Performance Measurement and Pay Dispersion

We identify differences in performance measurement precision between jobs within the same firm as an important, yet previously unidentified, source of pay dispersion. Downes and Choi (2014) conclude in their review of prior research that pay dispersion will not cause employees to withhold effort when the dispersion reflects differences in performance. We extend their characterization of the effects of pay dispersion by examining whether, even though pay dispersion resulting from differences in performance measurement precision reflects differences in performance, employees nevertheless withhold effort because they perceive the process generating the pay dispersion as unfair. In a series of experiments we find that, consistent with referent cognition theory, such performance measurement induced pay dispersion decreases lower-paid employees' effort by decreasing their perception of pay fairness and that reducing such pay dispersion increases their effort by increasing their perception of pay fairness. We discuss the importance of these findings for practice and theory