An Empirical Examination of a Merit Bonus Plan

Abstract

One of most frequently used methods of rewarding employees involves compensation based upon performance. Recently, a Tower's Perrin survey indicated that of 770 North American organizations, more than two-thirds had variable pay plans (Anonymous, 2000). While many of variable pay plans reward performance at organizational level, it appears that for exempt employees most frequently used method of pay for performance is merit pay (StOnge, 2000; Taylor and Pierce, 1999; Eskew and Heneman, 1996; Gerhart and Milkovich, 1992; Heneman, 1992). Merit pay is pay based on performance, but is distinguished from other forms of incentive pay in four ways: 1) typically it is allocated on basis of past performance rather than future performance, 2) it is based on subjective ratings of employee performance rather than objective measures, 3) it is based on individual rather than group performance, and 4) it is based on an assessment of long-term performance in that increase in pay becomes permanent (Heneman, 1992). Merit bonus plans are a subset of merit pay plans and share all of features enumerated by Heneman except last one; merit bonuses are just that--bonuses--so they are a one-time adjustment to pay and must be earned again during each evaluation period. Merit-based bonus plans have been proposed as one means to deal with some of problematic issues surrounding merit pay. One of benefits of using bonuses under a performance-contingent pay plan is that bonuses can better reflect current performance while at same time managing costs for organization (Lawler, 1990). It appears that businesses have been attempting to take advantage of these beneficial characteristics, as merit-based bonus plans are increasing and sometimes replacing traditional merit plans (Sturman and Short, 2000). Yet there has been no similar increase in research associated with these plans. Relatively recently, Heneman (1992) noted lack of evaluative research on merit bonuses and pointed out need for more inquiry in this area. As evidence, even Heneman and Schwab's Pay Satisfaction Questionnaire did not include a lump-sum bonus satisfaction component and only recently has that dimension been proposed as an addition to that scale (Sturman and Short, 2000). The purpose of this study was to provide some evidence of effectiveness of merit bonus plans by assessing implementation of a merit bonus pay program. Even though merit pay appears to be a fixture in American business, it is not without controversy. There is disagreement as to whether merit pay can and does bring about favorable outcomes (Campbell et al., 1998), and virtually every review of merit pay literature notes that some question its effectiveness (e. g., Heneman, 1992). But, we should not be surprised. After all, the implementation of successful performance appraisal and merit pay systems is one of most challenging aspects of human resource management (Gabris and Ihrke, 2000: 41). Both detractors and advocates recognize that manner in which merit pay is implemented is of crucial importance and some have noted that these mixed results may be due to manner of implementation and administration of program (Heneman, 1992; Taylor and Pierce, 1999; McGinty and Hanke, 1989). Heneman (1992) noted that theoretical foundations for merit pay are found in both psychological and economic literature and has proposed expectancy theory as unifying theme for understanding motivational force associated with merit pay. In expectancy theory, motivation is dependent upon three sets of perceptions that are related as a multiplicative function: expectancy, instrumentality, and valence. Expectancy refers to employees' perception that they can achieve level of performance expected; valence refers to whether a potential outcome is valued; and instrumentality is whether or not valued outcome will actually be delivered. …

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