FALL 2026
The Effect of Overall Pay Dispersion on Organizational Performance and the Moderation of Individual Incentives
Abigail Palin
ABSTRACT
Could individual incentives positively alter the relationship between overall pay dispersion and organizational performance, similar to horizontal pay dispersion? Related to this question, this research explores the interaction between overall pay dispersion and individual incentives on organizational performance. Using manager-reported data from the 2011 Workplace Employment Relations Survey (WERS), 2,231 United Kingdom workplaces were analyzed. Overall pay dispersion showed a relatively positive association with both financial performance and labor productivity, and individual incentives strengthened these associations. However, the moderation of individual incentives in the relationship between overall pay dispersion and labor productivity did not reach statistical significance.
Keywords: pay dispersion, individual incentives, organization performance
ACKNOWLEDGEMENT
I would like to thank Professor David Chung for his guidance, analysis, and contributions throughout this research. His support and feedback were essential in helping me complete this work.​
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BACKGROUND
Pay dispersion refers to the distribution of pay differences among individuals within an organization, which can occur both horizontally (i.e., among peers) and vertically (i.e., across hierarchical levels) (Shaw, 2014). It is commonly measured using indicators, such as the ratio of highest to lowest pay, standard deviation of pay, or Gini coefficients. This study examines overall pay dispersion (i.e., pay dispersion that accounts for both horizontal and vertical pay differences [Conroy et al., 2014]) within the workplace, focusing on its relationship with organizational performance.
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There are mixed theories about how overall pay dispersion (hereafter, pay dispersion) affects organizational performance. Arguments for positive effects suggest that wider pay dispersion can motivate employees by strengthening the connection between performance and rewards (Bishop, 1987) and attracting higher-quality workers (Freeman, 1977), consistent with tournament theory (Lazear & Rosen,1981). In contrast, arguments for negative effects—which are often advocated by scholars in sociology and economics—suggest that wider pay dispersion can undermine cooperation and communication, particularly in settings that depend on teamwork (Deutsch, 1985; Levine, 1991).
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Empirical research shows some support for both these competing theories, offering mixed evidence on the relationship between pay dispersion and organizational performance. Using a sample of data collected from private‑sector firms and their employees in Belgium, Lallemand et al. (2003) found that pay dispersion has a positive effect on organizational performance. In contrast, using a sample of non-profit hospitals, Dong (2016) found a negative relationship.
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While the theories and findings concerning how pay dispersion affects organizational performance are mixed, it may be possible that the effect is relatively more positive when workplaces use individual incentives. Individual incentives refer to compensation practices in which employees receive monetary rewards based on their own measurable performance. This prediction aligns with Shaw et al.’s (2002) theory and findings. Shaw et al. (2002) investigated how horizontal pay dispersion relates to organizational performance and, drawing on motivation-related theories, proposed individual incentives as a moderator, suggesting that individual incentives may strengthen the line-of-sight between effort and pay differences for employees. The study found that there were relative differences in the effect of horizontal pay dispersion based on the level of individual incentives. When individual incentives were high (versus low), the relationship between pay dispersion and organizational performance was relatively more positive (versus negative). Applying this understanding, a similar moderation effect of individual incentives may be expected in the relationship between pay dispersion and organizational performance, considering that pay dispersion accounts for both horizontal and vertical pay dispersion.
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Therefore, drawing on Shaw et al.’s (2002) theories and findings and using data from the 2011 Workplace Employment Relations Survey (WERS), this study examines whether individual incentives moderate the relationship between pay dispersion and organizational performance, making it relatively more positive. By addressing this question, the study extends previous pay dispersion research and offers insights into when and why the effect of pay dispersion on organizational performance may improve.
METHOD
Sample
The sample for the study comes from the 2011 WERS. This sample comprises cross-sectional observations of workplaces in the United Kingdom from the public and private sectors. The data offers information regarding pay practices and policies, workplace communication, and other company characteristics. In this study, only the information collected via manager responses were used. The available number of workplace-level observations in the data was 2,680. Among them, 449 observations were removed due to missing values. Specifically, 139 were dropped due to missing values in pay dispersion, four were additionally dropped due to missing values in individual incentives, and 306 were further dropped due to missing values in organizational performance. This resulted in a final sample of 2,231.
Measures
Pay Dispersion
Pay dispersion was measured as the difference between the highest and lowest pay reported to be offered within each workplace. This approach to measuring pay dispersion aligns with how prior studies have measured pay dispersion (Kepes et al., 2009; Shaw et al., 2002).
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Individual Incentive
Individual incentives were measured dichotomously (0 = no individual incentive, 1 = individual incentive). I computed the value for this variable as one if either merit pay increase or individual-level payment-by-results were implemented in the workplace. The value for this variable was computed as zero if neither were implemented in the workplace. This measurement approach aligns with how Shaw et al. (2002) measured individual incentives.
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Organizational Performance
I used two indicators of organizational performance: Financial performance and Labor productivity. These two indicators were measured based on managers’ ratings of their workplaces in relation to other workplaces in the same industry (1 = A lot better than average to 5 = A lot below average, reverse-coded). It has been suggested that perceptual measures of organizational performance may be useful in proxying actual organizational performance (e.g., McClean & Collins, 2011).
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Control Variables
“Interorganizational studies require control of factors that may affect independent or dependent variables” (Shaw et al., 2002, p. 496). In that regard, three control variables were included: Organization size, Industry type, and Organization type. Organization size was measured as the number of total employees in the workplace. Industry type was categorically measured based on the 2007 Standard Industrial Classification codes used in the United Kingdom. Organization type was categorically measured as follows: 1 = one of a number of different organizations in the United Kingdom which are part of the same organization, 2 = single independent organization, and 3 = sole United Kingdom organization which is part of a foreign organization.
Analytical Strategy
I have used linear regression to analyze the data. The 2011 WERS data was intentionally designed to have biases in the estimates if the data was analyzed as is. To address these issues, a specific weighting procedure needed to be conducted. The weight procedures to be used in this were provided in the 2011 WERS data. Therefore, the aforementioned linear regression was carried out along with the application of the weighting procedure.
RESULTS
Table 1 shows descriptive statistics and correlations for the variables of this study. As shown in Table 1, individual incentive had a weak positive correlation with pay dispersion (r = .05, p < .05). Pay dispersion had a positive correlation with financial performance (r = .10, p < .05), as well as a marginally positive correlation with labor productivity (r = .04, p < .10). Additionally, organization size positively correlated with pay dispersion (r = .20, p < .05) and individual incentive (r = .08, p < .05) and negatively related with labor productivity (r = -.08, p < .05). Meanwhile, it did not have a statistically significant correlation with financial performance (r = -.02, n.s.).
Table 2 shows the regression analysis results of this study. As shown in Model 1-2, pay dispersion is positively associated with financial performance (b = .09, p < .05). As shown in Model 2-2, pay dispersion is also positively associated with labor productivity (b = .05, p < .05). As shown in Model 1-3, the interaction term between pay dispersion and individual incentive had a marginally positive association with financial performance (b = .07, p < .10). Meanwhile, as shown in Model 2-3, this interaction term did not have a significant relationship with labor productivity (b = .00, n.s.). Figure 1 shows the form of the interaction effect found in Model 1-3. A simple slope test indicated that the relationship between pay dispersion, and financial performance was relatively more positive when there was individual incentive (b = .14, p < .05), compared to when there was no individual incentive (b = .07, p < .05).
On a separate note, as shown in Figure 1, the following two findings were also observed from the results of Model 1-3. On the one hand, it was found that organizations with higher pay dispersion that adopted individual incentives (predictive margin for financial performance: 3.75) achieved roughly 2.18% higher financial performance than those with higher pay dispersion but did not adopt individual incentives (predictive margin for financial performance: 3.67). On the other hand, it was found that organizations with lower pay dispersion that did not adopt individual incentives (predictive margin for financial performance: 3.50) achieved roughly 2.94% higher financial performance than those with lower pay dispersion that adopted individual incentives (predictive margin for financial performance: 3.40).
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Post-Hoc Analysis
As an additional test, I conducted a three-way interaction analysis to further examine whether pay communication alters the relationship between pay dispersion and individual incentives. I postulated that the interaction effect of pay dispersion and individual incentive on organizational performance may arise more saliently when there is pay communication, which could strengthen individual incentives’ bolstering of the line-of-sight between effort and pay differences. The pay communication variable used in the post-hoc analysis was measured dichotomously, based on whether pay-related issues were discussed and communicated to employees in the workplace (0 = no pay communication, 1 = pay communication). Due to missing values in pay communication, the sample size for the post-hoc analysis was reduced to 2,205. Table 3 shows the results of the post-hoc analysis. As shown in Models 3-3 and 4-3 of Table 3, the three-way interaction among pay dispersion, individual incentives, and pay communication was not significant for the outcome of financial performance (b = .01, n.s) but was significant for the outcome of labor productivity (b = -.33, p < .05).
Figure 2 shows the form of the three-way interaction observed in Model 4-3, which revealed a pattern different from what was expected. A simple slope test indicated that when there was no pay communication, the relationship between pay dispersion and labor productivity was relatively more positive when there was individual incentive (b = .07, p < .05), compared to when there was no individual incentive (b = .03, n.s.). The test also indicated that when there was pay communication, the relationship between pay dispersion and labor productivity was relatively more negative when there was individual incentive (b = -.10, n.s.), compared to when there was no individual incentive (b = .19, p < .05).
DISCUSSION
This research addresses the question of whether individual incentives positively alter the relationship between pay dispersion and organizational performance. Analyzing 2,231 managers’ responses from organizations in the United Kingdom, I found that pay dispersion is positively associated with organizational performance, and the relationship with financial performance becomes relatively more positive when individual incentives are present. Labor productivity also showed a relatively more positive association when individual incentives were present; however, this pattern was not statistically significant.
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These findings add to the ongoing debate regarding mixed arguments about the effects of pay dispersion. The positive relationships with financial performance and labor productivity support the idea that a wider pay gap can motivate employees and improve organizational performance (Bishop, 1987). At the same time, the results suggest that even if pay dispersion harms cooperation, it is often outweighed by the performance-enhancing aspects of pay dispersion.
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The moderation results offered some support to the postulation of this paper. Put differently, the moderating effect of individual incentives identified in Shaw et al.’s work (2002) on the link between horizontal pay dispersion and organizational performance was, to some extent, reflected in the link between pay dispersion and organizational performance. Indeed, the results, taken together, pointed to a pattern of a stronger positive association between pay dispersion and organizational performance when individual incentives were adopted.
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The post-hoc findings further show that pay communication may influence how pay dispersion and individual incentives relate to performance. Although I originally predicted that higher levels of pay communication would have a positive effect, the three-way interaction did not follow the expected pattern. I could not make inferences on what may have theoretically led to the findings for the three-way interaction. For this reason, these findings should be interpreted cautiously and viewed as exploratory rather than conclusive.
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These findings offer practical insights for organizations with larger pay dispersion. Overall, what the results imply is that the effectiveness of pay dispersion in enhancing organizational performance tends to be maximized when employees see a clearer line-of-sight between their contributions and differences in pay. In other words, supplementing higher pay dispersion with individual incentives can make the pay structure work more effectively.
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My research should be evaluated in light of several limitations. First, I calculated pay dispersion as the difference between the highest and lowest pay in each workplace; the results might vary depending on the pay dispersion measure used. In addition, I treated individual incentives as a binary variable, which may not fully capture differences in their implementation. Also, I relied on manager reports, which may be subject to biases, to measure organizational performance.
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Second, the cross-sectional design of my study raises concerns about common method bias and reverse causality. Common method bias can occur when “both the independent and dependent variables are measured within one survey” (Kock et al., 2021, p. 3). In addition, reverse causality is also a concern because measuring all variables within the same timeframe makes it possible that organizational performance influenced pay dispersion rather than pay dispersion influencing organizational performance.
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Third, there is also the possibility that some omitted variables may have influenced my findings. Therefore, future research is encouraged to retest the relationships investigated in this study while accounting for additional factors that may confound these relationships.
CONCLUSION
Drawing on Shaw et al.’s (2002) theory and findings, this research investigates whether individual incentives positively alter the relationship between pay dispersion and organizational performance. Using a sample of workplaces in the United Kingdom, I found results that offered some support to the idea that individual incentives positively moderate the relationship between pay dispersion and organizational performance. I hope this work is considered to offer meaningful implications to the body of academic work in human resource management.
REFERENCES
Conroy, S., Gupta, N., Shaw, J., & Park, T.-Y. (2014). A multilevel approach to the effects of pay variation. Research in Personnel and Human Resources Management, 1–64.
Bishop, J. (1987). The recognition and reward of employee performance. Journal of Labor Economics, 5(4, Part 2), s36–s56.
Deutsch, M. (1985). Distributive justice: A social psychological perspective. Yale University Press: New Haven, CT.
Dong, N. G. (2016). Wage dispersion and financial performance of nonprofit hospitals. Health Care Finance, 1–23.
Freeman, S. (1977). Wage trends as performance displays productivity potential: A model and application to academic early retirement. Bell Journal of Economics, 8(2), 419–443.
Kepes, S., Delery, J., & Gupta, N. (2009). Contingencies in the effects of pay range on organizational effectiveness. Personnel Psychology, 62(3), 497–531.
Lallemand, T., Plasman, R., & Rycx, F. (2003). Intra-firm wage dispersion and firm performance: A review and empirical tests on Belgian data. Brussels Economic Review, 46(4), 5–29.
Lazear, E. P., & Rosen, S. (1981). Rank-order tournaments as optimum labor contracts. Journal of Political Economy, 89(5), 841–864.
McClean, E., & Collins, C. (2011). High-commitment HR practices, employee effort, and firm performance: Investigating the effects of HR practices across employee groups within professional services firms. Human Resource Management, 50(3), 341–363.
Shaw, J., Gupta, N., & Delery, J. (2002). Pay dispersion and workforce performance: Moderating effects of incentives and interdependence. Strategic Management Society, 23(6), 491–512.
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