Is there merit in merit pay increase?

In a statement released yesterday, ECA International, a global association of human resource practitioners says that Singapore workers can expect their pay to go up by an average of 5 per cent in 2008 as compared to last year's average increase of 4.5 per cent. However, inflation is likely to take a big bite of that pay rise.

According to the ECA report, the surge in prices of oil, food and lodgings will 'counter-balance' the projected big pay rise 'considerably'. With Singapore workers looking forward to some of the biggest pay rise in the developed economies, real take-home increases will be 'relatively subdued'. Most other developed economies in the ECA survey are showing forecast wage increases of approximately 4 per cent.

'This latest upswing in inflation, which has caught many people by surprise, will have an impact on real salary increases in 2008,' said the firm's general manager. Employees in Singapore are likely to experience relatively subdued real income rises and employers may have to budget for higher salary increases next year to make up for this year's relatively low increase in real incomes.

If compensation practitioners are considering an upward revision in their forecast salary increases to retain talented employees, they should instead consider the merits of merit pay. Are merit pay increases simply employees’ entitlement based on cost of living adjustment (COLA), or are merit pay increases really based on merit?

According to the Business Times report dated 10 January 2008, Singapore’s inflation rate could soar past 6 per cent in the current quarter, beating previous estimates, as an upward revision of the value of public housing kicks in this month and food and oil prices continue to climb. If employees perceived merit pay increases as entitlement for COLA, there may be an reduction in their real take-home pay.

The concept of merit pay has been around for some time. Evans (1970) believed that merit pay has its origins in the sixteenth and seventeenth centuries with the Protestant Reformation. The protestant work ethic, which views man as competitive and individually oriented, emerged from the belief that economic success was evidence that a person who worked hard was serving God; material success was equated with spiritual purity. Thus, according to Evans (1970), performance-based pay plans continue this theme by rewarding those who have worked the hardest and contributed the most.

It appears logical to base merit pay upon performance, or is it? Commentators say that merit pay plans based upon performance can have many defects, including improper design and implementation; difficulties in paying for individual performance; lack of conviction on the part of employees that pay is really linked to performance; inadequate or inappropriate objectives, criteria, and measures; as well as other shortcomings.

Merit pay continues to be a popular vehicle for rewarding employees. However, merit pay systems that are poorly designed and implemented can lead to perceptions of inequity for individuals; and these perceptions of inequity held by individuals can have a negative impact on important organizational outcomes.

Voluntary turnover is one possible response to merit pay inequity. Those who quit in response to perceived merit pay inequity are typically an organization’s better performers. The average and below-average performers are typically “not bothered” by a merit pay system that pays them the same as their harder-working coworkers.

Another possible response to merit pay inequity is that high-performing employees who receive the same merit pay as lower-performing employees may choose to stay on the job, but they may decide to lower their performance or reduce the quality of their work in the future in an attempt to restore equity.

Regardless of the methods employees adopt to restore their perception of fairness and equity, there is a need for practitioners to know if such behaviors are harmless or may create serious consequences for organizations. Talented employees, especially if they are working in (overseas) Chinese work communities, may simply choose to quit and seek their fortune elsewhere.

In administering merit pay increases, we are forced ranked and fitted into merit pay matrices representing normal distribution curves. This forced-fitting ensures that our pay increase budgets are on target. On occasions, we may "rob Peter to pay Paul" to balance the pay "bucket".

In addition, the spread in pay increase percentages between high performing employees and average employees are usually insignificant and/or inadequate to drive change in behaviors toward increased work performance.

What if a merit pay increase budget contains both cost of living adjustments and work performance outcomes? Where the quantum of merit pay increase lags inflation, as it appear to be the current situation, can we seriously talk about merit pay increase aligned to work-related performance?

Is there really merit in merit pay increase?