Attention, class: merit pay doesn't work

As the emperors of Wall Street and corporate boardrooms stand naked before the world, it's only a matter of time before various hallowed business practices are similarly laid bare. One of them is merit pay. Fay Hansen, a journalist specializing in corporate benefits and finance, reports in FinancialWeek:

Survey reports show years of flat merit increase budgets that barely meet inflation rates and bear no relationship to productivity growth or profitability trends. The major salary budget surveys point to 2009 merit increases averaging 3.6% to 3.8%, with the highest performers receiving 5.6% to 6%. In effect, for the vast majority of employees, merit increases are unevenly distributed cost-of-living and market-adjustment increases couched in the language of performance rewards.

Even when companies create seemingly significant pay differentiation between low and high performers, the actual cash increase is insufficient to sustain performance—or it drives the wrong behaviors, Mr. Pfeffer said. And as many studies show, high levels of differentiation destroy engagement, breed distrust and undermine teamwork.

A series of experiments conducted by Hewlett-Packard in the 1990s verified long-standing academic studies demonstrating that high incentives for top performers adversely affect organizational performance. Despite the deluge of consultants calling for companies to boost pay differentiation, Mr. Pfeffer cites dozens of studies showing that more dispersed pay distributions generate higher turnover, lower quality and a vast array of unintended results, including serious ethical breaches and business-killing behaviors.

Hansen's primary source is Jeffrey Pfeffer, a professor of organizational behavior at Stanford University’s Graduate School of Business, who cites three decades of empirical studies and asserts, “The evidence is overwhelming that individual pay for performance does not improve organizational performance except in very limited cases."

Someone should ping those fire-breathing education reformers who want to base teachers' pay on "performance." I've long thought that tying individual teacher's pay to measurable student performance would lead to manic teaching to the test -- not to say rampant cheating. It would also doubtless "breed distrust and undermine teamwork" in what is by nature a collective, service-oriented enterprise.

Just as free market fundamentalists who are "always for less regulation" have been discredited, it's time to take a hard look at various nostrums of corporate management.