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What’s the best mix of compensation elements to elicit top performance?

MIT Sloan Mgt. Rev., Winter 2007 at 8, has a provocative article about how best to allocate base pay, merit raises, and bonuses to motivate employees. Based on research on about 700 employees who worked in the US operations of a large diversified corporation, the author – Michael Sturman of Cornell University – arrived at a number of interesting conclusions.

For example, when the research assessed raises and bonuses and their respective effects on performance, “the effect of a 1% raise was about equal to that of a 3% bonus.” As the article puts it, “the enduring nature of raises makes them, in the long run, more valuable.” Unexpectedly, however, “tying pay to performance for merit raises seemed to have no effect. In other words, making raises more contingent on performance did not appear to spur employees to do better at their jobs.”

Bonuses, by contrast had a strong link to performance. In fact, “[I]f all managers were to tie bonuses strongly to an individual’s performance, the company would theoretically see an overall 16% increase in employee performance.”

Of course, the hands of many general counsel are tied with regard to decisions on some aspects of pay (think of bonus targets and COLA increases), but the findings deserve thought.

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