Is asking employees to assess their performance as part of the compensation setting process beneficial or detrimental to employer welfare?

Abstract

This study examines how asking employees to self-assess their performance during the compensation-setting process, when they are unaware of their marginal contribution to firm profit, affects employer welfare. Previous research suggests that giving employees a voice in the compensation setting process can positively affect employee performance and firm profit (Jenkins & Lawler, 1981; Roberts, 2003). However, I propose that asking employees to assess their own performance as part of the compensation setting process can have unintended consequences that ultimately lead to higher employee compensation demands. This is because asking employees to assess their performance increases their overconfidence in their own performance and their compensation demands. As a result, employers may face the dilemma of whether to meet these higher compensation demands or risk economic losses due to employee retaliation if their demands are not met. Through experimental evidence comparing a control condition without self-assessments and three self-assessment reporting conditions, I provide evidence that supports the notion that eliciting employee self-assessments as part of the compensation process reduces employer welfare. Data on employee perceptions of performance further support the idea that asking employees to evaluate their performance leads to an inflated perception of their performance. These findings provide a theory-based explanation of why, in practice, many companies disentangle employee performance assessments from the compensation setting process and that companies are well advised in doing so.

Keywords: Incentives, employee participant, compensation setting

JEL Classification: M4, M40, M52