Human Resources Chapter 9 Evidence Suggests That Organizations Using Fair Procedures And Having Supervisors Who Are

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Chapter Nine: Pay-For-Performance: The Evidence 9 – 12

Education.

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%.

• A review of 26 studies gives high marks to profit-sharing plans: Organizations with

such plans had 3.5 to 5% higher annual performance.

• Gerhart and Milkovich took the performance-based pay question one step further.

• Numerous critics, led by Alfie Kohn, argue that incentives are both morally and

practically wrong.

• Kohn also suggests that incentive systems can actually harm productivity, a

decidedly negative practical outcome.

o His conclusion, based heavily on the work of Deci and colleagues, is that

• Critics of this interpretation point out at least two important flaws in Kohn’s

conclusions:

o The pragmatics of business demands that some jobs be performed that are not

the most intrinsically interesting.

▪ If incentives are required for these jobs to be completed and to create value

o His studies frequently looked at people in isolation.

• Should we tie pay to performance?

o One view says, “Not always.”

o Employers are less likely to offer performance-based pay when the job involves

• The first question should focus on an obvious but often overlooked issue: Do

9 – 13 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich

employees think any link at all should be made between pay and performance?

o Substantial evidence indicates that management and workers alike believe pay

should be tied to performance.

• Other research supports these findings.

o 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.

o At the top of the list: Create greater distinction between high and low

• The role that performance levels should assume in determining pay increases is less

clear-cut for blue-collar workers.

o Unionized, workers prefer seniority rather than performance as a basis for pay

increases.

• 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!

• How does this performance improvement occur?

o One view suggests that linking pay to performance occurs through two

mechanisms:

• 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.

o Strong evidence suggests that linking pay to performance does increase

Chapter Nine: Pay-For-Performance: The Evidence 9 – 14

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.

• 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.

V. Designing a Pay-for-Performance Plan

• The pay model suggests effectiveness is dependent on three things:

o Efficiency

o Equity

o Compliance

A. Efficiency

• Efficiency involves three general areas of concern—strategy, structure, and

standards.

Strategy

o A 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.

o The plan also should link well with HR strategy and objectives.

o The plan should address the most difficult question of all—how much of an

increase makes a difference?

9 – 15 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich

response.

Structure

o Is the structure of the organization sufficiently decentralized to allow

different operating units to create flexible variations on a general pay-for-

performance plan?

Standards

o Operationally, the key to designing a pay-for-performance system rests on

standards.

o 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:

o Distributive 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

o Procedural justice—employees are concerned about the fairness of the

procedures used to determine the amount of rewards they receive.

Chapter Nine: Pay-For-Performance: The Evidence 9 – 16

Education.

▪ 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.

o Employees want to know in advance what is expected of them.

o They want the opportunity to provide input into the standards or

C. Compliance

• A pay-for-performance system should comply with existing laws.

VI. Your Turn: Burger Boy

Summary of Case

Burger Boy is a fast food restaurant. The case explains the scenario at the restaurant on a

Friday lunch rush hour. Friday is considered the busiest day and lunch hour usually sees

Learning Objective

The students are expected to understand the management of the restaurant and identify the

discrepancies, and analyze the best possible compensation package to motivate the

employees at Burger Boy.

Teaching Guideline

9 – 17 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich

Education.

Use this case to help students relate the issues at a demanding workplace to compensation

and to provide solutions to these issues.

Discussion of Case Questions

1. What appear to be the problems at this Burger Boy?

Burger Boy, on the Friday afternoon that has been summarized in the case, is

understaffed by 5 people and the afternoon is considered the busiest of the week. The

fact that most employees have prior experience at similar jobs in different companies

2. How many of these problems could be explained by compensation issues?

Otis and Leon seem to be mostly dissatisfied with the work they do. Marge, although

working at the easiest job at this Burger Boy (the fries station), is simply unable to

3. How many other problems could be lessened with diligent use of rewards other

than pay?

The lack of motivation and the sense of unrest can easily be combated with the regular

use of a well-planned out reward system. Jerry Newman (second author of this book)

Education.

4. Are hours of work a reward? What might explain why I was happy to be

working 20 hours per week, but Chuck was unhappy with 30 hours per week?

How might schedules be used as a reward?

In the current scenario presented, hours of work are probably not considered a reward.

If that was the case, then simply put, Otis, Leon, and Lucy should have been the

happiest working, followed closely by Chuck and Marge. This, however, is not the

case. The fact that the Jerry Newman (second author of this book) is happy working

Answers to Review Questions

1. A father decides to put his two sons to work landscaping. The business involves going

to a customer’s home and providing landscaping services (cut grass, edge sidewalk,

pull weeds in flower beds, prune bushes and trees, rake leaves). Rather than paying a

flat wage, the father decides to pay an incentive according to the following schedule

(average across all lawns):

Task

Piece Rate

Incentive per

Person

Physical Effort

Time to

Complete per

Person

Charge to

Customer

9 – 19 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich

Cut grass

Easy

.4 hr

$30

Edge sidewalk

Easy

.1 hr

Pull weeds

Very Hard

.5 hr

$40

Prune bushes, etc.

Hard

.5 hr

$30

Rake leaves

Hard

$25

At the end of the second week under this arrangement the boys are quarreling with

each other and not happy with their dad. All of the disagreements revolve around the

incentive system. What might be the problems?

First, the amount of money each boy could expect to make from each activity (cutting

grass, edging sidewalk, pulling weeds in flower beds, pruning bushes and trees, raking

Incentive

Wage/hour

Wage/day

Cut grass

$10.00

$80

Edge sidewalk

$10.00

$80

Pull weeds

$12.00

$96

Prune bushes, etc.

$10.00

$80

Rake leaves

$10.00

$80

Notes related to calculations: Wages per day (8 hours) for cutting grass, edging sidewalk,

Since we do not have information about which activities, if at all, the boys prefer, we

assume that the boys would rather spend time cutting grass, since it consumes lesser time

(24 minutes) and many houses can be combined together. The wages earned will be $10

grass is cut, sidewalks edged, houses at which weeds are pulled, houses at which bushes

are pruned, and houses at which leaves are raked. What if it rains? What if a customer

forgets and is not at home for an appointment? Another issue is the expectations from the

Chapter Nine: Pay-For-Performance: The Evidence 9 – 20

Several changes need to be made:

• The father should consider paying a base wage, perhaps $2 to $3 per hour. This

2. Father Michael’s Wraps’ (pitas, wraps, flat breads) is experiencing turnover in the

range of 100 percent. Most of this occurs in the first 18 months of employment. How

would you determine if this turnover rate is high? How would you justify to your boss

that lower turnover is strategically important? What would you look at in both pay

and other forms of rewards to identify ways of reducing turnover? Justify your

choices based on your reading of this chapter.

Several assumptions have to be made. Although it is known what type of product is

provided by Father Michael’s Wraps, do they make the bread products? Or do they

distribute bread products? What employee groups are involved—exempt or non-exempt?

• The first issue is to provide an adequate wage. Use of a salary survey could assist in

determining an amount the employees would view as fair.

• The pay program should include a large base pay component with a low or no

incentive component.

• Any incentive component should be based on work performance over which the

employee has control and should not be linked to risk sharing (where employees

give up some base pay in anticipation of possible larger incentive payments later).

• Other rewards that should be provided include:

o Providing good benefits

Education.

5. You supervise in a company that is a low payer relative to competitors. What things

do you have control over to increase the likelihood that workers will feel fairly

treated?

As a supervisor, the base pay, pay-for-performance (if put in place), and other benefits and

rewards cannot be directly controlled by you. These are decisions affected by the upper

management, external factors such as competition, economic factors, etc. that are beyond

your control. As a supervisor, you cannot control elements of distributive justice either.