IV. Does Compensation Motivate Behavior?
Now let’s look at the role of compensation in motivating the four types of behavior outline
earlier: the decision to join, to stay, to develop skills, and to perform well.
A. Do People Join a Firm Because of Pay?
Level of pay and pay system characteristics influence a job candidate’s decision to
join a firm. Being perceived as more objective, it’s more easily communicated in the
employment offer.
Recent research suggests job candidates look for organizations with reward systems
that fit their personalities.
Some of the ways that “fit” is important is outlined below:
oMaterialistic (relatively more concerned about pay level)
oLow self-esteem (want large, decentralized organization with little pay for
performance).
oRisk takers (want more pay based on performance).
oRisk-averse (want less performance-based pay).
oIndividualists (“I control my destiny”) (want pay plans based on individual
performance, not group performance).
Evidence suggests talented employees are attracted to companies that have strong
links between pay and performance.
B. Do People Stay in a Firm (or Leave) Because of Pay?
There is clear evidence that poor performers are more likely to leave an organization
than good performers.
oTurnover is much higher for poor performers when pay is based on individual
performance. Conversely, group incentive plans may lead to more turnover of
better performers.
Data suggest dissatisfaction with pay can be a key factor in turnovers.
oToo little pay triggers feelings of unfair treatment, resulting in turnover.
Supporting this, pay that employees find reasonable can help reduce turnover.
oEven the way an organization pays can impact turnover.
Evidence suggests that some employees are uncomfortable with pay systems
that put any substantial future earnings at risk or pay systems that link less to
personal effort and more to group effort.
Another recent study found superior performing employees were less likely
to leave if they received bonuses. No such positive result was found with pay
increases (thus changing base pay).
Recent efforts to use different types of compensation as a tool for retaining workers
have focused on what is called scarce talent.
Besides money, other rewards also influence the decision to stay (retention) in a
firm. According to one recent study, the rewards that “work” to help retain
employees in the tough economic times we face heading into the middle of this
decade are as follows:
oJob Satisfaction – work enjoyment.
oPay and Benefits.
oSocial – coworkers are fun.
oOrganizational commitment – not a job jumper; loyal.
oOrganizational Prestige – respect afforded company in industry or region.
C. Do Employees More Readily Agree to Develop Job Skills Because of Pay?
The answer to this question is not known.
Skill-based pay is intended, at least partially, to pay employees for learning new
skills that hopefully will help them perform better on current jobs and adjust more
rapidly to demands on future jobs.
Evidence is starting to accumulate that pay for skill may not increase productivity,
but it does focus people on believing in the importance of quality and in turning out
significantly higher quality products.
D. Do Employees Perform Better on Their Jobs Because of Pay?
A well-designed plan linking pay to behaviors of employees generally results in
better individual and organizational performance.
One particularly good study looked at the HR practices of over 3,000 companies.
One set of questions asked:
oDid the company have a formal appraisal process?
oWas the appraisal tied to the size of the pay increases?
oDid performance influence who would be promoted?
oOrganizations significantly above the mean (by one standard deviation) on these
and other “high-performance work practices” had annual sales that averaged
$27,000 more per employee. So rewarding employees for performance pays off.
In another comprehensive review, Heneman reports that 40 of 42 studies looking at
merit pay show performance increases when pay is tied to performance.
One study of 841 union and nonunion companies found gain-sharing and
profit-sharing plans (both designed to link pay to performance) increased individual
and team performance 18 to 20 percent.
A review of 26 studies gives high marks to profit-sharing plans: Organizations with
such plans had 3.5 to 5 percent higher annual performance.
Gerhart and Milkovich took the performance-based pay question one step further.
Across 200 companies they found a 1.5-percent increase in return on assets for
every 10-percent increase in the size of a bonus. Further, they found that the variable
portion of pay had a stronger impact on individual and corporate performance than
did the level of base pay.
Numerous critics, led by Alfie Kohn, argue that incentives are both morally and
practically wrong.
oThe moral argument suggests that incentives are flawed because they involve
one person controlling another. The counterargument to this notes that
employment is a reciprocal arrangement.
Kohn also suggests that incentive systems can actually harm productivity, a
decidedly negative practical outcome.
oHis conclusion, based heavily on the work of Deci and colleagues, is that
rewarding a person for performing a task reduces interest in that task—extrinsic
rewards (money) reduce intrinsic rewards (enjoyment of the task for its own
sake).
Critics of this interpretation point out at least two important flaws in Kohn’s
conclusions:
oThe pragmatics of business demands that some jobs be performed that are not
the most intrinsically interesting.
oHis studies frequently looked at people in isolation. In the real world people
interact with each other, know who is performing and who isn’t, and react to this
when rewards are allocated.
Substantial evidence indicates that management and workers alike believe pay
should be tied to performance.
Dyer and colleagues asked 180 managers from 72 different companies to rate nine
possible factors in terms of the importance they should receive in determining the
size of salary increases. This group believed the most important factor for salary
increases should be job performance.
Other research supports these findings. Both college students and a second group of
managers ranked job performance as the most important variable in allocating pay
raises.
Another way to make the pay-for-performance argument is to look at the ways HR
professionals try to cut costs. At the top of the list: Create greater distinction
between high and low performers! In other words, really pay for performance!
The role that performance levels should assume in determining pay increases is less
clear-cut for blue-collar workers.
oUnionized, workers prefer seniority rather than performance as a basis for pay
increases. Part of this preference may stem from a distrust of subjective
performance measurement systems.
oSome evidence also suggests that women might prefer allocation methods not
based on performance.
It’s probably a good thing that, in general, workers believe pay should be tied to
performance, because the research reported in the text suggests this link makes a
difference. And the difference may translate into bottom-line results!
oIn a study of over 3,000 companies, convincing evidence showed that linking
pay to performance has a positive impact on the bottom line. Over a five-year
period such practices can increase per-employee sales by as much as $100,000.
One view suggests that linking pay to performance occurs through two mechanisms:
oIncentive effect—pay can motivate people to perform better.
oSorting effect—people sort themselves by what is important to them.
Many meta-analyses (reviews of pay for performance research that use statistical
tools to estimate the magnitude of pays impact on performance) demonstrate the
incentive effect of pay. Strong evidence suggests that linking pay to performance
does increase motivation of workers and lead to improved performance.
Choice of pay systems (pay increases based on performance or some other attribute
like seniority) also influence productivity through the sorting effect—people sort
themselves into or out of organizations based on a preference for being paid based
on personal performance or some something else.
oHigher ability individuals are attracted to companies that will pay for
performance.
oHigh performers will also leave firms that don’t reward their performance.
Compensation experts estimate that every dollar spent on any performance-based
pay plan yields $2.34 more in organizational earnings.
Before employers rush out and develop a variable-pay component to the
compensation package, though, they should recognize that such plans can, and do,
fail. Sometimes the failure arises, ironically, because the incentive works too well,
leading employees to exhibit rewarded behaviors to the exclusion of other desired
behaviors.
V. Designing a Pay-for-Performance Plan
A recent survey of HR professionals indicates widespread use of different
pay-for-performance plans.
The pay model suggests effectiveness is dependent on three things:
oEfficiency
oEquity
oCompliance
A. Efficiency
Efficiency involves three general areas of concern—strategy, structure, and
standards.
Strategy
oA pay-for-performance plan must support corporate objectives.
The plan should be cost-effective and should help the organization
improve the quality of its services.
oThe plan also should link well with HR strategy and objectives.
oThe plan should address the most difficult question of all—how much of an
increase makes a difference?
While there are few hard data on this question, most experts agree that
employees don’t begin to consider changing behavior unless payouts are
at least 10 percent higher, with 15 to 20 percent more likely to evoke the
desired response.
Structure
oIs the structure of the organization sufficiently decentralized to allow
different operating units to create flexible variations on a general
pay-for-performance plan?
oThe text explains this concept with the help of IBM’s example. At IBM
managers get a budget, some training on how to conduct reviews, and a
philosophical mandate: Differentiate pay for stars relative to average
performers, or risk losing stars.
Standards
oOperationally, the key to designing a pay-for-performance system rests on
standards. Specifically, employers need to be concerned about the following:
Objectives: Are they specific yet flexible? Can employees see that
their behavior influences their ability to achieve objectives (called the
“line-of-sight” issue in industry)?
Measures: Do employees know what measures (individual appraisals,
peer reviews of team performance, corporate financial measures, etc.)
will be used to assess whether performance is sufficiently good to
merit a payout?
Eligibility: How far down the organization will the plan run?
Funding: Will an organization fund the program out of extra revenue
generated above and beyond some preset standard? If so, what
happens in a bad year?
B. Equity/Fairness
Two types of fairness are concerns for employees:
oDistributive justice—fairness in the amount that is distributed to employees.
Does an employee view the amount of compensation received as fair?
Perceptions of fairness depend on the amount of compensation actually
received relative to input compared against a relevant standard.
Recent research suggests that employees may look at the relative
distribution of pay. Some evidence suggests that narrower ranges for pay
differences may actually have positive impacts on overall organizational
performance.
oProcedural justice—employees are concerned about the fairness of the
procedures used to determine the amount of rewards they receive.
Managers have somewhat more control over this type of equity.
Evidence suggests that organizations using fair procedures and having
supervisors who are viewed as fair in the means they use to allocate
rewards are perceived as more trustworthy and command higher levels of
commitment.
Some research even suggests that employee satisfaction with pay may
depend more on the procedures used to determine pay than on the actual
level distributed.
A key element in fairness is communications.
oEmployees want to know in advance what is expected of them. They want
the opportunity to provide input into the standards or expectations.
oIf performance is judged lacking relative to the standards, employees want a
mechanism for appeals.
oThe importance of open communications extends to upper management.
Executives perform better when told what the linkage is between pay and
performance.
C. Compliance
A pay-for-performance system should comply with existing laws.
Firms want a reward system that maintains and enhances their reputation.