The Effect of Horizontal Pay Transparency on Employee Motivation When Pay Dispersion Is Performance Based and Non-Performance Based

Abstract

The movement toward pay transparency within firms has intensified. We investigate the effect of horizontal pay transparency on employee motivation in a broader information environment where (1) performance-based and non-performance-based pay dispersion coexist and (2) relative performance information allows employees to alleviate pay dispersion ambiguity in order to assess the basis of any pay dispersion that pay transparency reveals. Drawing on distributive justice theory, we predict and find that pay transparency differentially affects employees’ motivation based on what it reveals about their relative standing while working under the same performance incentives. Specifically, it depends on whether they are underpaid, overpaid, or their relative pay aligns with their relative performance. Our analysis provides additional insights related to these three scenarios, and in doing so, our study highlights the importance of considering employees’ broader information environment when considering the potential benefits and costs associated with pay transparency.