CHAPTER NINE
PAY-FOR-PERFORMANCE: THE EVIDENCE
Overview
This chapter is the first of three chapters comprising Part Four – Employee Contributions:
Determining Individual Pay. The primary focus of Part Three was on determining the worth of
jobs, independent of who performed those jobs. Job analysis, job evaluation, and job pricing all
have a common theme. They are techniques to identify the value a firm places on its jobs. This
fourth part of the book finally brings people into the pay equation. The premise is that different
people performing the same job may add different value to an organization. How much should
one employee be paid relative to another when they both hold the same jobs in an organization?
Entering people into the compensation equation greatly complicates the compensation process.
People do not behave like robots. In this section, the authors argue that organizational success
ultimately depends on human behavior. Compensation decisions and practices should be
designed to increase the likelihood that employees will behave in ways that help an
organization achieve its strategy and strategic objectives.
Employee behavior is the subject of chapter nine. First, four kinds of behaviors organizations
are interested in are identified. Next, key motivation theories are discussed as they relate to an
organization’s ability to motivate these behaviors. Specific attention is focused on what these
theories predict about performance-based pay, along with the implications of these predictions
as they relate to pay. The success, and sometimes the lack thereof, in designing compensation
systems to elicit these behaviors is presented. The chapter concludes with a discussion on the
effectiveness of different reward systems based on the objectives of the pay model: efficiency,
fairness, and compliance.
Lecture Outline: Overview of Major Topics
I. What Behaviors Do Employers Care About? Linking Organization Strategy to Compensation
and Performance Management
II. What Does It Take to Get These Behaviors? What Theory Says
III. What Does It Take to Get These Behaviors? What Practitioners Say
IV. Does Compensation Motivate Behavior?
V. Designing a Pay-for-Performance Plan
VI. Your Turn: Burger Boy
Learning Objectives
Define what behaviors employers’ desire and connect organization strategy to employee
behavior.
Recognize that behavior is a function of motivation, ability, and environment;
differentiating between theory and practice on how to get desired behaviors.
Identify the role of compensation in motivating the four types of desired behavior: the
decision to join, to stay, to develop skills, and to perform well.
Discuss the dependent components of an effective pay-for-performance plan: efficiency,
equity, and compliance.
Lecture Outline: Summary of Key Chapter Points
I. What Behaviors Do Employers Care About? Linking Organization Strategy to
Compensation and Performance Management
Employers want employees to perform in ways that lead to better organizational
performance. Exhibit 9.1 shows how organizational strategy is the guiding force that
determines what kinds of employee behaviors are needed.
The job of Human Resources is to devise policies and practices (and compensation falls
in this mix) that lead employees to behave in ways that ultimately support the corporate
goals.
Every organization, whether they realize it or not, has human resource practices that can
either work together or conflict with each other in trying to generate positive employee
behaviors. One way of looking at this process is evident from Exhibit 9.2.
Employee behavior = f (M, A, E)
Where M = Motivation, A = Ability, and E = Environment
Wanting to succeed isn’t enough. Having the ability but not the motivation also isn’t
enough. Even with both ability and motivation, an employee’s work environment (both
physical and political) must be free of obstacles.
Success depends on finding people with ability—that’s the primary job of recruitment,
selection, and training.
oOnce good people are hired, they need to be motivated to behave in ways that help
the organization.
oPay and other rewards should reinforce desired behaviors. But so, too, should
performance management, by making sure that what is expected of employees, and
what is measured in regular performance reviews, is consistent with what the
compensation practices are doing.
oMost important of all, the culture of the organization (i.e., the informal rules and
expectations that are evident in any company) should point in the same direction.
oHR needs to establish policies and practices that minimize the chances that outside
“distractors” hinder performance.
If employers don’t recognize changing skills requirements (human resource planning),
it’s hard to set up revised training programs or develop compensation packages to
reward these new skills instantly.
The key lesson from Exhibit 9.2 in an important one: Compensation can’t do it all alone.
oCompensation should be sufficiently attractive to make recruiting and hiring good
potential employees possible (attraction).
oCompensation needs to make sure that good employees stay with the company
(retention).
oIf employers can successfully attract and retain employees, then they can
concentrate on building further knowledge and skills (develop skills).
oEmployers need to find ways to motivate employees to perform well on their jobs—
to take their knowledge and abilities and apply them in ways that contribute to
organizational performance.
The impact on performance measures a sound compensation package.
oEmployers can’t reward performance if they can’t measure it.
oOne of the biggest recent advances in compensation strategy has been to document
and extend the link between units of performance and amount of compensation to
the ease of measuring performance and the type of compensation system that
works best.
The cells in Exhibit 9.3 help explain why incentives work in some situations and not in
others. The columns divide companies into those with widely variable performance
from year to year and those with much more stable performance across time.
oEvidence suggests that the companies are best able to get employees to adjust, be
flexible, and show commitment when a broader array of rewards, rather than just
money, is part of the compensation package.
There are four questions that organizations should address.
oHow do we attract good employment prospects to join our company?
The long-run success of any company depends on getting good people to
accept employment.
oHow do we retain these good employees once they join?
It doesn’t do much good to attract exceptional employees to the company
only to lose them a short time later. Once the compensation practices get a
good employee in the door, company needs to figure out ways to ensure it’s
not a revolving door.
oHow do we get employees to develop skills for current and future jobs?
The compensation challenge is to get employees, traditionally resistant to
change, to willingly develop skills that may not be vital on the current job but
are forecast to be critical as the company’s strategic plan adjusts to change.
oHow do we get employees to perform well while they are here?
The compensation challenge is to design rewards that enhance job
performance.
II. What Does It Take to Get These Behaviors? What Theory Says
In the simplest sense, motivation involves three elements:
owhat’s important to a person, and,
ooffering it in exchange for some
odesired behavior
As to the first element, what’s important to employees, data suggest employees prefer
pay systems that are influenced by:
oIndividual performance
oChanges in cost of living
oSeniority
oMarket rate
To narrow down specific employee preferences, there has been some work on what’s
called flexible compensation – based on the idea that only the individual employee
knows what package of rewards would best suit personal needs.
Exhibit 9.4 briefly summarizes some of the important motivation theories.
Several of the theories in Exhibit 9.4 focus on content—identifying what is important to
people.
oMaslow’s and Herzberg’s theories both fall in this category.
People have certain needs, such as physiological, security, and self-esteem, that
influence behavior.
Although neither theory is clear on how these needs are offered and how they
help deliver behavior, presumably if employees are offered rewards that satisfy
one or more needs, they will behave in desired ways.
These theories often drive compensation decisions about the breadth and depth
of compensation offerings.
Flexible compensation, with employees choosing from a menu of pay and
benefit choices, clearly is driven by the issue of needs.
A second set of theories, best exemplified by expectancy theory, equity theory, and
agency theory, focus less on need states and more on the second element of motivation
—the nature of the exchange– company rewards in exchange for desired employee
behaviors.
oMany compensation practices recognize the importance of a fair exchange.
oJobs are evaluated using a common set of compensable factors (Chapter 5) in part to
let employees know that an explicit set of rules that governs the evaluation process.
oEmployers collect salary survey data (Chapter 8) because they want the exchange to
be fair compared to external standards.
oEmployers design incentive systems (Chapter 10) to align employee behavior with
the needs (desired behaviors) of the organization.
oAll of the pay decisions, and more, owe much to understanding how the
employment exchange affects employee motivation.
Expectancy theory argues that people behave as if they cognitively evaluate what
behaviors are possible in relation to the value of rewards offered in exchange.
According to this theory, employers choose behaviors that yield the most satisfactory
exchange.
oEquity theory also focuses on what goes on inside an employee’s head. It argues that
people are highly concerned about equity, or fairness of the exchange process.
Employees look at the exchange as a ratio between what is expected and what is
received.
Some theorists say that employees judge transactions as fair when others
around them do not have a more (or less) favorable balance between the give
and get of an exchange.
Agency theory depicts employees as agents who enter an exchange with principals—the
owners or their designated managers.
oIt is assumed that both sides to the exchange seek the most favorable exchange
possible and will act opportunistically if given a chance.
oCompensation is a major element because it is used to keep employees in line—
employers identify important behaviors and important outcomes and pay
specifically for achieving desired levels of each. Such incentive systems penalize
employees who try to shirk their duties by giving proportionately lower rewards.
Goal setting theory focuses on the third element of motivation—desired behavior.
oIdentifying desired behaviors—and goals expected to flow from these behaviors—is
the emphasis of a large body of goal-setting research.
oMost of this research says that how we set goals (the process of goal setting, the
level and difficulty of goals, etc.) can influence the performance levels of
employees.
Self Determination Theory (SDT) purports to integrate motivation theories under a
broad umbrella.
oThis approach believes that employees are motivated not only by reward systems
and pay grades, examples of extrinsic motivators, but also by intrinsic motivators.
oAnything that promotes our sense of autonomy, competence and relatedness is
believed to generate the highest quality motivation and level of engagement.
III. What Does It Take to Get These Behaviors? What Practitioners Say
In the past, compensation people didn’t ask this question very often.
oEmployees learned what behaviors were important as part of the socialization
process or as part of the performance management process.
oCompensation might have rewarded people for meeting expectations, but usually the
compensation package wasn’t designed to be one of the signals about expected
performance.
Now, progressive companies ask, “What do we want our compensation package to do?”
oFor example, “How do we get our product engineers to take more risks?”
oCompensation is then designed to support this risk-taking behavior.
Compensation is but one of many rewards that influence employee behavior.
oSurveys indicate that workers highly value other job rewards such as empowerment,
recognition, and opportunities for advancement.
oThere is growing sentiment for letting workers choose their own “blend” of rewards
from the thirteen mentioned in Exhibit 9.5.
oEmployers may be overpaying in cash and missing the opportunity to let employees
construct both a more satisfying and less-expensive reward package. Known as
flexible compensation, this idea is based on the notion of different rewards having
different dollar costs associated with them.
While widespread use of this type of system may be a long time in the future,
the approach still underscores the need for integration of rewards in
compensation design.
If employers don’t think about the presence or absence of rewards other than money in
their organizations, they many find the compensation process producing unintended
consequences. The text explains this concept with the help of the following three
examples:
oExample 1: McDonald’s recently completed a worldwide “employment branding”
exercise. Their goal was to find out what people liked about jobs at McDonald’s and
feature these rewards in the recruitment strategy for new employees. Three things
emerged as strengths at McDonald’s:
An emphasis on family and friends in a social work environment
Flexibility in work assignments and work schedules
Development of skills that helped launch future careers
oExample 2: Southwest Airlines promotes a business culture of fun and encourages
employees to find ways to make their jobs more interesting. All this is accomplished
without using incentives as a major source of competitive advantage. Indeed, pay at
Southwest isn’t any higher than for competitor airlines, yet it’s much easier to
recruit top people there. Fun, a good social environment, is a reward!
oExample 3: Consider the relationship between the different forms of compensation
and another of the general rewards listed in Exhibit 9.5: security. Drastic reductions
in middle-management layers during the downsizing decade of the 1980s increased
employee concerns about job security and probably elevated the importance of this
reward to employees today. Maybe that’s why new millenial workers are concerned
not only about employment risk but also about compensation at risk. There is
evidence that compensation at risk (pay based on incentives rather than base pay
that is secure) leaves many employees less satisfied both with their pay level and
with the process used to determine pay. The trend today is toward less stable and
less secure compensation packages. The very design of compensation systems today
contributes to instability and insecurity and leads to rejection by some potential
employees, or for some current employees to decide to leave.
Exhibit 9.6 outlines the different types of wage components. It generally orders
compensation components from least risky to more risky for employees. Risky is
defined in terms of stability of income, or the ability to accurately predict income level
from year to year.
oBase pay is, at least as far as there are any guarantees, the guaranteed portion of
income, as long as employees remain employed.
oAcross the board increases, cost-of-living increases and merit increases all help the
base pay component increase on a regular basis.
oThe next seven components are distinguished by increasing levels of uncertainty for
employees.
Over the last several decades, companies have been moving more toward compensation
programs higher on the risk continuum.
oNew forms of pay are less entitlement-oriented and more linked to the uncertainties
of individual, group, and corporate performance.
oEmployees increasingly are expected to bear a share of the risks that businesses
have solely born in the past. It’s not entirely clear what impact this shifting of risk
will have in the long run, but some authors are already voicing concerns that efforts
to build employee loyalty and commitment may be an early casualty of these new
pay systems.
oRecent surveys show engagement levels for employees have fallen across the globe.
Some research suggests that employees may need a risk premium (higher pay) to
stay and perform in a company with pay at risk.
Security-driven employees actually might accept lower wages if they come in a
package that is more stable.