value as and is as important to the
organization as that being done on the loading dock and should be compensated similarly.

Comparable worth of two different jobs, however, remains very difficult to prove because of the
lack of objective, measurable data that would support an assessment of job value. Gender stereotyp-
ing of certain jobs creates an additional obstacle in this regard. For example, the majority of school-
teachers (particularly in elementary schools), secretaries, nurses, and flight attendants are female.
Although the courts have been sympathetic to arguments for comparable worth, they have been
extremely reluctant to take action because the doctrine falls outside existing federal law. In addition,
the value of a particular job is very difficult to objectively determine and prove in a legal arena.
Comparable worth may be our society’s best hope for narrowing the gender gap in wages, in which
women consistently have been found to earn 70–75 cents on the dollar of what men earn.17 This is
particularly true given that the Equal Pay Act does have exclusions that allow gender-based pay dif-
ferentials to exist. Comparable worth, however, will most likely remain an unenforceable ideal until
laws are passed that specifically address it. Equal pay for equal work is still the standard; the courts
have refused to manufacture standards and policies that have not been legislated.

One additional law that impacts compensation is the Fair Labor Standards Act (FLSA) of
1938, which regulates the federal minimum wage, overtime policies, and the use of child labor.

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502 | Part 2 Implementation of Strategic Human Resource Management

It exempts from minimum wage and overtime requirements certain groups of employees (managers,
administrators, outside salespeople, and professionals) who exercise independent judgment in carry-
ing out their job duties. However, there has been significant controversy concerning whether certain
types of sales positions, temporary employees, and independent contractors are legally considered
employees and/or covered under the FLSA. As nontraditional employment relationships continue
to develop, this Act will require the courts to increase scrutiny of the legal status of such nontradi-
tional employees. In the interim, companies that employ these workers will have to exercise caution
when designing compensation programs to ensure that they follow the law.

The FLSA has caused numerous problems for employers in recent years. Because it was writ-
ten and passed long before our economy became based on services, knowledge, and information
technology, Congress was unable to anticipate many of the changes that would take place relative
to the nature of jobs, work, and organizational life. Problems have arisen because of the ambiguity
of the law regarding specifically who is covered under the Act and is therefore eligible for overtime
pay. In response, there have been a number of high-profile class-action lawsuits that have resulted
in major payouts by employers. RadioShack recently settled a class-action lawsuit for $30 million
that was filed by managers who claimed that they were classified improperly under the Act in an
attempt to avoid paying them overtime.18 Similar settlements were offered by Starbucks ($18 mil-
lion), Rite Aid ($25 million), and Pacific Bell (two separate cases settled for $35 million and
$27 million).19 Such responsibilities and consequences are not limited to large organizations. A
small chain of three Asian restaurants in the New York City suburbs was recently fined more
than $1 million by the U.S. Department of Labor to settle violations of minimum wage and over-
time provisions for 255 employees. In addition to these payments for back wages and interest, the
employer was also required to pay nearly $100,000 in civil penalties.20 While the U.S. Department
of Labor offers employers a comprehensive FLSA compliance assistance program, much confusion
still exists and lawsuits continue to be filed.

In 2006, Congress amended the FLSA to provide some additional clarification as to which
employees are exempt from its provisions. Under the revised FLSA standards, an employee is
exempt from FLSA coverage if he or she is paid a minimum salary of $455 per week, has primary
duties that involve “management,” customarily oversees at least two employees, and has the author-
ity to hire and fire or provide recommendations for hiring and firing. This standard of hiring/firing
decision making or participation has become critical in determining FLSA exempt status.

Executive Compensation

One important and controversial area of compensation concerns the pay received by executives.
There is no real average or standard for executive compensation, largely because of differences
between industries as well as between organizations within a given industry. The demand for tal-
ented CEOs and other chief officers who can generate results for shareholders often results in sig-
nificant compensation packages. Typically, a senior executive receives no more than 20 percent of
annual compensation in the form of salary, with the remainder usually divided between annual
(30 percent) and long-term (50 percent) incentives.21

Executive compensation has been criticized for its excessiveness as well as for the fact that it
is often unrelated to actual performance. In 1980, the average CEO made 42 times the average
hourly worker’s pay; by the year 2000, average CEO pay had grown to 531 times the average
hourly workers pay.22 Forbes magazine reported that in 2013 utility company CEOs were earning
475 times the average employee salary in that sector.23 More so, a CNNMoney report noted that
Apple CEO Tim Cook’s 2011 $378 million salary was 6,258 times the annual pay of the average
Apple employee.24 These compensation differentials are even more noteworthy in comparison to
Great Britain, Canada, and Japan, where average CEO pay is 22, 20, and 11 times that of the aver-
age employee wage, respectively.25

Recent corporate accounting scandals in which executives reaped millions of dollars in com-
pensation while their organizations were going bankrupt has drawn even more attention to execu-
tive compensation. The lesson learned from the Enron scandal is that heavy reliance on stock

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Chapter 11 Compensation | 503

options as part of executive compensation can create a culture obsessed with improving stock per-
formance at the expense of all other concerns. Nonetheless, stock options remain a key component
of executive compensation packages.

In response to the growing number of corporate scandals of the early 2000s, Congress passed
the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Dodd-Frank requires
all publically traded companies to enact executive compensation policies under which employers
could recover any and all incentive-based compensation paid out to executives during the previous
three years when company financial reports or performance were restated or revised. These “claw-
back” provisions apply to all company executives and greatly expanded the scope of the Sarbanes-
Oxley Act of 2002, which allowed such action only against the CEO and chief financial offer and
then only when the subjected individual had consciously engaged in fraudulent reporting. Dodd-
Frank allows retrieval of financial benefits paid to executives regardless of whether or not any
error was deliberate or the affected executives were aware of the error.

Stock options provide employees with the opportunity to purchase shares at some future date,
at a price that is determined at the time the options are awarded. They are designed to focus
employee attention on creating shareholder value, and in doing so, employees are also able to
reap the benefits of the organization’s financial performance. However, stock options can prompt
executives to engage in creative accounting practices in which revenues and profitability are artifi-
cially inflated, driving up the value of the stock and the options. In addition, stock options are
deductible on corporate income taxes despite the fact that they do not have to be reported as
expenses in the organization’s financial reports.26

Several large organizations, including Coca-Cola and Bank One Corp., however, have volun-
tarily decided to expense stock options offered to employees. Designed to ease concerns in the
investment community in light of the recent accounting scandals, this move will make earnings
appear lower. Ideally, this may reduce the use of stock options, particularly among rank-and-file
employees, as stock options and cash will cost the organization an identical amount. With stock
options requiring more time and recordkeeping for the organization and oversight by employees,
both employers and employees might find simple equivalent cash compensation more efficient
than stock options. Regardless of the decisions that individual organizations make regarding the
future of stock options, those organizations that continue to offer stock options to executives as
well as other employees will now find their compensation practices more carefully scrutinized by
those outside the organization.

A number of employers have been moving away from stock options and instead compensat-
ing employees, particularly executives, with stock grants.27 Stock grants require that the organiza-
tion meet specific financial goals, such as a given return on capital or return on assets, as a
condition of their issuance. At the same time that organizations have been moving away from
stock options, there has been a marked trend in privately held organizations offering equity stakes
as part of executive compensation packages. Designed largely to allow these privately held organi-
zations to compete with publically held organizations for executive talent, such plans are now
offered by 43 percent of private employers. A recent study from Pricewaterhouse Coopers found
that the typical compensation package for executives at the fastest growing privately held organiza-
tions generally consists of 74 percent base salary, 16 percent annual performance incentives, and 5
percent each of long-term cash and equity-based incentives. The survey further found a trend
toward privately held employers basing an increasing percentage of executive compensation on
performance and longer-term measures.28

The “pay for performance” trend among executives has also made its way into the board-
room. Coca-Cola recently announced a radically new plan for director compensation. Typical
director compensation includes cash and/or stock options. In Coke’s case, this amounted to
$50,000 cash and $75,000 in options annually. However, under the new plan, all director compen-
sation was to be performance based. Directors would receive annual $175,000 option packages
only if the organization posted annual compound growth in earnings per share of 8 percent.
Coke saw this as a necessary step in light of the fact that the organization had been struggling
financially for a number of years, as sales of its flagship products slipped and its expansion into
noncarbonated drinks produced mixed results.29

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504 | Part 2 Implementation of Strategic Human Resource Management

Executive compensation decisions are among some of the most important policy decisions
made today. Because the demand for seasoned, talented executives greatly exceeds the supply of
such and with increasing rates of turnover in CEO positions, organizations need to carefully strat-
egize their executive compensation packages.

Conclusion

Organizations face a number of key strategic issues in setting their compensation policies and pro-
grams. These include compensation relative to the market, the balance between fixed and variable
compensation, utilization of individual versus team-based pay, the appropriate mix of financial
and nonfinancial compensation, and developing an overall cost-effective program that results in
high performance.

In addition to these strategic issues, the fast pace of change in our society and the corre-
sponding need for organizations to respond to remain competitive create challenges for all HR
programs but particularly for compensation. Probably more now than at any time in the past,
organizations need to re-evaluate their compensation programs within the context of their corpo-
rate strategy and specific HR strategy to ensure that they are consistent with the necessary perfor-
mance measures required by the organization. Overly rigid compensation systems inhibit the
flexibility needed by most contemporary organization’s competitive strategies, so it is no surprise
to see such flexibility being incorporated into compensation systems.

At the same time, organizations wishing to be more innovative may need to alter their com-
pensation systems to promote more intrapreneurial behavior that encourages employees to act as
risk-taking entrepreneurs. Similarly, smaller entrepreneurial organizations will usually need differ-
ent compensation systems than their larger counterparts. Organizations taking a strategic
approach to compensation realize the need for creativity to meet strategic objectives. Also, within
a given organization, different compensation programs may be needed for different divisions,
departments, or groups of employees. Compensation systems must grow and evolve in the same
manner as the organization to ensure that what is actually being rewarded is consistent with the
organization’s strategic objectives. This link between strategy and compensation is essential for
ensuring optimal performance.

Critical Thinking 6. Is performance-based pay effective? Why or why not?
How can performance-based pay systems be better
1. Does money motivate employees? Why or why not? designed to ensure optimal results?

2. Why should compensation systems be equitable? How Reading 11.1
can an organization design an equitable compensation
system? 7. What are the advantages and disadvantages of organiza-
tional policies that mandate pay secrecy? Consider this
3. Compare and contrast the four job evaluation methods. question from the perspective of managers, employees,
Give an example of an organization in which each of the and owners. Is pay secrecy a good practice?
four methods might provide an optimal strategic fit.
Reading 11.2
4. Discuss the pros and cons of employee pay being fixed
versus variable and dependent on performance. How 8. What obstacles exist to developing pay-
might such decisions impact recruiting, motivation, for-performance plans in the public sector? How can
and retention? these obstacles best be overcome? Do public sector
pay-for-performance plans differ from those found in
5. Analyze your current job responsibilities. Determine the private sector?
whether the method by which you are compensated is
appropriate.

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Chapter 11 Compensation | 505

Exercises 3. Visit the Web site http://www.salary.com. Click on
“salary trends” and then prepare a brief report on the
1. Briefly interview an employee in his or her 20s, 30s, latest developments in compensation practice.
40s, 50s, 60s, and 70s. Determine what motivates
workers from different generations and design com- 4. At the same Web site, click on “salary wizard.” Select a
pensation plans for each generation that would result job category and then determine the median compen-
in high performance. sation figures for this position in eight different loca-
tions within the United States. Should an organization
2. Is salary compression an issue at your college or univer- that operates in these different locations pay different
sity? If so, what are its effects, and how is it being han- salaries for identical work? Is cost of living a sufficient
dled? Interview administrators and individual faculty to explanation for an employee who senses inequity?
gain a sense of the extent of the problem, how serious it
is perceived as being, and how it is being managed.

Chapter References

1. Sunoo, B. P. “Blending a Successful Workforce,” 12. Tanikawa, M. “Fujitsu Decides to Backtrack on
Workforce, March 2000, pp. 44–48. Performance-Based Pay,” New York Times, March 21,
2001, p. W1.
2. Chen, H.-M. and Hsieh, Y.-H. “Key Trends of the Totals
Reward System in the 21st Century,” Compensation and 13. Heneman, F. and Von Hippel, C. Interview in the Wall
Benefits Review, 38, (6), Nov–Dec 2006, pp. 64–70. Street Journal, November 28, 1995, p. A1.

3. Adams, J. S. “Toward an Understanding of Inequity,” 14. Albanese, R. and VanFleet, D. D. “Rational Behavior in
Journal of Abnormal and Social Psychology, October Groups: The Free-Riding Tendency,” Academy of
1963, pp. 422–436. Management Review, 10, 1985, pp. 244–255.

4. Wellner, A. S. “Salaries in Site,” HR Magazine, May 15. McClurg, L. N. “Team Rewards: How Far Have We
2001, 46, (5), pp. 89–96. Come?” Human Resource Management, 40, (1), pp. 73–86.

5. Shea, T. F. “Send Employees a Message—About Their 16. Garvey, C. “Steer Teams with the Right Pay,” HR
Pay,” HR Magazine, December 2002, 47, (12), p. 29. Magazine, May 2002, 47, (5), pp. 71–78.

6. Fisher, C. D., Schoenfeldt, L. F. and Shaw, J. B. Human 17. U.S. Bureau of the Census. Current Population Reports,
Resource Management, 4th ed, Boston: Houghton No. P60-197, Washington, DC: U.S. Government
Mifflin Co., 1999, p. 560. Printing Office, 1997.

7. Williams, V. L. and Grimaldi, S. E. “A Quick Break- 18. “RadioShack Agrees to Pay $30 Million to Settle Suit,”
down of Strategic Pay,” Workforce, 78, (12), December Baltimore Sun, July 17, 2002.
1999, pp. 72–75.
19. Clark, M. M. “FLSA: Will Ya Still Need Me When I’m
8. Bates, S. “Pay for Performance,” HR Magazine, January 64?” HR News, October 2002, p. 3.
2003, 48, (1), pp. 31–38.
20. FLSA Violations Cost Restaurant Chain More than $1M.
9. Ibid. Society for Human Resource Management, January 22,
2013. Available at http://www.shrm.org/legalissues/statean
10. Cadsby, C, Song, F. and Tapon, F. “Sorting and Incentive dlocalresources/pages/ny-FLSA-Violations-Restaurant.aspx
Effects of Pay for Performance: An Experimental Inves-
tigation,” Academy of Management Journal, 50, (2), 21. Overman, S. “Executive Compensation to Undergo
2007, pp. 387–405. Intense Scrutiny,” HR News, May 2002, p. 1.

11. Cadrain, D. “Put Success in Sight,” HR Magazine, May 22. Patel, D. “The Evolution of Compensation,” Work
2003, pp. 85–92. Visions, No. 3, 2002.

Copyright 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

506 | Part 2 Implementation of Strategic Human Resource Management

23. Silverstein, K. “Are Utility CEO Pay Packages Fair 26. Bates, S. “More Firms Take High Road by Expensing
Compared to Average Workers?” Forbes, April 7, Stock Options,” HR Magazine, August 2002, 47, (8),
2013. Available at http://www.forbes.com/sites/kensil p. 10.
verstein/2013/04/07/are-ceo-pay-packages-fair-compared-
to-average-workers/ 27. Gerena-Morales, R. “Balancing Pay and Performance,”
South Florida Sun-Sentinel, May 23, 2003, p. 1 E.
24. Fortune 50 CEO Pay vs. Our Salaries. Available at
http://money.cnn.com/magazines/fortune/fortune500/ 28. “Public, Private Exec Comp Programs Increasingly
2012/ceo-pay-ratios/ Similar,” HR Magazine, 53, (1), January 2008, p. 12.

25. Cossack, N. “Designing Executive Compensation Plans,” 29. Terhune, C. and Lubin, J. “In Unusual Move, Coke
Society for Human Resource Management, December 29, Ties All Pay for Directors to Earnings Targets,” Wall
2011. Available at http://www.shrm.org/templatestools/ Street Journal, April 6, 2006, pp. A1, A11.
toolkits/pages/executivecompensationplans.aspx

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

Chapter 11 Compensation | 507

READING 11.1

Exposing Pay Secrecy

Adrienne Colella, Ramona L. Paetzold, Asghar Zardkoohi and Michael J. Wesson

Pay secrecy is a contentious issue in many organizations and a The authors of the second memorandum then walked around
controversial one in our society. However, there has been little the office with signs stating their salaries hanging from their
scholarly research on this topic. We hope to address this void necks, leading the organization to give up its pay secrecy pol-
by exposing the complexity of pay secrecy as a construct. What icy. This anecdote describes the managerial viewpoint toward
are its costs and benefits? What factors affect the link between pay at a magazine where humorist Robert Benchley worked
pay secrecy and the extent to which it is a cost or benefit? This in 1919. Although Benchley and his coworkers chose a witty
article reveals the complexity of pay secrecy and, we hope, gen- manner in which to voice their discontent with the maga-
erates ideas for much new research in the broad management zine’s pay secrecy policy, one perhaps different from how
field. you or we would have chosen to respond, pay secrecy itself
remains a serious, contentious issue in organizations today.
Pay secrecy in organizations is a contentious issue and
has been for a long time. Take, for example, the following For example, Mary Craig, an assistant cook for an Ohio
memoranda that were exchanged in October of 1919: nursing home, was fired in 1997 after discussing her pay with
her coworkers. Although the nursing home had told her
POLICY MEMORANDUM (October 14, 1919) never to discuss pay so as to avoid “hard feelings” among
Forbidding Discussion among Employees employees, she violated the mandate after listening to other
of Salary Received workers’ complaints of being shortchanged on overtime or
not receiving a promised raise. A federal appellate court
It has been the policy of the organization to base salaries affirmed the National Labor Relations Board’s (NLRB) deter-
on the value of services rendered. We have, therefore, mination that the nursing home had to reinstate her with
a long established rule that the salary question is a back wages (NLRB v. Main Street Terrace Center, 2000).
confidential matter between the organization and the
individual. Intuition tells us that there must be detriments flowing
from pay secrecy. What is the big deal about how pay is dis-
It is obviously important that employees live up to tributed if we are not supposed to know about it? Why is our
this rule in order to avoid invidious comparison and dis- organization treating us as though we cannot handle knowl-
satisfaction. Recently several cases have come to the edge of others’ pay? What if our pay reflects illegal discrimi-
notice of management where employees have discussed nation? And, if we cannot determine what pay levels are
the salary question among themselves. possible, wouldn’t pay secrecy actually demotivate us so that
our performance levels would be expected to drop?
This memorandum should serve as a warning that
anyone who breaks this rule in the future will be instantly In fact, the limited empirical research has shown that
discharged. pay secrecy leads to employee dissatisfaction and low moti-
vation (e.g., Burroughs, 1982; Futrell & Jenkins, 1978). In the
POLICY MEMORANDUM (October 15, 1919) scanty compensation literature addressing pay secrecy,
Concerning the Forbidding of Discussion researchers argue, in general, that pay secrecy is bad for orga-
among Employees nizations, also demonstrating lowered motivation (Bartol &
Martin, 1988; Lawler, 1965a,b, 1967; Leventhal, Karuza, &
We emphatically resent both the policy and working of Fry, 1980; Milkovich & Anderson, 1972). Thus, the state of
your policy memorandum of October 14. We resent being empirical knowledge continues to suggest that pay secrecy is
told what we may and what we may not discuss, and we negative for both individuals and organizations. Further, evi-
protest against the spirit of petty regulation which has dence of the negative effects of pay secrecy include its being
made possible the sending out of such an edict (Robert viewed as a way for organizations to hide pay discrimination.
Benchley, cited in Steele, 1975: 102–103). In fact, England recently passed legislation permitting
employees who suspect pay discrimination to request detailed

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508 | Part 2 Implementation of Strategic Human Resource Management

pay information from their supervisors (BBC News, 2004), information about pay, such as pay ranges and/or average
suggesting a growing awareness that pay secrecy may be pay raises, but fail to give precise individual-level information
costly to society by covering discriminatory practices. about employees. Third, the employer may restrict the man-
ner in which pay information is disseminated. For example,
However, current attitudes and practices suggest that the employer may encourage strong norms against discussing
there may be beneficial aspects to pay secrecy. First, surveys pay, even if pay information is technically publicly available.
asking how people feel about pay secrecy indicate that the In this case the employer may actually threaten to impose
majority of U.S. workers are in favor of it (Hrnext.com Sur- heavy sanctions against employees who disclose pay or
vey, 2001; Walsh, 2000). Furthermore, many organizations engage in discussions about it.
seem to employ some form of pay secrecy. Employer surveys
(Balkin & Gomez-Mejia, 1985; Hrnext.com Survey, 2001) and The traditional venue for discussions of pay—the com-
anecdotal data (e.g., Pappu, 2001; Walsh, 2000) indicate that pensation literature—identifies several dimensions of pay:
some form of pay secrecy is prevalent in many organizations, pay level, pay structure, the basis for pay, and the form of
despite its potential illegality (e.g., Fredricksburg Glass and pay (see Gerhart & Rynes, 2003). Although pay secrecy can
Mirror, 1997; NLRB v. Main Terrace Center 2000). This evi- range across these various dimensions, the traditional focus
dence seems to suggest that individual employees and many has been on pay level itself (i.e., the average pay across jobs;
organizations find pay secrecy useful and desirable. Gerhart & Rynes, 2003). Because we are interested in advanc-
ing the discussion about pay secrecy as a general construct,
Thus, although the academic research of the 1960s and and because we also do not want to limit ourselves to a micro
1970s (e.g., Futrell & Jenkins, 1978; Lawler, 1965a,b, 1967; human resource (HR) focus but intend, rather, to write for a
Milkovich & Anderson, 1972) seems to leave us with one much broader audience, we focus on pay-level discussions
view of pay secrecy—that it presents costs to organizations and avoid the complexities of compensation systems. In
because, among other things, individual employees should other words, when we speak of pay secrecy, we are talking
not want it—there has been no scholarly investigation that about the lack of information that employees have about
we are aware of since then to determine whether there may the level of other employees’ pay in the organization.
also be benefits to organizations. No organizational scholars
have investigated how individual demands and organiza- Although much prior research has conceptualized pay
tional practices can continue to be at such odds with this secrecy as all-or-nothing, we argue that it is best understood
dated academic knowledge. along a continuum. Thus, for us, pay secrecy is conceptualized
as representing the amount of information about pay available
In this article we discuss the apparently contradictory to employees. Burroughs (1982) was the first to hint at such a
positions about pay secrecy and argue that there is no simple continuum when he referred to examples of how different
answer to the question of whether pay secrecy is beneficial or organizations could have varying levels of pay secrecy, with
detrimental to individuals and organizations. Instead, we the most secret anchor being represented by organizations in
posit that the effects of pay secrecy depend on a variety of which no information is provided to employees other than
factors that render it sometimes valuable or of benefit to their own pay and salary increase. The least secret (or most
employers and employees and other times costly. Throughout open) anchor reflects organizations where information about
the course of our discussion, we examine arguments based on specific pay levels and increases for individuals is made avail-
management, economics, psychology, and cultural perspec- able to all employees. We base our view on Burroughs’. In
tives to look at the role of pay secrecy in our lives and to addition, we assume that any costs and benefits of pay secrecy
suggest avenues for further study. Our ultimate goal is to become more extreme as pay becomes more secret.
reopen the discussion of pay secrecy in organizations so
that new empirical work in this area can be generated. We Finally, we assume throughout that organizations are
first turn to a definition of pay secrecy. making good faith efforts to provide equitable compensation
and that compensation accurately reflects an individual’s
What Is Pay Secrecy? contribution to the organization, however that is determined.
Because equity is ultimately in the eye of the beholder, we
Although there is no one definition of pay secrecy, it can recognize that employees’ views on whether they receive
simply be viewed as a restriction of the amount of informa- pay that is fair may deviate from those of the organization.
tion employees are provided about what others are paid. In Thus, our discussion of pay secrecy will rely heavily on the
practice, however, pay secrecy can become quite complex. perceptions it creates in the minds of employees.
First, there is the issue of availability of information. An
employer may keep pay information secret by never provid- Why Is Pay Secrecy Interesting?
ing for its publication or release. Second, the employer may
restrict the type of pay information made available. For Based on earlier discussion, we find pay secrecy interesting
example, it may choose to provide certain aggregate because it obviously has the potential to apply to many people

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Chapter 11 Compensation | 509

across jobs, organizations, and industries (Balkin & Gomez- determine whether to disclose our pay and to whom. Thus,
Mejia, 1985; Hrnext.com Survey, 2001). Since pay secrecy its social and personal salience appears to be grounded in the
reflects a lack of information, one way of conceptualizing pay general resurgence of privacy concerns that are part of our
secrecy is in terms of pay uncertainty. Humans are generally evolving world.
motivated to reduce uncertainty or the discomfort that arises
from it (Lind & van den Bos, 2002) and, thus, can be expected One final, but not less important, aspect of pay secrecy
to engage in a variety of behaviors as a means of eliminating, that renders it interesting to us is the fact that it might well
reducing, or otherwise coping with pay uncertainty. In partic- be a culturally bound construct. Investigations of collectivist
ular, a host of cognitive biases in information processing are and individualist societies (Triandis, 1989) have indicated
known to result when judgments must be made under uncer- that Western cultures and economies reflect autonomous,
tainty (Kahneman & Tversky, 1973). Thus, the possible individualistic goals and values, whereas Eastern cultures
breadth of application of pay secrecy policies immediately and economies tend to reflect collectivistic, group-based
raises controversial issues about the extent to which U.S. goals and values. Thus, pay secrecy may not be as controver-
employees are making less than optimal decisions about jobs sial an issue in an Eastern culture. There, the tendency would
and career choices and what the impact might be on American be toward values that favor the collective (Triandis, 1989,
society. Although the answer to such a question is beyond the 1994). Moreover, members of the collective typically are not
scope of this article, the very nature of this consideration truly recognized as “others” completely distinct from the self,
enhances our interest in thinking about pay secrecy. causing the very notion of “others’ pay” and “referent others
for comparison” to be ill-defined. In addition, the collecti-
Additionally, part of the fascinating character of this vist’s sense of trust in the group or organization might be
topic stems from the fact that it is not a new concern but, expected to accompany lack of concern for what people
rather, one of continuing debate without many insights over other than oneself are making in the workplace. The interde-
the years. For example, pay secrecy was a major difficulty pendence that accompanies collectivism further suggests that
around the time of the passage of the National Labor Rela- a view of “what is good for one of us is good for all of us”
tions Act ([NLRA], 1935), because it was determined to would also tend to dominate and render pay secrecy less con-
interfere with the attempts of employees to unionize. Because troversial (Markus & Kitayama, 1991). Finally, individuals in
information about pay is so critical to employee behaviors collectivist cultures typically do not want to stand out from
and decision making, the NLRA continues to make enforced the group or compete with others in the group; pay secrecy
pay secrecy illegal in order to promote maximal employee would allow this to flourish. Thus, pay secrecy may always be
information about their job circumstances and workplace positive in an Eastern culture.
fairness (Bierman & Gely, 2004; Gely & Bierman, 2003).
Given this historical background, we would have expected In contrast, in Western cultures, individuals engage in
two things. First, its sheer illegality should have deterred self-construal that tends not to include general “other in
employers from using pay secrecy over the period since the self” enhancements (at least outside of close partners and
initial enforcement of the NLRA. Quite to the contrary, many friends; Mashek, Aron, & Boncimino, 2003). Thus, each indi-
employers willingly announce and promote their pay secrecy vidual in the workplace is seen as fairly autonomous and a
policies. For example, a survey of U.S. employers found that competitor for resources. Independence instead of interde-
36 percent of respondents indicated their companies prohib- pendence is associated with individualistic societies, implying
ited discussion of pay (Hrnext.com Survey, 2001). Second, the that each person’s welfare depends on his or her own efforts
controversial nature of this topic should have promoted and rewards. Pay secrecy reflects values emanating from this
extensive research in this area to build a nomological net- type of culture, and it is both supported and promoted by
work of understanding about the costs and benefits of pay more capitalistic societies that promote individual competi-
secrecy for individuals, organizations, and even society. No tiveness (Markus & Kityama, 1991). It may only be within
such comprehensive course of study exists. Western culture that pay secrecy can produce the costs that
are associated with it.
Pay secrecy also seems to reflect current social or cul-
tural values that are expressed or facilitated through its prac- What Are the Costs and Benefits
tice. One key value is that of privacy. Today, privacy concerns of Pay Secrecy?
are reawakening, as evidenced by relatively new legislation or
new awareness of older legislation (such as the Family Edu- Before turning to the focus of our article—that the costs and
cational Rights and Privacy Act [FERPA], 1974, and the benefits of pay secrecy depend on a variety of previously
Health Insurance Portability and Accountability Act undiscussed factors—it is essential to first lay out the costs
[HIPAA], 1996), as well as public outrage about technologi- and benefits themselves. In this section we first review the
cally possible behaviors, such as identity theft. Pay secrecy apparent costs of pay secrecy before turning to a discussion
promotes the notion that our own pay should be kept of the benefits. Perhaps surprisingly, some aspects of pay
private—that we, not the employer, should have the right to secrecy can turn out to be both costs and benefits, as we

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510 | Part 2 Implementation of Strategic Human Resource Management

will show. Further, factors adding an even greater level of be negative because, for example, the lack of information
complexity will be addressed in the next section of the restricts employee voice, permits inferences of bias, and sug-
paper. For now, we try to elucidate the major costs and ben- gests that decision making about pay may be done without
efits as seen by researchers and practitioners. accurate information. These deficits violate the known require-
ments for procedural justice to be perceived (Leventhal et al.,
Costs 1980; Thibaut & Walker, 1975).
There are at least three major costs to pay secrecy, according
to research scholars (who continue to challenge the use of Distributive fairness judgments can be expected to be
pay secrecy by organizations). First, employee judgments negative for two major reasons. First, inaccurate estimates
about fairness and their perceptions of trust may be sacri- about what referent others (Dornstein, 1989) are being paid
ficed. Second, employee performance motivation can be can be expected owing to the lack of information about pay.
expected to decrease. Third, from an economics perspective, Lawler’s seminal research (1965a,b) indicated that, in the
the labor market may be less efficient because employees will absence of individual pay information, managers overesti-
not move to their highest valued use. This would mean that mated the salaries of other managers at their own and
organizations are not obtaining the best employees for the lower levels and underestimated the salaries of managers at
jobs. Why, and from where, would these costs occur? higher organizational levels. (In other words, they tended to
compress the pay range.) The fact that those at lower levels of
Pay secrecy is about lack of information, thus producing the organization were perceived as having higher pay than
uncertainty for employees and an asymmetrical information was actually the case would lead to judgments of distributive
status between employees and the organization. Based on this unfairness, because they would arguably be making lesser
lack of information, employees may infer that pay outcomes contributions to the organization than was commensurate
and procedures for distributions are unfair, even when the with their perceived pay.
organization is making a good faith effort to provide equita-
ble compensation based on individual contributions. (Recall Second, fairness heuristic theory (Lind, 2001) states that
that this was an underlying assumption we made earlier.) people are likely to base specific fairness judgments on their
general impression of organizational fairness in the absence
One reason this might occur is because the uncertainty of other information. Thus, in the absence of information
of not knowing where employees stand with respect to others about pay, distributive fairness concerning pay level cannot
and the extent to which their contributions are valid may be known, and judgments about it will be inferred based on
lead to general anxiety about workplace worth. According judgments about other aspects of fairness. If procedural and
to recent work in the organizational justice literature on informational fairness judgments are negative, as indicated
uncertainty management theory (Lind & van den Bos, above, then distributive fairness judgments should be nega-
2002), increased uncertainty enhances the degree to which tive as well (van den Bos, Lind, Vermunt, & Wilke, 1997).
people care about fairness, because apparent fairness is one This reliance on other fairness judgments generally may be
way of coping with the anxiety generated by uncertainty. viewed as akin to use of the availability heuristic in prospect
When the environment is uncertain, people are able to gain theory (Kahneman & Tversky, 1973). In the absence of spe-
some degree of predictability of their future treatment by cific pay information, employees would be expected to rely
looking at how fairly they recently have been or now are on recent or vivid information that was readily available or
being treated. When treated fairly, people can develop trust accessible in memory. This information might well be other
and reduce their fears of being exploited in the future. When judgments about fairness regarding aspects of the
treated unfairly, however, they may take a defensive stance in organization—that is, even fairness judgments beyond those
an attempt to avoid exploitation. Thus, ceteris paribus, regarding pay could become relevant under pay secrecy.
employees who are faced with pay secrecy should be more
concerned about whether their pay is fair than employees Related to unfairness judgments resulting from pay
who are in positions where pay information is open. As a secrecy is the notion of distrust in the organization. We fol-
result, they may be more vigilant about the extent to which low Mayer, Davis, and Schoorman’s definition of trust as “the
pay and pay determination processes are fair, and this willingness of a party to be vulnerable to the actions of
becomes a cost when fairness judgments are negative. another party based on the expectation that the other will
perform a particular action important to the trustor, irrespec-
Unfortunately, under high levels of pay secrecy, judg- tive of the ability to monitor or control that other party”
ments can be expected to be negative for all three general (1995: 712). Pay secrecy should generally be expected to
types of fairness judgments: informational, procedural, and lower employees’ organizational trust. Research on organiza-
distributive (Bies & Moag, 1986; Colquitt, Conlon, Wesson, tional trust all points to the importance of managers’ open-
Porter, & Ng, 2001; Leventhal, 1976; Thibaut & Walker, ness with both themselves and others (Butler, 1991), since
1975). Obviously, judgments about informational fairness can this behavior suggests that management has both integrity
be expected to be negative because information is being with- and benevolence. Such openness has been shown to be a pri-
held. Judgments about procedural fairness can be expected to mary driver of trust (Mayer et al., 1995; Mishra, 1996).

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Chapter 11 Compensation | 511

Two other key factors strongly suggest that organiza- could perform in his or her current company or in another
tional trust should be affected by pay secrecy and its ensuing company with a pay secrecy policy, then that engineer may
judgments of unfairness. First, media attention to young, self- stay in the “wrong” job and be underemployed. Employers
made millionaires during the technology boom of the 1990s, cannot “lure” or “pull” good employees away from other
astronomical executive pay levels, and corporate scandals employers if they maintain pay secrecy, because they cannot
have highlighted the wide discrepancy in pay in American advertise current wage or salary levels. Thus, pay secrecy is one
society, tending to enhance perceptions that pay may be factor that prevents labor markets from clearing in an efficient
unfair. Pay secrecy in this environment enhances views of manner. This represents a cost to employees who could hold
this unfairness and corruption, suggesting that organizations better jobs, as well as to organizations that would prefer to hire
cannot be trusted. Second, pay secrecy signals that the orga- these employees. Economists would argue that there are social
nization does not trust its employees. costs imposed because of the inefficient use of human capital
in society (Williamson, 1985).
Pay secrecy should also reduce work motivation.
Because a pay-performance linkage underlies many theories Benefits
of motivation, one can argue that pay secrecy will reduce Although pay secrecy may have the foregoing costs, it is clear
motivation by breaking that linkage. The only study we are that it must also have benefits attached to it since it continues
aware of that examines this connection was conducted by to be relatively pervasive in organizational practice. Here we
Futrell and Jenkins (1978), who found that moving from identify three major benefits—organizational control, protec-
pay secrecy to pay openness resulted in increased perfor- tion of privacy, and decreased labor mobility—which we now
mance on the part of their sample of salespeople, suggesting discuss in detail.
that motivation was hampered by pay secrecy. This result
appeared to stem from an equity theory explanation: since One benefit of pay secrecy would be that it appears to
managers acting under pay secrecy compressed the manage- enhance efforts at organizational control. One major way in
rial pay scale in their estimates, as mentioned earlier, the link which organizations prefer to control employees is by main-
between pay and performance was weakened, and there was taining a civil, peaceful workplace, free from conflicts. In fact,
less motivation to perform. avoiding conflicts is one of the main reasons managers give
for enforcing pay secrecy (Gomez-Mejia & Balkin, 1992;
Other theories of work motivation also depend on link- Steele, 1975). There are many reasons to believe that pay
ing pay to performance; without perceptions of this link, secrecy is a major source of avoiding or reducing conflict in
employees lack an essential driver of motivation. For exam- the workplace.
ple, expectancy theorists (Naylor, Pritchard, & Ilgen, 1980;
Vroom, 1964) argue that the motivation to perform is a First, for example, differentials in pay are hidden under
direct function of the subjective probability that engaging in pay secrecy, thus preventing problems in corps de sprit and
a certain level of performance will result in given outcomes levels of satisfaction among workers. As Sally J. Scott, a part-
(i.e., instrumentality). Goal theorists suggest that perfor- ner in a Chicago law firm stated, “[Pay secrecy] would create
mance goals employees are committed to drive motivation morale problems if one person were allowed to boast about
(Locke & Latham, 1990), and goal commitment is partially their huge merit bonus” (Walsh, 2000). Second, social psy-
determined by the valence of outcomes associated with chologists (e.g., Leventhal et al., 1980; Leventhal, Michaels,
achieving a goal (Klein, Wesson, Hollenbeck, & Alge, 1999). & Sanford, 1972) have argued that people who allocate
Thus, if employees do not know the relative worth of their resources have a motivation not only to maintain equity but
outcomes, they may be less likely to be committed to goals also to avoid conflict. If pay were open, managers might feel
that assure the achievement of the desired outcomes. They that they would have to keep the pay distribution artificially
may make poor estimates of their subjective probabilities or narrow in order to avoid conflict (Leventhal et al., 1980;
the valence of their outcomes. Major & Adams, 1983). Pay secrecy, however, allows them
to provide maximal separation in reward for performance
Pay secrecy can also have an important and deleterious (Bartol & Martin, 1988), while at the same time avoiding
effect on the labor market, thereby imposing a cost on some negative reactions by those who end up at the lower end of
businesses and society. Economic theory is based on the the distribution (Gomez-Mejia & Balkin, 1992; Leventhal
assumption of perfect information in order to have perfect et al., 1972). Finally, economists (Brickley et al., 2000) have
markets so that resources can migrate to their most valued use argued that employers engage in pay secrecy because the cost
(i.e., market efficiency). Labor markets would be one type of of the political behavior (such as influence activities) and
market to which this argument should apply (Brickley, Smith, conflict resulting from pay openness policies makes pay
& Zimmerman, 2000). Pay secrecy, by hindering information openness inefficient.
to employees, generates information asymmetry between
workers and organizations, thus preventing workers from In addition, pay secrecy allows organizations to correct
moving to better-fitting jobs. In other words, if a top-quality pay inequities that arise (even despite good faith efforts to
engineer is not aware of a higher-paying job that he or she avoid them) without having to face employees’ negative

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512 | Part 2 Implementation of Strategic Human Resource Management

reactions to those inequities (Gomez-Mejia & Balkin, 1992). because, by enforcing pay secrecy, it protects her privacy
(Ironically, although pay secrecy may generate inferences of rights. Regardless of the impact on targets, paternalism is gen-
pay discrimination, as alluded to earlier, it may also prevent erally seen as an organizational benefit.
employee awareness of an unintentional pay inequity, thus
precluding moderate reactance to or even charges of pay A second benefit of pay secrecy would be expected to be
discrimination.) Pay secrecy can therefore be beneficial, the enhanced privacy that comes from having one’s own pay
because it can actually avoid perceptions of unfairness when kept secret from others. Stone and Stone (1990), in a review
pay inequities do exist and can minimize claims of discrimi- of the organizational privacy literature, found that employees’
nation or other organizational wrongdoing. perceptions of privacy led to many positive organizational
outcomes, such as performance (Klopfer & Rubenstein,
Furthermore, if we think of cooperation as the opposite 1977; Sundstrom, Burt, & Kamp, 1980), satisfaction and
of conflict, it seems clear that organizations, although major commitment (Klopfer & Rubenstein, 1977; Sundstrom et al.,
players in our capitalistic economic system, prefer some level 1980), and retention (Sundstrom, 1978).
of cooperation among employees and like to maintain com-
petition in the workplace at a “healthy” or otherwise nonde- In today’s society, in general, as previously mentioned,
leterious level. We can think of employers in North America privacy has become a major concern. Living in an age of
as operating within an individualistic culture but seeking to technology, we have all become more sensitized to the trou-
transcend it by encouraging more of a tempered collectivistic blesome ease with which information about us is available
culture within the workplace. For example, organizations and how it can be used to our disadvantage. Much informa-
may prefer that employees form identities that include the tion about us is requested by, and potentially available from,
organization (Ashforth & Mael, 1989). The recent emphasis our employers (e.g., in order to work, we must present an
on teamwork in organizations means that organizations want official form of ID and a social security number; employers
to encourage employees, under many circumstances, to be perform credit and sometimes criminal background checks).
good team players instead of striving for “superstardom” at Given this, it is perhaps not at all surprising that surveys of
the expense of the team. Pay secrecy should give employers employees often find that the majority of employees are in
operating in individualistic societies the opportunity to intro- favor of pay secrecy policies (Markels & Berton, 1996). In
duce a more interdependent approach to culture and values addition, in North American culture there continues to be a
in the workplace. strong norm against discussing one’s pay (Steele, 1975).
Many people prefer not to have their pay discussed by cow-
Another way in which pay secrecy can serve as a form of orkers (Pappu, 2001; Sim, 2001). Most people would be more
organizational control is by being a form of organizational comfortable answering questions about personal family mat-
paternalism—a way of treating employees as children and lim- ters such as religion—or even perhaps sex—than about their
iting their autonomy, supposedly for their own benefit (cf. salary (BBC News, 2004; Bierman & Gely, 2004). In addition,
Colella & Garcia, 2004). Organizational sociologists and econ- the discomfort of discussing pay may result from another’s
omists (e.g., Jackman, 1994; Padavic & Earnest, 1994) have revealing too much information about himself or herself
often discussed how organizations use paternalism to control (Paetzold, Boswell, & Belsito, 2004).
their employees. Pay secrecy can be viewed as a paternalistic
policy when managers argue that pay should be kept secret for Of course, some of us might be curious about the pay of
the benefit of their employees, because (1) employees really others and, thus, be willing to trade off some secrecy about
want pay kept secret, (2) it will upset them to know what our own pay in order to learn something about how much
others are making, or (3) they may make “irrational” decisions referent others are making. To date, there is no empirical
(such as leaving) if they know what others are being paid. In research that tests this notion. Based on employee surveys,
each case, managers are assuming that they know what is in we conclude that the desire for privacy about oneself and
employees’ best interests while limiting their autonomy by fail- one’s own pay dominates and overrides the desire to know
ing to provide them with full pay information. pay information about others.

From the organization’s point of view, using pay secrecy Finally, pay secrecy can actually benefit organizations
as a form of paternalistic control would be a benefit of pay with respect to labor market immobility. Although the labor
secrecy. It would allow the organization to control its employ- market inefficiency resulting from pay secrecy may be a cost
ees, but at the same time would let the employers feel good to society as a whole and some employers in particular, as
about it, since they were supposedly acting in the best interest mentioned above, other employers can profit from this inef-
of their employees (Abercrombie & Hill, 1976). It is unclear ficiency by reducing the mobility of their productive workers.
whether this would be a benefit from the employees’ perspec- For example, Danzinger and Katz (1997) argue that a policy
tive. Some argue that paternalism always causes harm to its of pay secrecy prevents employees from comparing their
targets (Jackman, 1994), but targets often welcome paternalis- wages with others inside the firm, as well as wages of the
tic behavior (Jost & Banaji, 1994). An employee may reason, firm with those in the job market. Such comparisons are
for example, that an organization really cares about her needed for employees to switch jobs when it is to their
advantage to do so. Thus, pay secrecy reduces this source of

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Chapter 11 Compensation | 513

information and prevents employees from recognizing other organization with employees having a low need for privacy,
good employment opportunities. A net benefit can accrue to but with a history of organizational unfairness and distrust,
the organization requiring pay secrecy, not only because the should not use a pay secrecy policy. For this organization, pay
pay secrecy facilitates the organization’s ability to keep pro- openness could help with perceptions of fairness and trust, as
ductive employees but also because the organization can well as potentially improve work motivation and perfor-
avoid costs associated with labor transitions—for example, mance. In addition, this organization may prefer to enhance
recruiting and training. Thus, it is clear that pay secrecy can the mobility of its dissatisfied employees and, thus, should
be advantageous for some employers, presumably those who prefer pay openness as a way of making outside opportunities
continue to use it. more appealing. For example, as discussed above, the pay
distribution under pay openness would tend to be narrower
A related construct in the organizations literature is that than under pay secrecy so that opportunities for pay raises
of continuance commitment, which reflects an employee’s would appear to be small. Although we mentioned that this
commitment to an organization because of a need to remain has the benefit of reducing conflict, we must also note that it
with the organization (Meyer, Allen, & Gellatly, 1990). It is will tend to encourage employees to move to other positions,
not necessary that the employee have positive feelings about where they can be put to their “most valued use.”
the organization; instead, continuance commitment is a func-
tion of the opportunities that an employee perceives he or she Thus, separate consideration of costs and benefits does
has. As indicated above, pay secrecy operates by reducing the not reveal the whole picture of pay secrecy; their joint con-
perceived number of alternative job possibilities, because pay sideration is relevant. In joint consideration, these costs and
information about other jobs is lacking and appropriate pay benefits can help us to identify why some employers may
comparisons cannot be made. Hence, continuance commit- prefer pay secrecy while others do not; characteristics of indi-
ment is increased. At the same time, pay secrecy also pre- vidual employees, for example, suggest that some employers
vents “poaching” from other companies, because it keeps should prefer pay secrecy while others should not.
competitors from knowing what they must offer to lure
good employees away (Sim, 2001). (Notice that we men- But individual characteristics cannot tell us the whole
tioned this earlier as a social cost and a cost to some organi- picture either. In fact, the context or contextual factors
zations. Here, it is an organizational benefit.) employers face may be the most important determinant of
why some employers engage in pay secrecy policies while
Trading off Costs and Benefits others do not. The relationships between pay secrecy and
As indicated so far in our discussion, there are both costs and its costs or benefits are not fixed but depend on these contex-
benefits to pay secrecy, but it should also be clear that not all tual factors. Organizations and their environments are com-
organizations will experience the costs and benefits to the same plex, and there are a number of contextual factors that are
degree. This would appear to depend, in part, on the quality of likely to accentuate or minimize the costs and benefits men-
employees, their individual needs and perceptions, and the his- tioned above. For example, which employees should respond
tory of those employees with the employer. Employers can more positively to pay secrecy—those who hold knowledge
therefore be “profiled” based on their employees in order to and skills specific to the organizations or those who do not?
predict which of them should choose pay secrecy policies. For The answer to this and similar questions suggests that con-
example, an organization that has many high-quality employ- text, or a variety of contextual factors, helps to determine
ees whom it would like to retain and also has high recruiting whether pay secrecy is costly or beneficial for organizations.
and training costs, all else being constant, should be more likely This consideration has never been addressed in the academic
to use pay secrecy than an organization that does not. literature, and our presentation of it follows.

Once we remove the constraint that all else is being held When Do Costs and Benefits of Pay
constant, pay secrecy can look even better for this organiza- Secrecy Occur?
tion. Consider that work motivation may not be as much of a
concern if the “good” employees are intrinsically motivated In addition to identifying that there are legitimate benefits to
(so that pay secrecy will not work to reduce their level of pay secrecy, despite its costs, we also view the thrust of our
work motivation) and tend to have a lot of accumulated work as identifying a set of contextual factors that make pay
trust in the organization stemming from other aspects of secrecy more likely to be either a benefit or a cost—that is, they
the work relationship. Such an employer (who uses pay make it more likely for organizations to incur the costs or reap
secrecy) may enjoy, therefore, the benefit of lack of labor the benefits of pay secrecy. Because many organizations seem
mobility (continuance commitment), in addition to not suf- to prefer pay secrecy today, and because we have presented our
fering the costs associated with reduced work motivation and discussion from the perspective of highlighting reasons why
lack of trust in the organization. such a policy may be beneficial, we now assume that pay
secrecy is operating throughout the discussion that follows.
Other employers with different cost/benefit trade-offs We identify contextual factors that exist at different levels of
should be expected not to employ pay secrecy. An

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514 | Part 2 Implementation of Strategic Human Resource Management

the organization and write from the perspective of how they This means that although there is a relationship between
mitigate the costs and help to make the benefits realizable for pay secrecy and labor immobility (continuance commit-
those organizations employing pay secrecy. We discuss, in ment), the nature of the relationship is highly dependent on
order, the nature of human capital, the criteria used for pay the type of human capital workers possess. Looking inside
allocation, and the gauging of employees’ relative pay status. the firm for pay information, employees with firm-specific
human capital will find their efforts to learn about pay levels
We do not claim that these are the only contextual fac- thwarted. Employees with general human capital, however,
tors that can affect how organizations experience pay secrecy, can look to the external labor market and find little hin-
but we view them as three major contexts that share com- drance to obtaining pay information.
monality of importance for many organizations.
Similarly, because of the availability of external informa-
Contextual Factor 1: Nature of Human Capital tion, privacy should be less of a concern to employees with
Consider the following scenario. Heather has worked at AAB general human capital. These employees cannot keep their
(Anti-Ad-Bot) for just a few years, but she has reached a high pay completely secret if an industry compensation norm
rung on the internal employment ladder—operations man- exists. They may also be less likely to make incorrect fairness
ager. To accomplish this, she has held a variety of positions, judgments, because they can use external comparison others.
beginning as a programmer and working her way up, one job If the firm is paying market rates, then employees with gen-
after the other. She has received training and experience eral human capital should perceive that their pay is fair.
along the way that has enabled her to perform all jobs (Those with firm-specific human capital lack external com-
below her current position, and that training has also been parison others and may be more likely to make incorrect
essential to her knowledge of the unique culture at AAB. Eric comparisons.) Also, pay secrecy should have less of an effect
started working at AAB at the same time as Heather, but he on motivation when employees have general human capital,
remains a programmer. He has never undergone specialized because the employees should want to maintain high enough
training, remaining in a “dead-end” position within AAB. performance levels to make them attractive to other firms.
Between Eric and Heather, who should react to AAB’s pay
secrecy policy more positively? Thus, having general human capital should mitigate the
costs of pay secrecy and enhance any benefits, at least mar-
We would posit that Eric should. Because Eric has only ginally (assuming that an asymptotic level of benefits has not
lower-level skills and no firm-specific training about particu- been reached). In our scenario, Heather cannot easily benefit
lar jobs within AAB, Eric also has no special, firm-specific from any outside pay information, but Eric perhaps can. The
value to AAB beyond what he would have to similar firms. benefits of having no firm-specific skills accrue to him when
Thus, Eric should be able to go outside the organization in pay secrecy is operating. The organization does not suffer
the labor market that is pertinent to programmer jobs for pay costs from pay secrecy with regard to its general human cap-
information (Milgrom & Roberts, 1992). Heather, however, ital employees—and is free to enjoy all the benefits—even
has such firm-specific skills that she probably cannot find though it may incur costs associated with its firm-specific
another firm where her talents could be as valuable as they human capital employees.
are to AAB. The market for her skills—the one inside AAB—
does not allow her to find pay information because it main- Contextual Factor 2: Criteria for Pay Allocation
tains a policy of pay secrecy. The criteria for pay allocation are those elements or aspects
of effort or performance used to determine pay levels. Pay
Firm-specific human capital refers to the skills, abilities, criteria may be measured either objectively or subjectively,
knowledge, and/or interpersonal relationships that positively and we suggest that the nature of measurement helps to
affect employees’ performance in their current employment determine whether costs or benefits will be experienced dur-
but that are relatively useless if the employee moves to ing pay secrecy. Using objective criteria for pay allocation
another organization (Williamson, 1985). Therefore, when should mitigate the costs of pay secrecy.
employees hold primarily firm-specific human capital, exter-
nal labor market information is less useful to them. In con- Consider, for example, Ryan and Natasha, supervisors of
trast, general human capital refers to human capital with two different sales teams at a retail outlet. Ryan’s manager
value that remains the same across various organizations. stresses “management by objectives” and has specific sales
For example, mathematics teachers are likely to provide the goals that Ryan’s sales team must reach in order for Ryan
same value across various schools. Similarly, carpenters may to be evaluated highly. Natasha’s manager uses more subjec-
move across sites to build homes without much change in tive criteria for evaluating her performance, including her
their duties across those various sites. In both cases, employ- communication skills, leadership abilities, and commitment
ees can be replaced, requiring little, if any, additional train- to diversity. Assume that the retailer maintains pay secrecy
ing, and pay is relatively difficult to hide from employees policies for its employees. For which supervisor will the
having general human capital. retailer be more likely to incur the benefits of pay secrecy?

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Chapter 11 Compensation | 515

We posit that it should be for Ryan. Recall that one should be amplified, and the positive effects with respect to
major cost of pay secrecy is that any pay differentials that cooperation will be mitigated. Why? Go back to Ryan and
may exist—here, between Ryan and Natasha—will lose their Natasha, who, under pay basis secrecy, do not know whether
power to motivate because they are unknown. In order to their pay is based on leadership, diversity initiatives, communi-
counter this difficulty, organizations can provide a clear link- cation skills, sales performance, or some other criteria. The level
age between pay and performance in order to create work of uncertainty is even higher than under ordinary pay secrecy
incentives for employees (Thompson & Pronsky, 1975). such that uncertainty management theory (Lind & van den Bos,
One factor that would enable the pay-for-performance link- 2002) suggests even more negative assessments than before, but
age to be clear would be the use of objective performance for all of the same reasons.
criteria. Here, Ryan’s raises could be justified to him clearly,
whereas Natasha’s could not. Thus, if Natasha believes she is Employees cannot predict their pay into the future. For
underpaid, her manager cannot point to objective perfor- all they know, chance factors, mistakes, and bias play a role
mance criteria to justify her pay and attempt to convince in determining their pay. Fairness assessments will be highly
her that her pay is commensurate with the goals that he or negative and lead to a lack of trust. As employees seek out
she has specified for Natasha. It would be difficult to discuss information about pay (which they are more predisposed to
“how much” leadership or “how many” skills were necessary do under uncertainty management theory), they will be able
for Natasha to satisfy her supervisor’s requirement. Ryan’s to learn even less than before, thereby creating the possibility
manager would be in just such a position to get that specific, of greater conflict. The organization may have passed the
however. And when employees perceive a specific pay- point at which individuals are willing to keep their own pay
performance linkage, they are more likely to be satisfied information secret, because a need for uncertainty reduction
with their pay (Huber, Seybolt, & Venemon, 1992). may lead to an enhanced desire to know others’ pay as a way
of judging one’s own.
Second, the performance appraisal literature (DeNisi,
1996; Murphy & Cleveland, 1995) states that when there is Clearly, therefore, organizations that provide for pay
objective information on which to base appraisals, managers secrecy should also provide known bases for pay if they
are less likely to engage in biases when evaluating employees, want to highlight the benefits of the pay secrecy policy and
and employees are more likely to perceive the appraisal as incur fewer costs. In other words, it is not only the issue of
fair. Such perceptions of fairness will attenuate the general measurement of pay criteria that determines whether costs or
unfairness in justice perceptions that accompany pay secrecy, benefits will be experienced but also knowledge of those very
making the costs of pay secrecy less likely to be incurred and criteria themselves.
providing for greater organizational trust. This would be true
regardless of the strength of the pay-for-performance link, Contextual Factor 3: Gauging of Relative Pay Status
but the two together provide a strong basis for arguing that Our last factor is at the most micro of the levels we consider,
the costs of pay secrecy will not be incurred. but it is nonetheless important. Employees may always attempt
to “guess” where they stand or rank against the pay distribu-
Third, privacy, a benefit of pay secrecy, is not automati- tion, even though the distribution itself is unknown. In other
cally threatened by having objective performance criteria. Just words, even under pay secrecy, employees will believe that
because performance may be measured more objectively, and they are better or worse employees and, thus, closer to the
hence may be more visible to others, this does not guarantee top or bottom of the pay scale. We argue that this affects the
that pay will be. Privacy issues, however, may be of less con- organization’s consequences of using pay secrecy.
cern to employees in this situation, because when objective
performance criteria are clearly linked to pay, there is a some- For example, assume that LaToya has always been suc-
what natural transparency concerning what people are paid. cessful in her work as a loan officer and therefore believes that
she probably falls near the top of the pay distribution for bank
Thus, although pay secrecy is operating, an organization loan officers at Fifth National Bank. Jonathan, however,
that uses objective performance criteria is more likely to doesn’t have as much confidence in his work, notices that a
experience benefits than one using subjective performance lot of the loan officers seem to be more successful than he is,
criteria. In addition, however, beyond the question of and decides that he is probably closer to the bottom of the pay
whether pay criteria are measured objectively or subjectively, distribution for loan officers at the same bank. Which of the
is the question of whether pay criteria are known and not two loan officers will respond more favorably to pay secrecy?
secret. We suggest also that when the criteria for pay—what
we call the basis for one’s pay—are known, then the costs of We argue that employees who perceive their relative pay
pay secrecy are less likely to be incurred, and the benefits are to be closer to the top of the relevant pay distribution should
more likely to be reaped. have a more positive reaction to pay secrecy, so we expect
LaToya to respond more favorably than Jonathan. It has been
When the basis of pay is secret, individuals do not know demonstrated that high performers desire pay secrecy more
why they receive the pay they get. The negative effects of pay than low performers (Schuster & Colletti, 1973). First, since
secrecy (which, recall, has been pay-level secrecy by assumption) these employees believe they are being paid more than others,

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516 | Part 2 Implementation of Strategic Human Resource Management

they may also believe that pay secrecy will prevent them from perceive to be paid at higher levels—a negative factor. Second,
becoming targets for conflict. Second, because these employees employees who experience negative pay outcomes are more
already believe they are being paid more than others, they will likely to perceive them as distributively unfair. It is under con-
be less likely to make judgments that pay levels are distribu- ditions of judgments of distributive unfairness that employees
tively unfair. Third, because people who are successful and paid will also be most concerned about procedural fairness of pay
more are more likely to attribute pay to internal causes (Miller allocation decisions (Brockner & Weisenfeld, 1996), which we
& Ross, 1975), they will likely attribute their pay to their own have already described as tending to be negative under pay
superior performance and, thus, be more motivated, regardless secrecy. Finally, employees who experience negative outcomes
of pay secrecy. Finally, because managers may narrow pay dis- will be more likely to attribute the cause of those outcomes to
tributions when pay is open, as previously discussed, those who external sources, such as bias on the part of the decision
believe they are highly paid may fear that they would be paid maker. This might increase the likelihood of conflict and
less relative to those at the bottom of the distribution were pay reduce motivation (Miller & Ross, 1975). Thus, pay secrecy
to become open. should clearly be linked to costs of judgments of unfairness
and lowered work motivation in this situation.
In summary, therefore, employees who perceive that
they have high relative pay will tend not to suffer from judg- In addition, perceptions of being paid less than relevant
ments of unfairness or decreases in motivation under pay others could increase perceptions of mobility by making rel-
secrecy. Thus, because pay secrecy was described as a poten- atively low offers or lesser opportunities from the outside
tial cost in the previous section, the implication is that this look more appealing than they otherwise would, particularly
expectation holds for employees who view themselves as if the employees are attributing low pay level to unfairness or
being at the bottom of the pay distribution (i.e., probably bias (Hulin, Roznowski, & Haichya, 1985). Thus, those who
the lower performers). We predict that what previously believe themselves to be at the lower end of the pay scale
appeared to be costs of pay secrecy—lack of fairness percep- should experience pay secrecy in a more negative manner
tions and lowered work motivation—would tend to occur than those who believe they are at the higher end.
most strongly for those employees who believe they are
paid low relative to relevant others. What Remains to be Known About
Pay Secrecy?
But does this make sense? What is it about these
employees that could render pay secrecy even more negative In short, much. In this article we have entered into a discus-
for them? For example, we might argue that the employees sion of pay secrecy with multiple goals in mind. The notion
who perceive themselves as making low relative pay may also of pay secrecy jumped into our research minds when one of
perceive themselves as having low value in the organization. us, Asghar Zardkoohi, discussed with the rest of us a news
article he had just read on the topic. As conversation evolved,
In that case, they should see pay secrecy as a benefit. As we realized that we knew and had heard very little about this
one worker stated: topic. Our own investigation of early research efforts indi-
cated that scant scholarly work existed on this topic, and
I worked in a place where a lot of people knew others’ most of it had been done many years ago. It seemed that
salaries… . I was humiliated when I found out that others most of what we thought we knew about pay secrecy was
at my title and experience level were making vastly higher anecdotal.
amounts of money… . If management had kept that infor-
mation to themselves, and discouraged discussion, they Numerous discussions later, we emerged with this frame-
would have prevented a lot of problems (Cohen, 2003). work for discussing pay secrecy. Our hope is to regenerate an
interest in the topic, one that this time will engage more scho-
The “humiliation” spoken of by this worker suggests a lars and produce more scholarship. We hope that our frame-
privacy violation: he or she experienced negative affect when work provides many research questions that academics will
allowed to compare his or her own pay with that of others. find interesting. No longer need we make the intuitive jump,
The humiliation was undoubtedly not only due to the reali- as many organizational researchers have, that pay secrecy is
zation that others at the same title and level of experience obviously bad for organizations. No longer need we embrace
were making more but also that coworkers could realize economists’ intuitive belief that pay secrecy must be good for
that this worker was making much less. This type of privacy organizations or organizations would not use it.
issue is the one we identified as a benefit to pay secrecy.
In addition, we have attempted to suggest that pay
However, employees who perceive themselves as being secrecy is not just a human resources issue. It has individual
paid less than others are more likely to experience an array and societal consequences that cannot be ignored, even beyond
of negative outcomes from pay secrecy for a variety of interre- their impact on the organization. For example, the very con-
lated reasons that do not concern privacy. First, they will intu- cept of privacy is an important social value during the early
itively be more likely to experience conflict with decision
makers about pay and perhaps other coworkers whom they

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Chapter 11 Compensation | 517

twenty-first century. Pay secrecy may not only reflect this not to discuss their pay with each other. At the most restric-
value but may be critical for promoting this value more tive level—the more explicit of the two poles—there is an
strongly in American society. Future research could focus enforced and formal organizational policy that prohibits dis-
more generally on the role that pay secrecy in organizations cussion of pay. Along the continuum are levels that include
plays in helping society maintain or even attain a level of indi- varying degrees of pay secrecy. For example, somewhat
vidual privacy that allows American citizens or residents to beyond the more lenient of the poles is a level where pay
live in comfort, experience important freedoms, or even secrecy is enforced by group or departmental norms alone,
achieve other goals that we, as a society, see as valuable. despite no formal organizational policy existing about the
discussion of pay. Closer to the more restrictive pole is a
What is the overall impact of pay secrecy on society? level where there are strong organizational norms or informal
Does it maximize the differential between higher- and policies against sharing pay information—for example, a
lower-paid employees? What is its net effect on wages? If it statement emphasizing that pay discussion should not take
is true, as we have conjectured, that pay secrecy will enable place, but without sanctions in place.
supervisors and managers to create larger pay differentials
among employees, then we expect that high-performing The manner in which pay secrecy is enforced is likely to
employees could make even more in wages or salary than affect how employees will respond to it. On the one hand,
they would tend to under pay openness. Also, the pay differ- when pay secrecy stems from either individual choices or
ential should be wider under pay secrecy, because there is less informal group norms not to discuss pay, employees are sig-
of a concern about conflict when employees do not know naling that they value the privacy avoidance of conflict that
what others are making, as we have discussed. Thus, society they obtain from pay secrecy to a greater degree than they
could experience an even bigger gap between those who are value information about what others are being paid. It is
highly paid and those who receive little pay. This topic unlikely that this situation would arise if there were suspi-
should be of particular interest to a broad range of manage- cions of bias in the pay distribution or if there were substan-
ment scholars. For example, is it even possible for all organi- tial negative fairness inferences regarding the organization.
zations to hold pay secrecy policies at the same time in a On the other hand, when the enforcement of pay secrecy is
capitalist society? What benefits would be expected to accrue tied to the organization and is not volitional on the part of
to the “first mover”—the first organization to offer pay open- employees, employees may view this as over-reaching, pro-
ness? What would characterize the first-mover organization? viding a basis for suspicion that the organization has some-
thing to hide and may be biased and unfair. Research on this
Pay secrecy also can be important in the study of inter- issue could help to elucidate the trade-offs employees make
national management or cross-cultural management, as we regarding privacy choices about their own pay, as well as
have alluded to in this article. First, further study regarding shed light on broader issues of organizational control.
the notion that organizations operating in a capitalistic soci-
ety may nonetheless try to instill the values associated with Certainly, strategic HR academics can pursue many
collectivist societies is interesting to explore in and of itself. research questions stemming from pay secrecy. For example,
What happens when American businesses locate in countries the question of internal alignment (i.e., the degree to which
having cultural values different from our own? Is it true that different HR practices fit together and work with the overall
pay secrecy has a different impact in more collectivist cul- strategy of the organization) is related to compensation strat-
tures? (Here, it might be interesting to consider whether egies and, thus, potentially, to pay secrecy. Corporate strategy
pay openness leads those at the top of the pay distribution may influence the effectiveness of a pay secrecy policy in
in Eastern cultures to be the most embarrassed for “sticking conjunction with whether the firm is pursuing a defender
out,” whereas in Western cultures those at the top may be the strategy or a prospector strategy (see Miles & Snow, 1978,
most proud, even if they want to avoid being the targets of for a review of these strategies).
conflict.) What happens when workers from different cul-
tural backgrounds and expectations must work alongside Gomez-Mejia and Balkin (1992) have proposed two dif-
each other in the same organization? The strategic considera- ferent compensation strategies that would be appropriate for
tions accompanying pay secrecy simply should not be these different business strategies: algorithmic and experiential
ignored, but research is needed to inform us of the impor- strategies. An algorithmic strategy is one characterized by pay
tance of culture to strategic decision making in this regard. based on individual performance, internal equity, above-market
salary and benefits, and pay secrecy. An experiential strategy, in
One aspect of organizational control not considered in contrast, is characterized by pay based on level of skills, exter-
this article is the manner in which pay secrecy is “enforced.” nal equity, below-market salary and benefits (but salary plus
We believe this variable falls along a continuum, from incentives above market), and pay openness. Gomez-Mejia
implicit to explicit enforcement. At the more lenient end is and Balkin hypothesized, and have found support for the
a situation where there are no explicit norms or organiza- idea, that defenders would use algorithmic compensation strat-
tional policies regarding the discussion of pay—where pay egies, whereas prospectors would employ experiential compen-
secrecy might exist only because individual employees choose sation strategies (Balkin & Gomez-Mejia, 1987, 1990).

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518 | Part 2 Implementation of Strategic Human Resource Management

However, our analysis makes it unclear as to the extent to Balkin, D. B., & Gomez-Mejia, L. R. 1987. Toward a contin-
which these aspects of a compensation system should occur gency theory of compensation strategy. Strategic Manage-
together if a firm wishes to achieve the benefits of pay secrecy. ment Journal, 8: 169–183.
For example, a firm following an algorithmic strategy would
appear to be attracting top employees, paying them along inter- Balkin, D. B., & Gomez-Mejia, L. R. 1990. Matching com-
nal hierarchical distinctions in individual performance (which pensation and organizational strategies. Strategic Manage-
could be relatively wide), and would probably invest in firm- ment Journal, 11: 153–169.
specific training for them. Both the relatively wide pay distribu-
tion and the firm-specific investments for the employees sug- Bartol, K. M., & Martin, D. C. 1988. Effects of dependence,
gest that the employer would suffer the costs of a pay secrecy dependency threats, and pay secrecy on managerial pay
policy instead of realizing the benefits. Pay openness would allocations. Journal of Applied Psychology, 74: 105–113.
appear to be more appropriate for firms in this situation.
BBC News. 2004. Salary secrecy “penalises women.” http://
If a firm followed an experiential strategy, however, it news.bbc. co.uk/1/hi/business/3392937.stm, January 14.
would appear to be maintaining general human capital for
its employees and encouraging weaker employees to leave Bierman, L., & Gely, R. 2004. Love, sex, and politics? Sure.
the organization by paying below market. The incentive pay Salary? “No way”: Workplace social norms and the law.
system should lead to wider pay distributions, providing per- Berkley Journal of Law and Employment, 25: 167–191.
ceptions that pay is unfair and potentially leading to conflicts.
Pay openness would seem inappropriate in this situation. Bies, R. J., & Moag, J. F. 1986. Interactional justice: Com-
Instead, the benefits of having pay secrecy could be achieved munication criteria of fairness. Research on Negotiations in
(privacy and lack of conflict; maintaining high-quality Organizations, I: 43–55.
employees) while its costs would be mitigated (perceptions
of unfairness and lack of trust; subjecting good employees Brickley, J. A., Smith, C. W., Jr., & Zimmerman, J. L. 2000.
to poaching). Thus, pay secrecy and not pay openness would Managerial economics and organizational architecture (2nd
be desirable in this situation. Further investigation of Gomez- ed.). New York: McGraw-Hill.
Mejia and Balkin’s contingency approach to compensation
strategies should be conducted as a result of our research. Brockner, J., & Weisenfeld, B. M. 1996. An integrative frame-
work for explaining reactions to decisions: Interactive effects of
Additional HR strategy issues may also be generated from outcomes and procedures. Psychological Bulletin, 120: 189–208.
our work by considering pay-level secrecy in conjunction with
other pay system characteristics more generally. Clearly, based Burroughs, J. D. 1982. Pay secrecy and performance: The
on the above, HR strategy can influence the effectiveness of psychological research. Compensation Review, 14: 44–54.
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strategy (implying a “best practices” approach), but future conditions of trust: Evolution of a condition of trust inven-
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crimination? Paper presented at the annual meeting of the
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Klein, H. J., Wesson, M. J., Hollenbeck, J. R., & Alge, B. J. ment Review, 20: 709–734.
1999. Goal commitment and goal setting process: Conceptual
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Psychology, 84: 885–896. and continuance commitment to the organization:
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18: 413–422.
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mental Social Psychology, 9: 92–131.

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Mishra, A. K. 1996. Organizational responses to crisis: The Sundstrom, E. 1978. Crowding as a sequential process:
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Chapter 11 Compensation | 521

READING 11.2

The Development of a Pay-for-Performance
Appraisal System for Municipal Agencies:

A Case Study

Michael A. Mulvaney, PhD, William R. McKinney, PhD, and Richard Grodsky

Well-designed employee performance appraisal instruments procedure for creating performance appraisal instruments;
assume great importance by providing agencies with informa- (2) described the appropriate training for those conducting an
tion that can guide administrative and developmental decision- appraisal interview; (3) implemented performance reviews using
making about their most important asset—their human the developed instruments and appraisal interview/review train-
resources. Administratively, performance appraisals serve as ing, and; (4) evaluated employee attitudes toward the newly
the formal evaluation tool used by managers when making deci- developed system. Survey results identified significant mean
sions about the distribution of pay increases and the promotion differences between employee attitude toward the original pay-
and demotion of an employee. Developmentally, performance for-performance instrument and appraisal interview process
appraisals assist agencies in identifying issues such as employee and the newly developed system. Results of the case study are
training needs and cross training opportunities.1 Despite its analyzed and discussed.
importance, both employees and management often view the
performance appraisal process as frustrating and unfair. These Introduction
frustrations are largely attributed to a reliance on performance
appraisal instruments that: are not job related; have confusing Performance appraisal has become a general heading for a
or unclear rating levels, and; are viewed as subjective and biased variety of activities through which organizations seek to pro-
by staff.2 This study was undertaken to identify steps for creat- vide feedback to their employees, develop their competencies,
ing a more effective pay-for-performance system for public agen- enhance performance, and distribute rewards.3 An agency’s
cies. Specifically, this case study: (1) identified a systematic performance appraisal system impacts individual and organi-
zational operations by prompting decisions regarding com-
Dr. Michael Mulvaney is an assistant professor in the Department of pensation and merit salary increases, training and
Recreation Administration at Eastern Illinois University. He received his development opportunities, performance improvement, pro-
PhD from the University of Illinois. Before enrolling at the University of motion, termination, organizational climate, and financial
Illinois, he was employed with the Decatur Park District, Decatur, Illinois management. Despite expected benefits, poor design often
in a variety of capacities, including assistant manager of the Decatur leads both administration and staff to resist the process as a
Indoor Sports Center, fitness coordinator, and special recreation supervi- painful annual exercise.
sor. His teaching and research interests include employee training and
development, learning technologies in human resource development, Recognizing that one of the major difficulties with per-
and performance appraisal practices in parks and recreation. formance appraisal stems from various competing objectives
(i.e., development, promotion, termination, staff training,
Dr. William R. McKinney serves as an associate professor in the etc.), but that salary decisions account for nearly 80% of its
Department of Recreation, Sport & Tourism at the University of Illinois. use,4 this study provides a case study of the collaborative
McKinney has authored numerous articles dealing with comprehensive steps involved in creating a performance appraisal system
planning, personnel psychology and personnel management. His public used for merit salary increase decisions. It then assesses the
service engagements include demonstration projects, educational pro- staff’s attitude toward the new vs. the old appraisal system.
grams, and direct consultation to park and recreation agencies and
organizations. Review of Related Research

Richard Grodsky is retired with 37 years of experience, focusing on In describing the cognitive and affective value of employee
agency reorganizations. He is a member of the American Academy for participation in the development of appraisal systems, research
Park and Recreation Administration, currently serving as executive has identified five benefits: (1) employee participation is an
director.

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522 | Part 2 Implementation of Strategic Human Resource Management

effective tool for enhancing job-related autonomy, a necessary outlines low to high performance measures; (2) a well-
precondition for employee growth; (2) appraisal participation conducted performance appraisal interview process, and; (3)
provides employees with a voice into the appraisal process. If equitable decisions regarding the amount of merit increases
employees are confident in the fairness of the appraisal pro- that will be given for different levels of performance.14 This
cess, they are more likely to accept performance ratings, even research is the first of a two-part study and focuses on the pro-
adverse ones; (3) employees possess valid, unique, and relevant cess of creating the performance appraisal instruments and con-
performance information that is unavailable or unobservable ducting the performance appraisal reviews. The second part of
by the rater, therefore the quality, quantity, accuracy and valid- the investigation will address the distribution of merit salary
ity of performance appraisal information increases; (4) increase monies (see the winter 2012 issue).
employee ownership in the process provides a personal stake
in the success of the system, enhancing employee acceptance; Even the most well-developed pay-for-performance sys-
tem is predisposed to problems, if it is viewed negatively by
(5) employee participation generates an atmosphere of cooper- staff.15 Researchers assert that perceptions of unfairness and
ation and employee support.5 dissatisfaction in the process of evaluations can doom any
appraisal system to failure.16 Thus, it is clear that assessment
This study is situated within a Strategic Human Resource of reaction to the performance appraisal instrument and
Management (SHRM) framework that places great importance interview process is important.17
on the employees and managers in the success of agency
operations.6 SHRM is cognizant of the value of an agency’s Research on performance appraisal reactions has identi-
material resources (i.e, financial and physical), but asserts fied two general areas of interest: First, there is satisfaction
that it is equally, if not more, important to give attention to with the appraisal instruments and fairness of the appraisal.18
an agency’s human resources. This approach is particularly This is the most widely studied reaction and it has been pri-
appropriate within the service fields of municipal government marily conceptualized into two subcategories: satisfaction
where human resources convert material resources into ser- with the appraisal interview and satisfaction with the overall
vices and programs, and where labor typically accounts for appraisal system.19 Satisfaction with the appraisal interview
more than 60% of municipal agencies operational budgets.7 refers to the employee’s attitudes toward the structure and
implementation of the performance review. Satisfaction with
A SHRM framework suggests that managers tailor their the overall appraisal system represents a more global measure
pay systems to support their agency’s strategic objectives. of the entire appraisal system, including the interview and
This approach is based on contingency notions, suggesting subsequent actions following the interview.20
that differences in an agency’s strategy should be supported
by corresponding differences in the agency’s human resource Fairness of the appraisal is the second area of interest and
strategies, including compensation.8 The underlying premise it has also been conceptualized into two subcategories: proce-
of SHRM, as it relates to compensation, is that the greater dural justice and distributive justice.21 In this case, procedural
the alignment, or fit, between the agency’s objectives and justice is defined as the perceived fairness of the processes and
the compensation system, the more effective the agency.9 procedures used in the agency’s performance appraisal system.
Distributive justice is defined as perceived fairness in the dis-
Pay-for-performance systems have been described as one tribution of outcomes (i.e., merit salary increase amounts).
of the most effective methods of motivating and increasing
employee performance.10 These plans theoretically forge a Focus of the Study
link between pay expenditures and individual productivity.11
A well-developed pay-for-performance appraisal instrument A Strategic Human Resource Management framework was
also addresses the norm of distributive justice, or the com- applied to the development of a performance appraisal system
monly held belief that individuals should be rewarded in pro- for the Elmhurst Park District (Elmhurst, Illinois), the munici-
portion to their contributions. An adequately developed pal agency serving as the representative case study. The Elm-
appraisal instrument potentially diffuses employee concerns hurst Park District sought to accomplish three goals with the
about equity and fairness while motivating employees to development of a new performance appraisal system. First, Elm-
increase performance.12 hurst Park District was interested in improving employee moti-
vation and job performance while controlling costs. By doing
An agency’s appraisal instrument serves as the tool to accu- this, the Elmhurst Park District hoped to further establish a
rately discriminate outstanding performers from those who are high performance culture. Second, Elmhurst Park District
below average. Likewise, it satisfies the increasing demand for sought to increase “employee buy-in” toward their performance
wise fiscal management practices in the public sector.13 Pay- appraisal system. Specifically, managers wanted to improve
for-performance plans signal a movement away from an entitle- employees’ perceptions of fairness and accuracy, and to increase
ment orientation where all employees receive the same raise overall satisfaction with the agency’s appraisal process. Third,
annually for simply showing up to work. However, creating a managers expressed a need to motivate staff to “keep up” with
valid and legally defensible pay-for-performance plan requires the highly demanding nature of today’s park and recreation
three things: (1) a definition of job specific performance that
leads to the creation of an appraisal instrument that clearly

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Chapter 11 Compensation | 523

users. A recognized method for inspiring the quick adoption of as managers were forced to evaluate employees on several
new technologies and approaches to constituent service is non-job specific traits (i.e., overnight facility maintenance staff
through the establishment of a valid pay-for-performance plan evaluated on public contact, lower-level employees evaluated
that rewards high performing employees while not rewarding on creativity, senior level employees on productivity). These
employees whose performance has been less than standard. skills/capabilities were evaluated on a six-point scale (1 ¼
needs improvement … 6 ¼ exceptional). The second section
Once the pay-for-performance system was implemented, asked the supervisor to identify the level (on a five-point
the study assessed the employees’ attitudes toward the newly scale) that best represented the employee’s overall performance
developed system compared to the agency’s previous system. for the year. This single assessment provided the basis for the
Specifically, it sought to address the following questions: annual pay-for-performance decision.

1. What are the specific steps involved in developing a pay- Data Collection Procedures
for-performance system for a public park and recreation Quantitative data was collected to compare employee attitude
agency? between the original performance appraisal system and the
newly developed system. Prior to starting the workshops to
2. What are the effective procedures for conducting the develop a new pay-for-performance appraisal instrument, every
performance appraisal review? full-time employee completed an existing performance appraisal
reaction instrument. Testing was then done to assess attitude
3. Did employee attitude toward the newly developed sys- toward the existing system.22 At the completion of the workshops,
tem change when compared to the previous system? a “trial run” was conducted using the new system. The “trial run”
was conducted instead of an actual live implementation due to the
4. Did employee perception of procedural justice toward developmental timeline of the new appraisal system.
the newly developed system change when compared to
the previous system? Following the completion of the “trial run”, the employees
repeated the Keeping and Levy23 survey instrument to measure
Although a case study with a limited number of respon- their attitudes toward the newly developed system. Every full-
dents can’t be widely generalized, the results should be of time employee completed the entire Keeping and Levy24 instru-
interest to management researchers and directors of munici- ment with two of the four sections (satisfaction with the perfor-
pal agencies who think critically about ways to increase mance appraisal review session and procedural justice of the
employee performance and seek methods to improve the performance appraisal system) being evaluated for this portion
management of pay-for-performance dollars available within of the study (the remaining two sections are examined in Part II
an agency’s operating budget. The need to develop a pay- of this study). Specifically, the two sections of the instrument
for-performance appraisal system that motivates staff, is used were: (1) employee satisfaction with the appraisal inter-
cost effective, and assists the agency in meeting its goals is view/session, and; (2) perceptions of procedural justice of the
arguably a problem, or opportunity, that has applications appraisal system. Previous studies in both private and public
across the field of municipal management. agencies have supported the construct validity of the items with
factor loadings ranging from .76 to .97, with an average loading
Methods of .89.25 In addition, reliability measures for each area have been
high, ranging from .91 to .96.26 The two sections of Keeping and
Case Study Site Levy’s27 survey instrument are provided in Figure 1.
The Elmhurst Park District was established in 1920 in portions
of Cook and Du-Page counties in the state of Illinois; it over- Data Analysis
sees approximately 460 park acres, 25 buildings, and 27 park Based upon previous research utilizing Keeping and Levy’s per-
sites and serves approximately 44,500 residents. The district formance appraisal reaction instrument, the survey data was ana-
employs approximately 70 full-time, 550 part-time and sea- lyzed in two ways.28 The data were first examined descriptively
sonal employees, is governed by seven members of a publicly according to the scoring protocol for each item: mean scores and
elected board of commissioners, and has an equalized assessed standard deviations were obtained. Next, to assess mean differ-
valuation of approximately 1.8 billion dollars. ences, the data was subjected to dependent samples t-tests.

Prior to the study, the Elmhurst Park District utilized a Outcomes
generic (agency-wide) performance appraisal instrument for
all employees of the agency. The instrument was divided into Defining Job Performance and the Creation of an
two sections. The first section asked supervisors to evaluate Appraisal Instrument
employee skills/capabilities that affected job performance. An employee’s job description is often used to identify job
Each employee’s job performance was evaluated in the follow- performance standards.29 In particular, the job description
ing areas: job knowledge, productivity, attendance, planning,
communication, attitude, dependability, leadership/subordinate
development, creativity, quality of work, and public contact.
These skills/capabilities were applied across the agency to every
full-time employee. This universal application was problematic

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524 | Part 2 Implementation of Strategic Human Resource Management

FIGURE 1
Keeping & Levy’s (2000) Employee Reactions Performance Appraisal Instrument

Satisfaction with the performance review session

1.) I felt quite satisfied with my last review discussion.

1 2345 6

Strongly Moderately Slightly Slightly Moderately Strongly
Disagree Disagree Disagree Agree Agree Agree

2.) I feel good about the way the last review discussion was conducted.

1 2345 6

Strongly Moderately Slightly Slightly Moderately Strongly
Disagree Disagree Disagree Agree Agree Agree

3.) My manager conducts a very effective review discussion with me.

1 2345 6

Strongly Moderately Slightly Slightly Moderately Strongly
Disagree Disagree Disagree Agree Agree Agree

4.) The performance review system does a good job indicating how an employee has performed in the period
covered by the review.

1 2345 6

Strongly Moderately Slightly Slightly Moderately Strongly
Disagree Disagree Disagree Agree Agree Agree

Procedural Justice

5.) The procedures used to evaluate my performance were fair.

1 234 5 6
Moderately Strongly
Strongly Moderately Slightly Slightly Agree
Disagree Disagree Disagree Agree Agree
6
6.) The process used to evaluate my performance was fair. 5 Strongly
Moderately Agree
1 234
Agree 6
Strongly Moderately Slightly Slightly Strongly
Disagree Disagree Disagree Agree 5 Agree
Moderately
7.) The procedures used to evaluate my performance were appropriate. 6
Agree Strongly
1 234 Agree
5
Strongly Moderately Slightly Slightly Moderately
Disagree Disagree Disagree Agree
Agree
8.) The process used to evaluate my performance was appropriate.

1 234

Strongly Moderately Slightly Slightly
Disagree Disagree Disagree Agree

must clearly identify the major job domains and tasks of a for job descriptions.31 Thus, conducting job analyses for
every full-time position in the Elmhurst Park District
job. Performance standards can flow directly from a job appeared to have merit as a starting point in the creation of
description.30 job specific pay-for-performance appraisal instruments. In
describing this initial step (and the subsequent steps), this
Researchers have suggested conducting a thorough job

analysis to define the appropriate content domains and tasks

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Chapter 11 Compensation | 525

study provides an overview of the research that guided the supervisor discussed and identified a list of specific tasks
step(s), and a description of what occurred during the imple- within each job domain. On average, 10-15 tasks were identi-
mentation of each of six steps. fied for each job domain. Consistent with previous research,
the tasks: (1) began with an action verb; (2) included only one
Step #1: Job analysis Job analyses are a systematic way to specific task, and; (3) described what the employee did.39
gather and analyze information about the content of jobs.32
The job analysis process should identify the job under review, Step #2: Rating of tasks Once an agreed-upon list of job
the participants involved, existing documentation (including domains and tasks were developed, “weights” were created for
the existing job description), the identification of the major each task to further describe its significance. This procedure
job content domains contained within the job, and a devel- followed that advocated by a number of authors as a means
oped list of tasks to be fulfilled under each domain.33 of ensuring the validity of job descriptions.40 The employee
and supervisor independently reviewed the list of tasks and
In completing job analyses, research has indicated that rated each on two, seven-point scales. The first scale, “impor-
involvement of employees at all levels facilitates acceptance of tance” (l ¼ low, 7 ¼ high) rated their perception of the impor-
the system and increases cooperation.34 Employee involve- tance of each task to overall job performance. The second scale,
ment in the performance appraisal and development process “time/frequency” (l ¼ low, 7 ¼ high) assessed the time/fre-
is critical. Because it can lower the system’s credibility, quency that each task required in comparison to all other
researchers caution against attempts to save time by bypass- tasks. The values from each scale were multiplied and a total
ing employee and manager input.35 If managers, acting alone, “weight” for each task was created. The employee and supervi-
produce a system that does not meet staff needs, it damages sor each independently completed the task rating form. An
the perceived connection between pay and performance and example of a portion of a task rating form completed by an
loses the performance-enhancing effect on employees. employee is provided in Figure 2. This example provides the
rating for only one of the seven domains in this job description.
Building upon this argument for employee participation, Next, a meeting was scheduled between the employee and
researchers have suggested that agencies that genuinely supervisor to review the weights. The intent of this discus-
respect their employees find ways to involve them—from sion was to agree upon the overall importance and the time
top to bottom—in decision-making activities that will later that should be spent on each task. If the supervisor and
affect them. Staff involvement is often an expression of the employee(s) had any disagreements about the overall weight
importance the agency places on its individual members and of a task, the ultimate decision was that of the supervisor.
can be effective in motivating agencies to a higher commit- However, the dialog between the supervisor and employee
ment to and valuation of its employees. Many companies that prompted an in-depth discussion about the significance of
involve their employees in problem identification and deci- each task. This discussion was guided by research suggesting
sion making discover that employees become happier, costs that if employees have a clear perception of their tasks, and
decrease, and quality, productivity, and profits increase.36 the importance their managers place on those tasks, it’s
likely the employee’s successful accomplishment of the
The involvement of staff also provides an opportunity tasks will occur.41 After discussing any discrepancies in the
for the employee to know their job better. In particular, the weight assignments, a final list was completed. Figure 3 pro-
employee is placed into an environment where he/she must vides an example.
examine the job domains and tasks of their job title in great
detail and discuss these roles with their supervisor. Job Step #3: Creation of appraisal instrument The information col-
domains are the major areas of responsibility a job may lected during the job analysis provides the content for the
entail. Tasks are the specific actions an employee completes appraisal instrument.42 Performance appraisal instruments
under each domain. When taken together, the sum of all are often divided into two general formats: ranking and rat-
tasks equal the job domain and the sum of all job domains ing. Ranking formats require the rater to compare employees
equal the job title.37 against each other. Rating formats have two elements: (1)
they require raters to evaluate employees on some absolute
Subscribing to this approach, job analyses were com- standard rather than relative to other employees, and; (2)
pleted for every full-time job title at the Elmhurst Park Dis- each performance standard is measured on a scale where
trict.38 To complete each job analysis, a meeting between the appraisers can check the point that best represents the
employee and their supervisor was conducted for every full- employee’s performance level.43
time position. In conducting the job analyses, the employee
and supervisor collectively reviewed the current job descrip- In deciding which appraisal format is most appropriate
tion. Job descriptions of similar positions from other agencies for an agency scholars suggest that an understanding of the
were also reviewed to guide the employees in brainstorming a type of tasks being performed is needed.44 As the task state-
list of job domains and tasks performed. During this meeting, ments that were developed during the job analyses phase
the employee and supervisor collectively identified between six
and 10 job domains that represented the job title. Once the
general content domains were identified, the employee and

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526 | Part 2 Implementation of Strategic Human Resource Management

FIGURE 2
Task Statement Rating Form

TASK STATEMENT RATING FORM IMPORTANCE TIME/FREQUENCY TOTAL
Please rate each task Please rate each task
Name: ______________________________ statement on a 0-7 scale that statement on the 0-7 scale 20
Agency:_____________________________ reflects, in your opinion, shown below. Looking at 20
Title: Division Manager - Recreation how important that task the whole job over 20
Date: _______________________________ statement is to overall job approximately a one-year 20
Length of time in title:________________ performance. Use the scale period, how would you 30
below as a guide to help allocate the task statements 16
TASK STATEMENTS you rate. in terms of the time/ 16
Programming Domain frequency with which 36
Develops programs that provide for the 0 each is done? 49
physical needs of participants 1 of no importance 0
Develops programs that provide for the 2 1 of no importance 9
societal needs of participants 3 moderately important 2 25
Develops programs that provide for the 4 3 moderately important 36
educational needs of participants 5 very important 4 24
Provides programs according to partici- 6 5 very important
pants’ demographic characteristics 7 of greatest importance 6
Provides programs according to partici- 7 of greatest importance
pants’ leisure needs 5
Provides structured programs 4
Provides unstructured programs 4
Plans seasonal programs 5
Evaluates recreational programs 4
Utilizes participant groups in program 5
planning and development 4
Adapts programs to meet ADA needs as 5
requested 6
Oversees outdoor aquatic operations 4 5
Responsible for building rentals 4 4
6 4
7 6
7
3
3
5
6 5
4 6
6

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Chapter 11 Compensation | 527

FIGURE 3
Task Statement Rating Form

TASK STATEMENT RATING FORM
Name: _______________________________________
Agency: ______________________________________
Title: Division Manager - Recreation
Date: ________________________________________
Length of time in title: _________________________

TASK STATEMENTS Supervisor’s Incumbent’s Agreed Rating
Rating Rating
Programming Domain 25
25 20
Develops programs that provide for the physical needs of 25
participants 25 20
Develops programs that provide for the societal needs of 25
participants 25 20
Develops programs that provide for the educational needs of 12
participants 12 20 49
Provides programs according to participants’ demographic 49 30 42
characteristics 42 16 42
Provides programs according to participants’ leisure needs 42 16 36
Provides structured programs 49 36 36
Provides unstructured programs 20 49
Plans seasonal programs 16
Evaluates recreational programs 16 9 25
Utilizes participant groups in program planning and 20 25 36
development 35 36 24
Adapts programs to meet ADA needs as requested 24 24
Oversees outdoor aquatic operations
Responsible for building rentals

included written statements of what the employee does, the and (3) exceeds standards. A “not applicable” rating was also
Elmhurst Park District chose to incorporate an “anchored” included. Figure 4 is the performance appraisal instrument
rating format. An anchored rating format describes perfor- for the Division Manager of Recreation.
mance variation along a continuum from good to bad.45 It
is the type and number of descriptors used in anchoring the Step #4: Identifying raters Once a performance appraisal
continuum that provide the major differences in rating scales. instrument has been developed, the agency must identify
Organizational research has indicated the reliability of a per- who will rate the performance (i.e., supervisor, subordinate,
formance appraisal instrument is strongest when using coworkers).47 In particular, the agency must be concerned
between three and seven descriptive anchors.46 The Elmhurst with improving the accuracy of performance ratings by
Park District selected a three-anchor approach. As a result, focusing their attention on who is most likely to be precise.
each task was evaluated against three anchors on a perfor- Management research documents a variety of rater methods
mance continuum: (1) below standards, (2) meets standards, that have been implemented in organizations, including

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528 | Part 2 Implementation of Strategic Human Resource Management

FIGURE 4
Division Manager of Recreation Performance Appraisal Instrument

Response Scale:
0 = Not Applicable The task is not performed/not observed
1 = Below Standard The performance is below standards
2 = Meets Standard The performance meets standards
3 = Exceeds Standard The performance exceeds standards

Programming Not Below Meets Exceeds
Develops programs that provide for the physical needs of Applicable Standard Standard Standard
participants
Develops programs that provide for the societal needs of Not Below Meets Exceeds
participants Applicable Standard Standard Standard
Develops programs that provide for the educational needs of
participants Not Below Meets Exceeds
Provides programs according to participants’ demographic Applicable Standard Standard Standard
characteristics
Provides programs according to participants’ leisure needs
Provides structured programs
Provides unstructured programs
Plans seasonal programs
Evaluates recreational programs
Utilizes participant groups in program planning and
development
Adapts programs to meet ADA needs as requested
Oversees outdoor aquatic operations
Responsible for building rentals

Financial Management
Prepare and monitor division budget
Coordinate purchase of division supplies, materials, and
equipment
Develop and implement program pricing policies
Manage internal and external assistance payments and delin-
quent accounts
Manage bid specs for major purchases

Organizational Planning
Serve as member of the Parks and Recreation Services Manage-
ment Team and other appointed committee assignments
Attend staff meetings
Prepare annual T-shirt bid
Develop and implement customer service standards

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

Chapter 11 Compensation | 529

FIGURE 4
Division Manager of Recreation Performance Appraisal Instrument (continued)

Communications/Customer Service Not Below Meets Exceeds
Applicable Standard Standard Standard
Develop and maintain cooperative relationships and effective
oral and written communications with internal and external Below Meets Exceeds
customers Standard Standard Standard

Promote District programs to patrons, guests, and staff Below Meets Exceeds
Standard Standard Standard
Prepare written and verbal bullet points, updates, and reports
as required Below Meets Exceeds
Standard Standard Standard
Act as a liaison to affiliates, community groups, and govern-
mental units

Design and distribute information for public distribution

Coordinate seasonal brochure productions

Safety Not
Applicable
Encourage and demonstrate safe work habits through use of
established safety program guidelines

Serve as member of the District’s Crisis Management Team
Maintain CPR and AED certification, and ensure that all staff
within supervision do the same

Personnel Management Not
Recruit, hire, and train staff Applicable
Manage and evaluate staff
Provide ongoing direction, foresight, and motivation to staff
Prepare for and conduct staff meetings and trainings as
needed

Registration Not
Manage program registration process Applicable
Manage program cancellation/expansion/addition process
Manage permit and rental registrations

360-degree feedback, a system that uses supervisors as supervisor ratings tend to be more reliable than those
from other sources.51
raters, peers as raters, self as raters, customers as raters,
and subordinates as raters.48 In deciding which approach Step #5: Rater training The next step in the construction of a
performance appraisal system is to understand how and where
to take, research suggests that organizations identify those raters make mistakes. In describing how raters process infor-
mation about the performance of employees they rate, scholars
individuals who possess the most complete information on identify five stages. First, the rater observes the behavior of the
the performance of the ratee.49 Research has also found the
immediate supervisor to be the most frequently used.50 In

addition, a comparison of the reliability of raters suggests

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

530 | Part 2 Implementation of Strategic Human Resource Management

ratee. Second, the rater encodes this behavior as part of a total Elmhurst Park District to test the appraisal process and
picture of the ratee. Third, the rater stores this information in instruments with no consequences assigned to the results.
memory. Fourth, during the evaluation phase, the rater reviews The “trial run” was conducted instead of an actual live
the performance dimensions and retrieves the stored informa- implementation due to the developmental timeline of the
tion (i.e., observations, impressions, etc.) to determine their rel- new appraisal system.
evance to the performance dimensions. Finally, the information
is reconsidered and integrated with other available information The “trial run” was initiated with the employee and
as the rater decides on the final ratings.52 Quite unintentionally, supervisor independently completing the appraisal instru-
this process can produce information errors and they can occur ment. To assist in the final calculations, the appraisal
at any stage. instruments were created in a Microsoft Excel format.
Paper copies of the spreadsheet-formatted instrument
One approach to limiting errors is through appraiser were printed and provided to the employee and supervisor
rater training.53 Surprisingly, managers frequently report (see Figure 4).
that they receive little training beyond a description of the
rating form.54 An effective formal performance appraisal sys- Once the employee and supervisor had independently
tem can’t exist without the ongoing education of all key completed the appraisal instrument they met and discussed
appraisers in the appraisal process.55 Developing the skills the ratings. During this time the employee and supervisor
necessary to conduct effective performance appraisals, reached an agreed upon rating for each task statement. At
including an understanding of psychometric errors, can be this point, the appraisal was completed and signed by both
completed through appraiser training.56 the employee and supervisor. The Elmhurst Park District
Human Resource Specialist applied the previously established
Training sessions subscribing to the previously men- “weights” for each task statement to determine a final percen-
tioned principles were conducted with the employees of tile score for each employee (see Figure 5). Statistically,
the Elmhurst Park District. Integrating the previously men- this procedure involved: (1) multiplying the score of the task
tioned principles, employees were provided with a three- (i.e., “1” – below standard, “2” – meets standard, “3” –
hour training session that focused on three error categories: exceeds standard) by the “weight” of each task (tasks receiving
(1) rater-error training; (2) performance dimension train- a “not applicable” rating were voided from the computations);
ing, and; (3) performance standard training. During the (2) determining the total points possible (i.e., the sum of each
rater-error training session, employees were introduced to task’s “weight” multiplied by “3 – exceeds standard”), and;
several psychometric errors (i.e., leniency, halo effect, (3) dividing the total possible points by the total points earned
recency) and offered suggestions for addressing these prob- by the employee to obtain a final percentile score. For exam-
lematic areas. The performance dimension training session ple, in Figure 5, the Division Manager’s final percentile score
involved a collective discussion on the performance dimen- was 68.42%.
sions between the raters and ratees. Finally, the performance
standard training focused on providing the raters with a Findings with Employee Assessments
standard of comparison or frame of reference for making
appraisal decisions. In addition to describing the steps involved in creating a pay-
for-performance appraisal system for a municipal agency,
Step #6: Performance appraisal interview There is a large this study used Keeping and Levy’s appraisal reaction instru-
body of research indicating that the level of employee par- ment to assess every full-time employee’s reactions toward
ticipation in the interview is associated with a variation in the newly developed process.58
various desirable appraisal-related outcomes, including
appraisal system fairness, appraisal satisfaction, supervisory Preliminary Analysis
support, satisfaction with supervisors, appraisal system Prior to testing the research questions, the data were
acceptance, and greater acceptance of feedback.57 In partic- examined for accuracy of data entry, missing values, and
ular, self-evaluation provides employees with the opportu- outliers. A review of the raw data entries identified
nity to systematically assess their performance. A common two participants who had not fully completed both the
method to facilitate self-evaluation is to require employees pre and post surveys. Specifically, the two participants
to complete their own appraisal and present the draft for had completed the pre survey instrument, but had volun-
discussion with the supervisor. The supervisor can review tarily left the agency before completing the workshops
the draft with the employee and compare the employee’s and post survey. As a result, these participants were
self-appraisal ratings to the supervisor’s appraisal ratings removed from the study, thus yielding a response rate of
of the employee. 97% (n ¼ 56).

Adopting this participative process of self-appraisal, a The instruments used in the study were then examined
“trial run” was conducted for the newly developed perfor- for internal consistency. In particular, reliability measures
mance appraisal instruments. The “trial run” allowed the were obtained for the satisfaction with the performance

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

Chapter 11 Compensation | 531FIGURE 5
Finalized Division Manager of Recreation Performance Appraisal Instrument
Copyright 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.Response Scale:The task is not performed/not observed
0 = Not Applicable The performance is below standards
1 = Below Standard The performance meets standards
2 = Meets Standard The performance exceeds standards
3 = Exceeds Standard

Programming Not Below Meets Exceeds Weighed Total
Develops programs that provide for the physical Applicable Standard Standard Standard Score Weight Score Possible
needs of participants
X X X 2 25 50 75
Develops programs that provide for the societal
needs of participants X X X 1 25 25 75
X X
Develops programs that provide for the educa- X X 2 25 50 75
tional needs of participants X
X 1 12 12 36
Provides programs according to X
participants’ demographic characteristics 3 49 147 147
Provides programs according to participants’ lei- 1 42 42 126
sure needs 2 42 84 126
2 36 72 108
Provides structured programs 1 36 36 108

Provides unstructured programs 2 16 32 48
3 25 75 75
Plans seasonal programs 3 36 108 108
2 24 48 72
Evaluates recreational programs
(continued)
Utilizes participant groups in program planning
and development

Adapts programs to meet ADA needs as requested

Oversees outdoor aquatic operations

Responsible for building rentals

FIGURE 5 532 | Part 2 Implementation of Strategic Human Resource Management
Finalized Division Manager of Recreation Performance Appraisal Instrument (continued)
Copyright 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Financial ManagementEditorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.NotBelow Meets Exceeds Score Weight Weighed Total
Prepare and monitor division budget Applicable Standard Standard Standard 1 36 Score Possible
Coordinate purchase of division supplies, materials, .36
and equipment Not X X X 3 25 108
Develop and implement program pricing policies Applicable Meets X 3 6 75
Manage internal and external assistance payments Below Standard 18 75
and delinquent accounts Not Standard X 2 12 18
Manage bid specs for major purchases Applicable X Exceeds 3 5 24
X Standard 15 36
Organizational Planning Meets Score Weight Weighed 15
Establish and monitor division goals and objectives X Standard X 1 36 Score Total
Serve as member of the Parks and Recreation X Exceeds 36 Possible
Services Management Team and other appointed Below X Standard 1 49 108
committee assignments Standard X 2 30 49
Attend staff meetings X X 1 15 60 147
Prepare annual T-shirt bid X 3 25 15 90
Develop and implement customer service standards X 75 45
Score Weight Weighed 75
Communications/Customer Service Score
Develop and maintain cooperative relationships 2 49 Total
and effective oral and written communications with 98 Possible
internal and external customers 2 36
Promote District programs to patrons, guests, and 72 147
staff 2 16
Prepare written and verbal bullet points, updates, 32 108
and reports as required 3 16
Act as a liaison to affiliates, community groups, and 48 48
governmental units 3 9
Design and distribute information for public 3 20 27 48
distribution 60
Coordinate seasonal brochure productions 27
60