Performance Management

Seniority Versus Performance Based Pay Systems

Determining the foundations of a pay system can be a very difficult dilemma. In most cases, the basis of the pay system will boil down to two main options: Seniority-based pay systems and performance-based pay systems. While the decision may seem to have implications solely in the area of compensation management, an inappropriate pay system choice can lead to higher turnover rates, especially for high performers.

Seniority Versus Performance Pay Systems

Seniority-based pay systems are those in which the primary basis for pay increases is the employee’s tenure. It should be noted that seniority-based pay systems can take into account performance, but the main factor is tenure. Some benefits of seniority-based pay include loyalty, retention, and stability of all staff members, regardless of performance levels.

Performance-based pay systems consider performance as the primary basis for pay increases. As with seniority-based pay systems, other factors, like tenure, can be accounted for in a performance-based system, but employee performance, however conceptualized by the organization, is the impetus in determining pay raises.

Performance-based pay systems can actually lead to a climate in which all employees are working hard to achieve maximum performance. While this certainly sounds like an ideal option, there are several downfalls, such as the potential for high turnover rates as average and lower performing employees can get discouraged when they regularly fail to receive merit increases.

A common analogy used to help conceptualize this is the tournament analogy. The ‘winners’ are the high performers who often receive increases, and the ‘losers’ are the average and low performers who are being passed over for increases. As you would expect, those who consistently lose the tournament are likely to stop playing the game, i.e. quitting.

What Factors Can Alter This Process?

  • Pay System Communication

The amount of communication about how pay increase decisions are made is crucial to the functioning of all pay systems. Workers should be told not only how the system is designed, but also how their pay increases compare to the averages within their jobs. This can be best accomplished by talking about pay increases as percentages, thus avoiding negative feelings related to salary differences. A final, very important note about pay system communication is that low levels of pay communication have shown links to increased union-organizing activities.

  • Pay Dispersion

The extent to which pay differs across employees in the same job is very important to the effectiveness and implications of pay systems based on both seniority and performance. When pay dispersion is high, there are important implications, especially to the quit rates of high performing employees.

In a seniority-based pay system, quit rates of high performing employees are higher when there is a great deal of pay dispersion. The assumed cause of this relationship is that high performing employees begin to perceive that their greater amounts of effort and performance are not appropriately appreciated by the organization. As a result, high performing employees are likely to leave the organization.

Conversely, when pay dispersion is high in a performance-based pay system, high performing employees tend to be the highest earners, as their high performance is being highly rewarded. In this type of structure, high performers tend to stay with the company, as they feel they are well compensated for their hard work. The downside is, once again, that average and low performing employees are more likely to leave.

Practical Implications

When choosing the emphasis for the pay system of any job within your organization, be sure to:

  • Determine what kind of balance you would like to find between a pay system that encourages only the high performers to stay, and one that is inviting to the entire workforce.
  • Remember that, while it may sound like a good idea to weed out the low and average performers and only retain the high performers, this can lead to an ongoing cycle of high turnover and its associated costs. Mentoring, training, and other forms of coaching should be utilized to try to raise the performance level of the lower performers.
  • Ensure that, regardless of pay system, a high level of pay system communication is present to reduce the likelihood of employee discontent and associated union organization.

David Daly

DeGarmo

This was a summary of the research and practice implications from: Shaw, J. D., & Gupta, N. (2007). Pay system characteristics and quit patterns of good, average, and poor performers. Personnel Psychology, 60, 903-928.