Psychological mechanisms explaining merit pay acceptance and effectiveness

In Finland, especially in central governmental and municipal sector, collective pay agreements make it possible to use—and even require—job evaluation and individual performance appraisals to determine employee base pay levels. These practices are generally designed to enhance pay satisfaction and the motivation of the current workforce, as well as to attract and retain skilled work force. This dissertation provides new insights into the psychological mechanisms that explain why employees adopt certain attitudes and behaviors in response to merit pay reforms, often referred to as incentive effects in the literature on compensation psychology. The dissertation summarizes five studies that draw upon different theoretical perspectives and concepts, including psychophysics, affective events theory, reflection theory, organizational politics and fairness. Each study contributes to our understanding of how merit pay in particular influences attitudes and behaviors of the existing workforce. The data were gathered from seven public sector organizations in Finland via employee surveys (sample size totals N=1350 for all the studies). We used records-based pay data from five of the seven organizations. Based on the results, I argue that pay increases of less than eight percent might not be meaningfully noticed. However, employees are comparatively more sensitive to negative pay changes such as indirect pay cuts. The results suggest that organizations should be aware that employees react to pay reforms affectively depending in part on how the reform personally impacts their pay, and these affective reactions may influence attitudes and behaviors at work. I argue that employee acceptance of merit pay practices depends on their understanding of why the system is being implemented and accepting these reasons in such a way that the pay system transmits positive symbolic and instrumental messages. Managers can have a positive impact on pay system success through participatory goal-setting processes and by creating trusting relationships where subordinates perceive performance appraisals as fair. The results imply that for a pay system to be effective, it is essential for employees to believe that politics do not play a part in performance appraisals and pay decisions. If employees believe that pay decisions are based on politics instead of performance, the organization risks having not only an ineffective pay system but one that produces undesirable outcomes. The results also suggest that employee participation in pay system development only matters when employees believe that managers' actions are sincere.