MBAO 6030 Strategic Reward Systems I

7/31/2019 MBAO 6030 Strategic Reward Systems I

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MBAO 6030 Human ResourceManagement

Strategic Reward Systems I

HR Management

MBAO 6030


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Strategic Reward Systems I:Pay for Performance

Financial Rewards Compensation

1. Base Salary

2. Pay Incentives

3. Employee Benefits

Reward Systems consist of the followingelements:

Reward Systems consist of the followingelements:

Non-financial Rewards1. Intrinsic Rewards centers on the work itself

2. Praise, recognition, time off and other rewards

given to the employee by peers or superiors.


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Strategic Reward Systems I:Pay for Performance

Reward Systems in most cases should beconsistent with other HR systems.

The Reward System is a key driver of:

HR Strategy

Business Strategy

Organization Culture


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Strategic Reward Systems I:Need for Consistency with Other HR Systems

Culture

Performance

Management

Employment

Training

Labor

Relation

s

Rewards

Overtime

pay rules incontract

Sign-on Bonus

Merit Pay

Merit pay reinforces

performance culture

Skill-based pay


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Strategic Reward Systems I

Critical Thinking Question:

1. Should pay policies lead or lag the

development of other HR systems?


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Theoretical Models of Pay and Performance:Equity theory (Adams, 1963)

Assumptions:

People develop beliefs about what is a fairreward for ones job contribution - an exchange

People compare their exchanges with theiremployer to exchanges with others-insiders andoutsiders called referents

If an employee believes his treatment isinequitable, compared to others, he or she willbe motivated to do something about it -- that is,seek justice.


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Theoretical Models of Pay and Performance:Equity theory (Adams, 1963)

Is/Os versus Ir/Or

O = Outcomes: the type and amount ofrewards received

I = Inputs: employees contribution toemployer

R = Referent: comparison person

S = Subject: the employee who is judgingthe fairness of the exchange


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Equity Theory Exchange Scenarios

Case 1: Equity -- pay allocation is perceived tobe to be fair - motivation is sustained

Case 2: Inequity (Underpayment) -- Employee

is motivated to seek justice. Work motivation isdisrupted.

Case 3: Inequity (Overpayment) -- Could be

problem. Inefficient. In other culturesemployees lose face.


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Consequences of Inequity

The employee is motivated to have an equitableexchange with the employer.

To reduce inequity, employee may

Reduce inputs (reduce effort)

Try to influence manager to increase outcomes(complain, file grievance, etc.)

Try to influence co-workers inputs (criticize others

outcomes or inputs)

Withdraw emotionally - or physically (engage inabsenteeism, tardiness, or quit)


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Equity Theory Implications

There is tension between internal and externalpay equity: Decide where to place theemphasis. Example: In and out versus

lifelong employment system Let employees know who their pay referents are

in the pay system: identify pay competitors andinternal pay comparators.

Strive for consistent pay allocations

Monitor internal pay structure and position in thelabor market for consistency.


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Agency Theory

Agency theory is a theory of governance in theworkplace.

It tries to solve the problem of separation of

ownership (atomistic shareholders) and control(professional executives and non-owners)

It also tries to solve conflicts of interest between

managers and employees with delegatedresponsibilities.


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Agency Theory

1. Principals = owners or managers who delegateresponsibilities

2. Agents = managers or employees who manage

firm assets for owners or other principals.3. Information asymmetry = managers or other

agents have greater access to strategic

information than principals, who are not willingto bear the cost of directly monitoring theagents due to steep agency costs.


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Agency Theory

4. Risk Preferences principals are risk neutraland willing to bear greater risks than agentsbecause their asset wealth is more likely to be

diversified between corporate assets and otherequities/investments. Agents are more riskaverse than principals, because most of theirwealth is concentrated in the firm and received

in the form of pay and opportunities forpromotion.


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Agency Theory

6. Agency Contract provides solution to moralhazard/agency problem, by establishing rules

of the game to control agent opportunism

agents performance will be judged byoutcomes (often financial benchmarks) notbehaviors (which require direct supervision ofagents actions). These outcomes will reflect

principals goals and risk preferences.


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Agency Theory

7. Incentive alignment the agency contract willspecify a compensation plan that aligns theinterests of the principal and agent. This

agency contract will be a type of pay forperformance plan. Meeting or exceeding pre-agreed upon financial or non-financialoutcomes triggers various forms of

compensation (individual or group-based) forthe agent. Some agency costs are borne bythe principal in the form of financial incentivesfor the agent.


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Tournament Theory

1. Tournaments are competitions between peersto achieve a promotion to a higher rank alongwith the pay and perks that go with it.

2. Tournaments are likely to result in a winnertake all outcome.

3. Managers who enter the tournament must

forego other alternatives (such as jobs withother firms, start own business, receive morepay with an alternative opportunity) to competein the tournament.


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Tournament Theory

4. A high pay differential (such as the CEOreceiving much greater pay than anysubordinates) attracts more players to the

tournament.5. Players must invest (work long hours, accept

less pay, show loyalty to their boss) to enter thetournament firm captures value from theseplayers, more than what it gives up to thewinner for the prize.


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Controversies that Surround Pay forPerformance Plans

1. Single Mindednessyou get what you payfor no more, no less. The activities that arerewarded get done, to the exclusion of other

activities that are not rewarded. Example: Thedysfunctional behaviors that are observed whena sales representative is put on straightcommission.


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2. Control externalities can control theoutcomes, positive or negative. There can bewindfall affects (the bull market improving the

stock value of all stock options) or negativeexternalities (a bear market or recession thatlowers the value of all stocks). Employeeperformance results may be magnified or

diluted by these effects.


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3. Measurement error some measures can begamed or manipulated and may not reflect

true performance. Sales reps can withhold

sales and report it in a different period so theyare not penalized by a cap on salescommissions. Managers can use creative

accounting measures to report greater profits

than were actually experienced by the firm.


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4. Inflexibility managers or employees mayresist change of the basis of compensationbecause they are comfortable with current

basis for pay and want to avoid risk of takingreduction in earnings in new system.


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5. Misalignment of incentives if pay emphasis ison a goal that is no longer relevant, that goal willcontinue to be emphasized until the pay system

places emphasis on a different objective.For example, managers may emphasize short-term

goals, even if long-term goals are more relevant,until the pay system recognizes long-term goals

to a greater extent than short-term goals. Thereward mix for complex jobs with several goalsmust reflect the relative value of attaining the

mix of goals.


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6. Line of Sight problem - division performanceand corporate performance should be reflectedin the pay system. If division performance and

corporate performance are closely linked thanboth division and corporate performance shouldcontribute incentives to the managers pay for

performance plan. If division performance is

independent of corporate performance, then theemphasis should be on rewards for meetingdivision goals.


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Some Suggestions for More Effective Pay ForPerformance Plans

Pay and Performance should be LooselyCoupled this gives managers more flexibilityto make changes when new situations arise.

Example: a formula with a bonus based on amoving average of a 3-year historicalperformance period. A 3-year period smoothesout performance over a longer cycle.


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It is Necessary to Nurture the Belief thatPerformance Makes a Difference there areimportant cultural values that are supported with

pay for performance even if the accuracy of theperformance metrics and the fairness of the payallocations fall short of an ideal situation.Abandoning pay for performance may be more

problematic than having an imperfect paysystem.


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Pay for Performance systems should bedesigned to fit each firms unique situationimitation of other firms plans should be avoided


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Six Myths about Pay (Pfeffer, 1998)

1. Labor rates and labor costs are the same thing.

2. Labor costs can be reduced by lowering laborrates.

3. Labor costs are a significant portion of total costs.

4. Low labor costs are a potent source of competitiveadvantage.

5. The most effective way to work productively isthrough individual incentive compensation.

6. People work primarily for money.


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Critical Thinking Questions

1. Sears Roebuck Auto Center paid its automechanics a commission based on the volume ofservices sold to each customer. This basis of pay

resulted in law suits filed against Sears by angrycustomers who claimed they were over-charged forservices they did not need. Sears was forced topay millions of dollars of penalties to thesecustomers which hurt its reputation. Pfefferbelieves that Sears mistake was that it should

have realized that individual pay incentives aredysfunctional. Do you agree with this conclusion?


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MBAO 6030 Human Resource

Critical Thinking Questions

2. Charles Schwab, the discount broker, does notuse commissions as pay incentives for itsbrokers, bucking financial services industry paypractices. Why do you think Schwab did this?

3. Do you think that the point of view of the author(of the 6 Myths of Pay) would work at a Wall

Street investment bank such as Morgan Stanley?

4. The author of the 6 Myths of Pay article prefersgroup-based pay for performance rather thanindividual pay for performance plans. What isthe reason behind this? Do you agree?

MBAO 6030 Strategic Reward Systems I

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