The Impact of Raising Employee Pay on Manager-Employee Relationships

Abstract

Good relationships between middle-level managers and employees are critical to many companies because they can enhance cooperation and motivate effort from all parties. In this paper, we experimentally examine how organizational interventions from the top of company to motivate employees via raising employee pay can adversely affect beliefs about relationship building between middle-level managers and their employees. We use a multi-period collaborative setting in which managers can improve the bonus pool allocation for employees via acquiring costly additional information on the employees’ effort and employee effort can improve manager’s welfare. Results show that a pay-raise intervention by the top causes both the employees and manager to develop more pessimistic beliefs about their partners continuing the relationship. This in turn reduces the employees’ motivation to continue expending effort and the manager’s propensity to continue acquiring information and providing fair bonus allocations. Companies should be aware that management control interventions for motivating employees can backfire in contexts in which relational contracts between managers and employees are important.

Keywords: pay raise; manager information acquisition; manager bonus allocation; employee effort; relational contracts

JEL Classification: C91, D83, M40