What’s the Best Way to Pay Employees?

Raises and bonuses are both effective for motivating people, but which is better for eliciting top performance?

Companies have long struggled with ways in which to motivate employees. To that end, many organizations offer a mix of base salary, bonuses, stock options and a variety of benefits, including a retirement plan, health-care program and so on. But what’s the most cost-effective package for getting employees to deliver their best efforts? What, for instance, provides more bang for the buck — merit raises or bonuses?

To investigate the effects of pay, Michael C. Sturman, an associate professor with the School of Hotel Administration at Cornell University in Ithaca, New York, studied the employees of a large diversified corporation with a variety of service-related businesses. Although the organization has operations in 35 countries, Sturman conducted his research in just the United States because those employees were paid under the same system. He also wanted to avoid any potential effects that different cultures might have on the data. Altogether, he studied almost 700 employees who worked in the U.S. operations of the company from 2001 to 2004.

Sturman focused his research on three major components of employee compensation: base pay, merit raises and bonuses. All the individuals in his study were paid a base salary and were eligible for raises and lump-sum bonuses depending on their performance, as assessed by their supervisors. At the company, supervisors use a four-point scale to assess an employee’s performance: (1) fails to meet expectations, (2) meets expectations, (3) exceeds expectations and (4) significantly exceeds expectations. Specifically, Sturman was interested in determining the difference between “how much” employees got paid (the total monetary amount) versus “how” they got paid (raises versus bonuses, and a person’s total pay compared to the average for that position, based on compensation surveys).

Not surprisingly, the best predictor of future performance is the past. That is, an individual who has received exceptional ratings in the past will tend to receive high ones in the future. But that knowledge doesn’t provide guidance about how to pay those top employees to help maintain their performance, nor does it offer advice about how to get other workers up to speed. In his research, Sturman was particularly interested in how pay could be used to motivate employees so that, for instance, a mediocre worker would become a stellar performer. Thus, in his study, he controlled the data for past performance.

Sturman also considered an employee’s manager.

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