I was listening to a lecture by Professor Armin Trost and discovered an intriguing dilemma within compensation strategy. If you’re curious as to why compensation is so important, check out TalentUp’s blog post here.

Here is the situation:

Imagine a situation where employees have to complete a task facing a high level of uncertainty. The outcomes and processes for completing the task are not clear. Moreover, the supervisor is acting in the role of a coach or partner.

Employees are dependent on each other to complete the task, and they must work as a team. Among them, there are some high-performing members. These are strategically relevant members and are hard to replace.

Now, you have the decision to make. Will you differentiate these high-performing members and reward them with a merit increase? Or will you reward the team equally, regardless of individual performance?

Neither of these responses is wrong.

Consider this: dealing with complex problems usually requires a high degree of collaboration within the team. If you pay for individual performance, then it might lead to colleagues competing with each other.

Collaboration requires sharing. Competition usually leads to information hoarding, which prevents teams from creating value through collaboration.

Competition distracts people to focus on the wrong things. If the group is paid based on individual performance, then it might foster an environment of competition. It will kill collaboration and transform colleagues into competitors.

On the flip side, if the high performers are not differentiated, they might feel unfairly treated. They might compare their contributions and the rewards they received with that of their colleagues.

They will learn that giving their best in their performance doesn’t pay off. It might lead to a sense of unfairness and injustice. As a result, the high performers might either leave the team or reduce their individual performance.

A similar dilemma arises within organizations while setting the overall pay strategy. Typically, compensation depends on the degree of responsibility associated with a role.

As a result, we see larger pay differences between the employees at the lower-level and upper level. This gap in pay can show up as differences in the importance of employees within the organization.

On the upside, it provides more opportunities and aspirations for employees to reach higher levels. On the downside, this clashes with the philosophy that all employees are equal.

If the organization does not differentiate high performers, then there is the risk of losing high performers. More importantly, there is an increased risk of attracting low performers.

There’s an interesting case of a company called Spill that experimented with this.

There is no perfect solution.

People are very sensitive to fairness. There will always be variability in how much people contribute to a team within a company. Some people contribute more and have more responsibilities, while others do less. There is a need for a balance between contributions and compensation in comparison with others.

It will help to treat the matter formally. It is critical that the team accepts the merit increase and believes the high performer deserves it. Therefore, the judgment about merit increases must come from a neutral perspective, and having a compensation committee or peer reviews will help.

To avoid such situations in the first place, try to avoid variable pay. Pay competitive base salaries and get money out of people’s minds. Don’t create too much differentiation between different pay grades, usually seen in broad pay bands. Avoid broadening pay bands to escape compensation negotiation; instead, try narrowing pay bands.

Narrow pay bands will provide more opportunities to adjust the compensation to the actual level of responsibilities. Make sure compensation policy is transparent and try using non-financial rewards to differentiate high performers.

The key message to take away is that treating team members differently might be a mistake, and not doing so might be a mistake too. On one side, it might hurt collaboration. On the flip side, it might lead to losing high performers in the organization.

If you are interested in learning more, then here is the link to Prof. Armin’s lecture: The Puzzle of Compensating High Performers in Teams

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