What Makes Performance-Related Pay Effective in the Public Sector? Target, Pay Design, and Context

Abstract

While performance-related pay (PRP) has been implemented in most OECD countries over the past four decades, its effectiveness is still up for debate. What is under-investigated in the previous literature is under what conditions the public sector can effectively implement an optimal design of a PRP system. This study investigates how the target of PRP, the design of performance pay, and organizational context affect the effectiveness of PRP. The findings indicate that PRP has a positive association with organizational performance but the aspects of performance it affects differ depending on to whom it is implemented and how PRP is designed. This study also finds that the positive effect of PRP for top executives is attenuated if organizational outcomes are not easily observable. This article suggests that public managers should pay careful attention to employee characteristics, pay design, and organizational contexts for the successful implementation of PRP in the public sector.