Pay for (individual) performance: A longitudinal study of merit pay plans and firm performance

Abstract

Prior research on merit pay plans is mainly earmarked by cross-sectional designs focusing on individual-level outcomes. We posit that, collectively, this body of work has not made substantial inroads in capturing the effects of merit pay plans on organizational level outcomes over time. We draw upon both psychological and economic arguments and examine the longitudinal relationships of merit pay and bonus pay with trends in firm performance across time. To model these relationships, we adopt random coefficient growth models and utilize archival data of 454 firms in South Korea across a ten-year time frame. Our primary empirical results demonstrate that only merit pay is positively related to revenue growth, but not to growth in profits. The revenue growth without accompanying increases in profit is most likely due to another finding: merit pay is also significantly associated with a growth in labor costs. In contrast, bonus pay is not significantly associated with temporal trends in our three primary financial outcomes; revenue, profit, and labor costs.