Firms should reward their employees based on the employee’s contributions to the organization. Sounds simple enough, right?
But what if employees don’t know their relative contribution to the firm? This is where pay disparity comes in to play.
Spears School of Business associate professors of management Aaron Hill and Federico Aime’s research, “The Performance Implications of Resource and Pay Dispersion: The Case of Major League Baseball,” dives in to pay and resource disparity using MLB as the sample.
“What we found is that people don’t often know their relative contribution to the organization,” Aime said. “Finding the balance between pay and contribution implies that people already know their contributions, so it gets tricky when they don’t. People at the bottom of the contribution spread usually assume they are performing about average, when in reality they could be performing below average and getting paid more than they’re worth. This leads to the employees at the top feeling underappreciated because they are not being rewarded at a level relatively higher to the under-contributing peers.”
This disparity is detrimental to firm performance, according to previous research in the area. What the previous research did not look in to is potentially the most important factor for pay dispersion: resource value.
“There are at least three reasons for this,” Hill said. “One, previous research believes that the negative effects of pay dispersion are independent of compensation differences because employees are more likely to focus on how they are treated by the firm instead of their contributions to the firm. But many times, you can assess your contributions to the firm with the existences of well-established measures that are visible to all organization members.
“Two, this type of data is difficult to collect, so the opportunity to compare pay and resource contribution is limited. Three, researchers may have been reluctant to investigate resource value because they feel it’s a less relevant consideration. But really, resource dispersion is manageable, it’s a fundamental responsibility to respond to turnover, and it’s becoming increasingly important to organizational performance. If people know how the relationship between how they are performing, how they’re being paid and the firm’s resources, there would be less inequity.”
It’s widely agreed that higher pay dispersion equates to lower firm performance, but the finding that the relationship between resource value and pay dispersion is affecting firm performance gives management a new area to focus on improving.
“When you start managing and tracking your resources, it’s going to lead to better firm performance,” Hill said. “Once you find the balance between dispersions of pay and work contribution in concert with the effects of your overall resource quality and pay level, you can start correcting that pay dispersion, and your employees are going to be happier.”