Organizational differences in managerial compensation and financial performance

Summary

The research paper "Organizational differences in managerial compensation and financial performance" by Gerhart and Milkovich (1990) aimed to understand how organizations make distinct managerial compensation decisions and the subsequent impact of these choices on firm financial performance. Drawing from compensation strategy literature, their first objective was to investigate the extent to which organizations, even those operating under similar conditions, exhibit varying approaches to base pay, bonus structures, and eligibility for long-term incentives. Their second purpose, framed by expectancy and agency theories, was to explore the ramifications of these compensation decisions on subsequent organizational performance, specifically as measured by return on assets. To achieve these objectives, the authors employed longitudinal data encompassing approximately 16,000 top and middle-level managers across 200 different organizations. The methodology involved analyzing significant between-organization differences in compensation decisions. For assessing the consequences of these decisions, the study utilized "residualized measures" of organization pay level and pay mix, which were adjusted for various employee and job-specific factors. A key finding was that organizational differences in compensation were most pronounced in bonus levels and long-term incentive eligibility, while differences in base pay levels were relatively minor. This suggests that organizations tend to distinguish their compensation strategies more through variable, contingent pay components than through the fixed base salary. Significantly, the study found no association between the overall level of base pay and organizational financial performance. In contrast, a greater emphasis on contingent pay, such as bonuses and long-term incentives, was positively associated with better financial performance. The implications of these findings are substantial for both compensation strategy and organizational theory. The results underscore that an organization's approach to designing its pay mix, particularly the degree of pay contingency, can be a critical driver of its financial success. This challenges perspectives that might overemphasize base pay levels or solely focus on individual and job attributes when explaining compensation differences, suggesting that broader organizational choices and strategies play a crucial role. The study's conclusion, that the beneficial effect of contingent pay on organizational performance is consistent with experimental research on individual incentives, highlights the practical relevance for designing effective compensation systems that align managerial interests with firm performance goals.