Thursday, May 06, 2021
Wednesday, 05 June 2013 15:09

Pay Up Now or Pay More Later: Compensation Practices and the Psychological Contract

Written by Jim Gallo MS., SPHR, Thomas S. Skiba, and Michael Tocci

Psychological contracts in the workplace are perceived relationships between an individual and an organization. These relationships are based on each party’s beliefs regarding the reciprocal exchange between contributions and rewards. In a sense, both parties develop expectations for reciprocation. These psychological contracts are influenced by organizational actions or trends that include such things as compensation and benefits practices; and employment policies reflecting recruiting, promotions, restructuring, etc. Employees influence this relationship by their efforts and commitments they make to the organization. These contracts emerge under the assumption of good faith and could lead to serious consequences when either party fails to fulfill its obligations.

The state of the economy sometimes makes these employer obligations difficult, which could lead to individuals feeling that their psychological contract has been damaged or, in some cases, completely severed. Organizations make promises (not in writing, we hope) that are perceived regarding the future. In some cases, these perceived promises have to be broken. The key word in the previous sentence is “have,” which we will refer to in a few moments. This severed relationship could influence an employee’s trust, engagement, obligations to perform, and intentions to remain with the organization; and additionally could lead to dysfunctional behaviors, including sabotage, theft, or aggressive behaviors. It is understandable that during turbulent times organizations may have to make tough decisions regarding their employment practices, which are not always in the best interest of an individual but are necessary for the survival of the organization. Individuals may also influence this psychological contract by their willingness to perform and remain with the organization. While many practices may influence the psychological contract, in an attempt to be parsimonious, we will focus specifically on organizational compensation practices during turbulent times and, more importantly, the past few years.

When jobs are scarce, as with high unemployment, organizations tend to have more power (supply market) because of relatively fewer opportunities for alternative work. Additionally, when unemployment is high, organizational resources may be limited, forcing an organization to take action that may divert resources away from members that are not contributing to organizational performance. However, when jobs are plentiful, as with low unemployment, this power shifts back to the employee (demand market). It’s just a matter of time before this power shift happens and happens again in the reverse direction. This is how our economy has been for the past 200+ years! However, this economic downturn (some have called the Great Recession) has lasted a little longer than many of us would have liked.

Before 2007, practitioners and researchers alike were predicting “The Great Labor Shortage.” The thought was that 76 million baby boomers would start retiring, and the following generation (Gen X) would not have enough workers to fill this “retirement void” in the workforce. Gen X’ers would now be in a position to magically convince employers to cough up the compensation they desire just like the famous hypnotist Uri Geller. Logically, it made some sense to infer a major labor shortage was looming. Of course, we all know this did not happen. Additionally, according to data from the U.S. Census Bureau, these baby boomers just refused to quit, and some decided to follow Brett Favre’s inspiration and come out of retirement and re-enter the workforce. In 2005, there were about 23 million employees aged 55 and over in the workforce. Over the past few years, we would have expected a slight decline. To the contrary, there has been a steady yearly increase in the number of workers over the age of 55; in 2011, the number reached just under 29 million workers. That, taken in combination with our economic death spiral and our GDP that has been increasing slower than a herd of snails crawling through syrup, means that we have a long road ahead.

Okay, so the work environment is not as pretty as it used to be; however, there are some positive signs showing (albeit small and slow). For example, the Hay Group companies are projecting a 3 percent pay increase in 2013, which, after inflation, leaves us with a 0.8 percent net inflation-adjusted pay gain. In fact, economists tell us that we are officially no longer in a recession! So, maybe we have left the hospital ICU, but we are still in the hospital with a long prognosis of recovery and a possible transfer to a mental hospital before being released. According to Barry Brown, SPHR, CCP, and president of Effective Resources, “we may have another 3-5 years before we get back to normalcy.” However, some organizations may be making this trip down the yellow brick road to normalcy more difficult.

Over the past few years of economic turmoil, most employers have done the right thing by balancing the needs of staying alive and paying their employees fairly; however, some may be taking advantage of the current supply market and under paying or holding back wage increases because they can and not because they have to. The following is a true story that was shared with us a few months back. In order to protect the innocent and more importantly, not be sued, we will use a generic name to identify the organization. We think ABC Company will suffice. Since 2008, employees at ABC Company, except for a chosen few, have received no pay increases and a substantial decrease in their benefits. However, since 2010, ABC Company has been realizing substantial profits. While preparing the 2013 budget, the VP of Human Resources inquired as to possible pay increases. The CFO and other senior executives agreed that, until the labor market turned, they did not have to give increases even though they could. “Retention is not a problem now; we can address it down the road,” said one executive. While this story may not be the norm (at least we hope to think so), our contention is that most organizations are doing the right thing, and some are even going above what would be expected to take care of their employees.

Employees are not stupid. They recognize when their companies are doing well and when they are not. In hard times, most employees will suck it up and fight along with the company to make it through tough times, which may increase the strength of the psychological contract. However, they will not forget compensation and benefit practices that do not align with company growth and profitability, which is the reason this article should be a wake up call for some and a well done for others.

Once again, it is understandable that organizational leaders must focus first on the overall survival of the organization. Not many would argue this point. An organization is an entity and will do what needs to be done to stay alive. How they do it will set the companies apart from their competitors. Barry Brown offers some valuable advice to companies contemplating what to pay. “Don’t pay more than you have to, but do what is right. If you take advantage of your employees now, they will not forget; and when the economy comes warring back, there will be a huge vacuum sound coming from your organization so much that your roof will collapse.”

When organizations are viewed as legitimately trying to uphold their previous commitments and communicating with openness when in fact they cannot, they may not only maintain the psychological contract but also increase it. Marilyn Durant, SPHR and President of Durant Resources Group, a human capital consulting company, stated that the employees of one of her clients volunteered to skip payroll periods when their organization was having cash flow problems. “They trusted their employer so much that they volunteered without solicitation to delay pay twice in a row until the company could get back on its feet.”

However, those organizations that breach this contract and do not effectively communicate sound reasons for the breach may decrease their employees’ motivation to perform tasks that would be helpful in meeting organizational objectives. If employees are not paid fairly, they may ruminate over the situation and lose their sense of loyalty and commitment to the organization. Once the labor market shifts (which is just a matter of time), this weakened or severed psychological contract will make it much easier for dissatisfied workers to jump ship, especially the good ones. Furthermore, offering increased pay at this time may be futile, as the lasting impression of the organization’s lacking integrity during hard times will devalue any actions in the future. In other words, employees will hold a grudge. It’s like an invisible volcano that is gathering pressure and, when it blows, all that’s left to do is to run. If your organization is interested in developing talent internally and maintaining its intellectual capital, it is risky to justify pay decreases unless the negative implications of not freezing pay are near catastrophic. Research has also shown that untrustworthy organizational leaders receive the highest degree of scrutiny by the most conscientious employees. Therefore, greedy leaders will find their top talent leaving and be left with a more ambivalent workforce. Likewise, organizations that have done the right thing will have upheld the psychological contract with their workforce and will be far more likely to retain high-performing employees even when they could leave when the market turns.

Final thoughts are to communicate the financial status of your organization on a regular basis, which is extremely important in a down economy. When you have to cut compensation, do so with focus and strategy. And, lastly, if you decide to take advantage by offering low-ball salaries, no increases, or reduced benefits with no financial reason to do so, be prepared for the consequences.

Jim Gallo MS., SPHR, is the associate director for the Center for Organizational Effectiveness and a PhD student in Industrial and Organizational Psychology at Florida Tech.

Thomas S. Skiba is a PhD student in Industrial and Organizational Psychology at the Florida Institute of Technology and a consultant with the Institute for Cross-Cultural Management.

Michael Tocci is a PhD student in Industrial and Organizational Psychology at the Florida Institute of Technology, Consultant at The Center for Organizational Effectiveness, and External Relations Liaison at The Institute for Cross-Cultural Management.