Do Formal Salary Systems Really Matter?

Using personnel records from a single firm, we analyze the kind of formal salary system used by most large firms. The system is highly centralized, covering salary levels, ranges, raises, and bonuses. Supervisors have little discretion over pay other than through subjective performance ratings. The firm holds relatively strictly to the salary rules, leading to observable constraints on pay for employees near the top of the salary range. However, there is little evidence that the firm suffers important costs from these constraints. We also examine whether this firm’s practices are consistent with prior theoretical and empirical research on internal labor markets.