Skill-Based Pay: Antecedents and Outcomes

This study investigates skill-based pay systems. Under such systems, pay levels are determined according to the nature, variety or specialized knowledge or skills that employees acquire, demonstrate or apply in the workplace. The aim of this study is to answer the following questions: (1) Which organizational characteristics are associated with the adoption of skill-based pay? and (2) Which outcomes of interest are associated with the adoption of skill-based pay in terms of perceived organizational performance and performance management system effectiveness?

Drawing from the contingency perspective, several authors suggest that leaders and organizations that pursue certain specific business strategies (e.g., quality emphasis, prospector, cost reduction, people-based strategies) are more likely to adopt skill-based pay schemes (e.g., American Compensation Association 1996; Donnadieu and Denimal 1993; Gomez-Mejia and Balkin 1992; Heneman and Dixon 2001; Heneman and Gresham 1998; Lawler 1990; Snell and Dean 1994; Thompson et al. 1997; Von Glinow 1985; Zarifian 1988, 1999). The resource-based view of the firm leads us to believe that skill-based pay is more likely to constitute a competitive (Barney 1991; Collins and Clark 2003; Snell, Youndt and Wright 1996; Wright, Dunford and Snell 2001) and a strategic compensation option (Gomez-Mejia and Balkin 1992) within firms in knowledge-based industries. Risher (2000) provides evidence that firms with research and engineering centers often compensate their research and development personnel as a function of their competencies.

In recent years, few studies have investigated the possible impacts of skill-based pay on objective measures of organizational performance (e.g., Long 1993; Murray and Gerhart 1998; Parent and Weber 1994). Although such studies are of great value, skill-based pay may also lead to improved performance management since it requires that more attention be given to how results are achieved. Therefore, the emphasis is more on behaviours than on results (Heneman and Gresham 1998; Smither 1998). As such, skill-based pay requires that leaders identify key competencies that are consistent with their business strategy and are considered a source of competitive advantage (Lawler 1996; Zingheim, Ledford and Schuster 1996).

Thus, this study investigates both the determinants and consequences of skill-based pay. The first three hypotheses flow from the need to better understand the organizational settings that are most likely to adopt skill-based pay.

Hypothesis 1. Compared to other organizations, those that adopt skill-based pay are more likely to (a) favour a differentiation strategy based upon innovation, (b) favour a differentiation strategy based upon quality, (c) favour a differentiation strategy based upon the development of people, (d) avoid a differentiation strategy based upon cost reduction.

Hypothesis 2. Compared to other organizations, those that adopt skill-based pay are more likely to share a business culture that values participative management.

Hypothesis 3. Compared to other organizations, those that adopt skill-based pay are more likely to be in knowledge-based industry sectors.

The last two hypotheses flow from the need to better understand the consequences of skill-based pay in terms of perceived organizational performance and performance management effectiveness.

Hypothesis 4. Compared to other organizations, those that adopt skill-based pay are more likely to consider that their organization is relatively effective in the areas of (a) marketing, (b) human resource management, and (c) financial performance.

Hypothesis 5. Compared to other organizations, those that adopt skill-based pay are more likely to consider that their performance management system is more effective in the areas of achieving (a) employee engagement, (b) business strategy implementation, (c) supporting organizational culture, and (d) equitable treatment of employees.

A questionnaire survey was mailed to a sample of human resource managers from firms with over 200 employees. Data analysis was performed on the 189 completed surveys. The adoption of skill-based pay was determined with two questions. First, respondents indicated whether their organization uses a formal competency-evaluation system for at least one category of personnel. Second, if a positive answer was provided on the first question, respondents then indicated whether there is in their organization a direct link between the assessment of competencies and employee compensation. Positive answers to both these questions determined that skill-based pay was used.

The findings from this study suggest that the adoption of skill-based pay is not a function of often-mentioned contingency factors such as organizational size or union presence, two control variables that are included in the analyses. Overall, the explained variance in the adoption of skill-based pay that could be accounted for by the independent variables included in the model – business strategies, business culture that values participative management, and being in a knowledge-based industry sector – was relatively low. The results do indicate, however, that the adoption of skill-based pay is positively associated with a business culture that values participative management. As such, the results of this study provide little basis for the theoretical perspective that views the adoption of skill-based pay as rationally determined by the business strategy. The business strategies investigated in this study provide little explanatory power. With regards to the consequences of the adoption of skill-based pay, the results suggest that – after controlling for size and union presence – respondents perceive relatively higher financial and human resource management performance. In addition, the results suggest that the adoption of skill-based pay is associated with more effective performance management in the areas of achieving business strategy implementation and equitable treatment of employees.