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CHAPTER 3

Traditional Bases for Pay: Seniority and Merit


Learning Objectives
1. Describe seniority and longevity pay practices.
2. List at least three elements of merit pay.
3. Give examples and definitions of performance appraisal methods.
4. Explain at least three ways compensation professionals can strengthen the pay-forperformance link and summarize each one.
5. Discuss three possible limitations of merit pay programs.
Lecture Outline
I.

Seniority and Longevity Pay


A. Overview
1. Reward employees with periodic additions to base pay according to length
of service
2. Assume that:
a. Employees become more valuable over time
b. Good employees may leave if not compensated fairly
3. Rationale based on the human capital theory
4. Human capital theory based on belief that:
a. Employees knowledge and skills generate productive capital
b. Knowledge and skills can be developed through formal education and
training
B. Historical Overview
1. National Labor Relations Act of 1935 (NLRA)
a. President Franklin D. Roosevelts response to:
i. Economic disaster caused by the Great Depression of 1929
ii. Desire for balance of power between labor and management
b. Established the collective bargaining system
2. Collective Bargaining
a. Led to job control unionism
b. Collective bargaining units to:
i. Negotiate formal work contracts
ii. Provide quasi-judicial grievance procedures to adjudicate disputes
between union members and employers
c. Union shops
i. Establish workers rights and obligations
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ii. Describe and delineate jobs


d. May determine specific type of seniority system used to decide job
i. Scheduling
ii. Transfer
iii. Layoffs
iv. Compensation
v. Promotions
3. Seniority pay systems
a. Essentially provide automatic pay increases
b. Performance assessments tend to be subjective
c. The automatic pay adjustments were used to protect public sector
employees from political quirks
C. Who Participates?
1. Most unionized private and public sector organizations
a. Union rank-and-file and clerical workers
b. Public sector positions include:
i. Administrative
ii. Professional
iii. Managerial
2. Public employers include:
i. Municipal governments
ii. State governments
iii. Federal government
D. Effectiveness of Seniority Pay Systems
1. Virtually no systematic research demonstrating seniority pay system
plans effectiveness or prevalence in the private sector
2. Will probably disappear from for-profit companies in the future due to:
a. Increased global competition
b. Rapid technological advances
c. Skill deficits of new and current workers
3. Until recently, public sector employers had less reason to change pay
systems, since their purpose is service not profit
a. Since 1949, federal pay based on the General Schedule
b. Its effectiveness is now under scrutiny
c. The federal government has extensively considered the strategic
importance of moving beyond seniority-based pay
d. The current pay system has not been modified yet
E. Design of Seniority Pay and Longevity Pay Plans
1. Seniority pay
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a. Object is to reward job tenure through permanent increases to base


salary
b. Employees start at set base pay then receive time-designated pay
increases
c. Employees can reach a maximum pay level for a position, but are
expected to be promoted and qualify for a new, higher pay structure
d. Aging baby boomer generation which would make these plans cost
prohibitive
2. Longevity pay
a. Rewards employees who have reached pay grade maximums and who
are not likely to move into higher grades
b. Used by state and local governments as an incentive to:
i.
Reduce employee turnover
ii. Reward employees for continuous years of service
c. Can take the form of:
i.
A percentage of base pay
ii. A flat dollar amount
iii. A special step increase based on the number of years the
employee has spent with the organization
d. Federal employees are subject to longevity pay via the General
Schedule (GS) system (refer to Salary Table 2013 GS)
i.
Classifies federal government jobs into 15 steps (GS 1 through
GS 15)
ii. Is based on such factors as skill, education, and experience levels
iii. Jobs that require high levels of specialized education, have
significant influence on public policy, or require executive
decision making are classified separately (e.g., Senior Level,
Scientific and Professional, Senior Executive Service)
iv. Employees are eligible for 10 within-grade step pay increases
which can take approximately 18 years to achieve
v. Waiting periods within each step are: Steps 13 = 1 year per step;
Steps 46 = 2 years per step; Steps 79 = 3 years per step
F. Advantages of Seniority Pay Plans
1. Employees may perceive that they are treated fairly because they earn pay
increases by an objective standard instead of supervisory judgment
2. Set pay increases facilitate the administration of pay programs for
employers
3. Avoids the perception, by employees, of favoritism

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II.

G. Fitting Seniority Pay with Competitive Strategies


1. Seniority pay does not fit well with the imperatives of competitive
strategies because employees can count on receiving the same pay raises
regardless of performance
2. Seniority pay does not fit well with the imperatives of competitive
strategies because employees can count on receiving the same pay raises
regardless of whether or not companies are meeting their differentiation or
cost goals
3. With the exception of companies that are shielded from competitive
pressures (e.g., public utilities), it is likely that companies that intend to
remain competitive will set aside seniority pay practices
4. Although seniority pay plans reflect employees increased worth, they
measure such contributions indirectly rather than based on tangible
contributions or the successful acquisition of job-related knowledge or
skills
Merit Pay
A. Overview
1. Pay programs that assume that employees compensation over time should
be determined, at least in part, by differences in job performance
2. Permanent increases are based on performance
3. Rewards excellent effort or results
4. Motivates future performance
5. Helps employers retain valued employees
6. Usually expressed as a percentage of:
a. Hourly wages of nonexempt employees
b. Annual salaries of exempt employees
7. In 2013, employees earned average merit increase of 2.8 percent and 2.5
percent
8. The highest performers earned 4.6 percent to base pay, average performers
earned 2.6 percent, and the lowest performers earned 0.2 percent
B. Who Participates?
1. Merit pay is one of the most commonly used forms of compensation in the
United States
2. Fits into the U.S. cultural ideal of rewarding individual achievement
3. Used more in the private for-profit sector than the not-for-profit and public
sectors
C. Exploring the Elements of Merit Pay
1. Based on objective and subjective indicators of an employees job
performance
2. Periodic review, by supervisors, of employees job performance compared
to performance standards and goals
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3. Accurate performance appraisals are key to effective merit pay programs


4. To be effective, standards and goals must be realistic and employees must
be prepared to meet job goals with respect to their skills and abilities
5. Employees must perceive a strong relationship between attaining
performance standards and pay increases
6. Important considerations for deciding on using merit pay
a. Adequate funds should be available to fulfill promises to compensate
employees (more in chapter 8)
b. Adjustments to base pay should be made according to changes in the
cost of living or inflation before awarding merit pay raises
i.
Inflation represents the increases in the cost of goods and services
ii. To minimize the effects of inflation cost-of-living adjustments
(COLAs) are added to base pay
c. Merit pay raises should be based on performance
d. Two important factors
i.
Commitment of top management
ii. Job design
e. Do employees have control over their performance without outside
influences that can affect the attainment of performance goals?
f. Have employers set explicit performance standards that specify the
procedures or outcomes against which employees job performance
can be clearly evaluated?
6. The amount of merit increase should:
a. Reflect prior job performance
b. Motivate employees toward improved performance
c. Be meaningful to employees; just-meaningful pay increase which
refers to the minimum pay increase that employees will see as making
a meaningful change in compensation
III.

Performance Appraisal
A. Types of Performance Appraisal Plans
1. Trait systems
2. Comparison systems
3. Behavioral systems
4. Goal-oriented systems
B. Trait Systems
1. Are based on having raters evaluate each employees traits or
characteristics such as:
a. Quality of work
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b. Quantity of work
c. Appearance
d. Dependability
e. Cooperation
f. Initiative
g. Judgment
h. Leadership responsibility
i. Decision-making ability
j. Creativity
2. Appraisals are typically scored using descriptors ranging from
unsatisfactory to outstanding
3. They are easy to construct, use, and apply to a wide range of jobs
4. They are easy to quantify
5. They are common in companies that rely on customer service
6. Drawbacks
a. Can be highly subjective
b. These systems rate individuals on subjective personality factors rather
than objective job performance data
C. Comparison Systems
1. Types
a. Ranking
b. Forced distribution
c. Paired comparison
2. Ranking
a. Designed to evaluate an employees performance against the
performance of other employees
b. Performance ratings are then ranked from best to poorest
c. Can be based on overall performance or individual traits
d. Pay increases are based on ranking
2. Forced distribution performance appraisal systems
a. Assign employees to groups that represent the entire range of
performance (such as best, moderate, and poor performers)
b. Used to minimize the tendency for supervisors to rate most employees
as excellent performers, because of supervisors self-promotion
motives
c. Used by some supervisors to avoid alienating employees by judging
them negatively
d. Can be problematic when the actual distribution is substantially
different from the forced one

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Example: Distorted Ratings due to Forced Distribution


Supervisor required to use the following forced distribution scale
15% well below average
25% below average
40% average
15% above average
5% well above average
If 35 percent of the employees actual performance ratings were above average or
well above average then 15 percent of those employees performances would be
underrated because only 20 percent can be rated as above average or better.

4. Paired comparisons
a. Each employee is compared to all others
b. Each employee is ranked according to the number of times they are
identified as being the better performer
c. This method is best suited for small groups of employees who perform
the same or similar jobs
5. Drawbacks
a. These methods tend to encourage subjective judgments
b. The chance for rater errors and biases increase
c. Small differences in performance between employees may become
exaggerated if supervisors feel compelled to distinguish among levels
of employee performance
D. Behavioral Systems
1. Rate employees on the extent to which they display successful job
performance behaviors
2. These objective job behavioral methods, when developed and applied
correctly, provide results that are relatively free of rater errors and biases
3. Three main types
a. Critical incident technique (CIT)
b. Behaviorally-anchored rating scales (BARS)
c. Behavioral observation scales (BOS)
4. CIT
a. Requires job incumbents and their supervisors to identify performance
incidents that distinguish successful performance from unsuccessful
ones
i. On-the-job behaviors
ii. Behavioral outcomes

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b. Supervisors then observe employees and record their performance on


these critical job aspects
c. Employees are then rated on how often they display the behaviors in
each critical incident (refer to Table 3-7)
d. Requires extensive observations and documentation that:
i. Identifies successful and unsuccessful job performance behaviors
ii. Is recorded by both employees and supervisors
5. BARS
a. Similar to CIT, except the incidents are written as expectations instead
of achieved behaviors
b. Only the most representative behaviors are documented; generally
eight to ten behaviors
c. Each behavior is then numerically scaled
d. Advantages
i. Most highly defensible in court because it is based on actual
observable job behaviors
ii. Encourages all raters to make evaluations in similar ways
e. Disadvantages
i. Difficult to maintain the volume of data
ii. Each job must have distinct appraisal documents
iii. As jobs change, so must documentation
6. BOS
a. Displays illustrations of positive incidents (or behaviors) of job
performance for various job dimensions
b. Evaluators rate the employee on each behavior according to the extent
to which the employee performs in a manner consistent with each
behavioral description
c. Scores are then averaged to provide an overall rating number
d. Developed similar to BARS, except that only positive behaviors are
recorded
e. Difficult and time consuming to develop and maintain, especially for
the supervisor who must observe the behaviors
E. Goal-Oriented Systems
1. Management by objectives (MBO) perhaps is the most effective
performance appraisal technique because:
a. Supervisors and employees determine objectives for employees to
meet
b. Employees rate themselves on how well they think they met the
objectives
2. Used mainly for managerial and professional positions
3. Evaluates employees progress toward strategic planning objectives
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4. Employees are expected to meet the objectives during the rating period
5. At the end of the rating period, employees will write a report explaining
their progress
6. Supervisors appraise performances based on accomplishment of the
objectives
7. Can promote effective communication between employees and
supervisors
8. Drawbacks
a. Companies generally do not fully describe the scope of managerial
positions
b. Time consuming
c. Requires extensive communication between supervisor and employee
d. Focuses on specific goals at the exclusion of other vital outcomes,
which is referred to as a results at any cost mentality
9. Often they are components of broader development programs
F.

Exploring the Performance Appraisal Process


1. Purposes
a. Represents a companys way of telling employees the companys
expectations of them
b. Informs employees how well they are meeting those goals
2. Typical process includes supervisors
a. Monitoring employees performance
b. Documenting observations on appraisal forms
c. Sharing appraisals with employees
d. Basing merit pay increases on job performance
3. Issues
a. Merit pay increases based on factors other than job performance can
lead to charges of illegal pay discrimination (violation of the Equal
Pay Act of 1963), except for:
i. A seniority system
ii. A merit system
iii. Quality or quantity of production
iv. Any factor other than gender

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Example: Illegal Pay Discrimination


Two female sawyers v. Cascade Wood Components Company
Male sawyers received pay increases before more experienced female sawyers
Cascade could not prove the raises were awarded because of:
Differences in job performance
Seniority
A merit system based on quality or quantity of production
Anything other than gender
Courts found Cascade in violation of Equal Pay Act
b. Appraisals must be based on job-related factors not on any
discriminatory factors
4. Four activities to promote nondiscriminatory performance appraisal
practices
a. Conduct job analyses to ascertain characteristics necessary for a
content valid performance appraisal system
i. Accurately define parameters of the job
ii. Define behaviors necessary to perform the job effectively
iii. Content validity displays the connection between a. and b. (above)
iv. Periodically review the appraisal instrument for validity
Example: Legislation and Performance Appraisal
Brito v. Zia Company (478 F2d 1200, CA 10, 1973)
Zia violated Title VII because:
A disproportionate number of protected class individuals were laid off, based on
low performance appraisal scores
Zia could not prove the appraisal instrument was valid because it did not assess
any job-related criteria based on quality or quantity of work
b. Incorporate these characteristics into a rating instrument
c. Train supervisors to use the rating instrument properly
d. Set up formal appeal mechanisms and have upper-level personnel
review the ratings to insure accuracy and effectiveness
i. Allowing employees to question ratings opens a dialogue with
supervisors
ii. Employees may point out overlooked performance or explain why
a performance was below standard
5. Sources of performance appraisal information
a. Five main sources are the employees:
i. Self
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ii. Supervisor
iii. Coworkers
iv. Subordinates (if applicable)
v. Customers or clients (if applicable)
b. 360-degree performance appraisals
i. Are performance appraisal systems that rely on many appropriate
sources of performance related information
ii. Help companies develop a more complete understanding of current
employee performance
iii. Help companies reduce the costs of:
Recruiting
Hiring
iv. Criteria for determining appropriateness of the information source
Is the evaluator aware of the objectives of the employees job?
Has the evaluator frequently observed the employee?
Is the evaluator qualified to determine if the performance is
satisfactory?
v. The use of 360-degree performance appraisals is on the rise in the
United States because:
Downsizing - organizational structures are becoming less
hierarchical
Managers and supervisors are responsible for a larger number
of employees, affording less appraisal time for each
These instruments are more conducive to the increased
prevalence of work teams, since employees can rate each other
Companies are able to get and use feedback from customers,
which increases customer satisfaction
6. Errors in the performance appraisal process
a. Rating errors reflect differences between human judgment processes
versus objective, accurate assessments uncolored by bias, prejudice, or
other subjective, extraneous influences
b. Rating errors occur because raters must make subjective judgments
c. Most common types of raters errors include:
i. Bias errors
ii. Contrast errors
iii. Errors of central tendency
iv. Errors of leniency or strictness
d. Bias errors

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i. Happen when rater evaluates employees based on a negative or


positive opinion of the employee rather than on the employees
actual performance
ii. Four types
First-impression effect
Halo effects (positive and negative)
Similar-to-me effect
Illegal discriminatory
iii. First-impression effecta manager would have a tendency to
make an initial judgment about an employee, and allows that to
affect their appraisal
iv. Halo effectsrater generalizes behavior on one aspect of the job to
all aspects of the job
v. Similar-to-me effect
Tendency on the part of raters to favorably judge employees
whom they perceive as similar to themselves
Supervisors rate more favorably employees similar to them in
such things as attitudes, values, backgrounds, or interests
vi. Illegal discriminatory bias occurs when supervisors allow an
employees race, gender, nationality, or religion influence their
performance ratings
e. Contrast errors
i. Take place when the rater compares the employee to other
employees rather than to specific performance standards
ii. This is an error because the employee is required to perform only
at minimally acceptable standards
f. Errors of central tendency
i. Occur when a supervisor rates all employees as average or close to
average
ii. Most often committed when raters are forced to justify only
extreme behavior
iii. It usually is a good idea to require justification at every level of the
scale and not just the extremes
g. Errors of leniency or strictness
i. Reflect the tendency to rate every employee at the high end or low
end of the scale, regardless of actual performance
ii. With a leniency error, managers rate employees performances
more highly than they would rate them using objective criteria
iii. Leniency errors cause employees to believe they are going to
receive larger pay raises than deserved
iv. The opposite occurs with errors of strictness
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IV.

v. These errors mitigate the beliefs that effort varies positively with
performance, and that performance influences the amount of pay
raises
Strengthening the Pay-for-Performance Link
A. Activities
1. Link performance appraisals to business goals
2. Analyze jobs
3. Communicate
3. Establish effective appraisals
4. Empower employees
5. Differentiate among performers
B. Link Performance Appraisals to Business Goals
1. Employee performance should be linked to the companys competitive
strategy
2. For example, everyone in the marketing department working on a specific
product should get a merit raise if sales goal are met
C. Analyze Jobs
1. Job analysis is important for establishing internally consistent
compensation systems (more in chapter 6)
2. Supervisors should match the employees performance to the job
description
a. Descriptions are a product of job analyses
b. Descriptions note the duties, requirements, and relative importance of
a job within the company
3. May help to reduce arbitrary decisions about merit increases by clarifying
the performance standards
D. Communicate
1. Employees must clearly understand the link between performance and
merit increases
2. Employees need to trust the system and the evaluators
E. Establish Effective Appraisals
1. Should be tied to employees future performance goals and career plans
2. Deficiencies in performance should include methods to remedy
3. Performance standards should be used for establishing performance targets
F. Empower Employees
1. Encourage employee self-appraisals
2. Supervisors as coaches
a. By ensuring that employees have access to the resources to perform
their job

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V.

b. By allowing employees to interpret and respond to work problems as


they occur
G. Differentiate Among Performers
1. Merit increases should consist of meaningful increments
2. Merit increases should clearly reflect differences in actual job
performance
2. Rewards can be other than base pay increases like:
a. Additional vacation days
b. Higher company discounts
Possible Limitations of Merit Pay Programs
A. Eight Potential Problems
1. Failure to differentiate among performers
2. Poor performance measures
3. Supervisors biased ratings of employee job performance
4. Lack of open communication between management and employees
5. Undesirable social structures
6. Factors other than merit
7. Undesirable competition
8. Little motivational value
B. Failure to Differentiate among Performers
1. Poor performers may receive merit increases even though theyre not
warranted
2. Poor performers may view increases as entitlements
3. Superior performers may lose motivation to excel
C. Poor Performance Measures
1. May be too subjective
2. Developing performance measures for every job is difficult and expensive
D. Supervisors Biased Ratings of Employee Job Performance
1. Supervisors are subject to a number of errors when they make subjective
assessments
2. These errors can undermine the credibility of the performance evaluation
process and give employees the perception that pay does not reflect
performance
E. Lack of Open Communication between Management and Employees
1. Lack of good communication can lead employees to mistrust the
performance appraisal process
2. Mistrust can lead to accusations of bias
F. Undesirable Social Structures
1. Pay grades can reflect status differentials

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2. Permanent merit increases may rigidify the relative pay status of


employees over time
3. Lower-paid employees may resent never being able to catch-up
G. Factors Other Than Merit
1. Supervisors may subconsciously use age or seniority instead of merit
2. Supervisors may let personal feeling determine pay increases
3. Company politics that puts focus on supervisors agendas or goals instead
of work goals
H. Undesirable Competition
1. Between individual employees for limited funds
2. Between individuals in team settings, which may hinder teamwork
I. Little Motivational Value
1. When employers and employees disagree on what is a large enough
increase
2. When the yearly increase seems negligible on each paycheck

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