Human Resource Management:Gaining a Competitive Advantage

Chapter 12

Recognizing Employee Contributions with Pay

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Learning Objectives

Discuss how pay influences individual employees.

Describe three theories that explain compensation’s effect on individuals.

Describe pay programs for recognizing employees’ contributions to the organization’s success.

List pay programs’ advantages and disadvantages.

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Learning Objectives

Describe how organizations combine incentive plans in a balanced scorecard.

Discuss issues related to executives’ performance-based pay.

Explain the importance of process issues such as communication in compensation management.

List major factors in matching pay strategy to the organization’s strategy.

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Introduction

Organizations have discretion in deciding how to pay.

Each employee’s pay is based upon individual performance, profits, seniority, or other factors.

Regardless of cost differences, different pay programs can have different consequences for productivity and return on investment.

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Pay Influences Individual Employees

3 Theories Explain Compensation’s Effects:

ReinforcementTheory

AgencyTheory

ExpectancyTheory

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How Pay Influences Individual Employees

Reinforcement Theory - A response followed by a reward is more likely to recur in the future.

Expectancy Theory - Motivation is a function of valence, instrumentality, and expectancy.

Agency Theory- interests of the principals (owners) and their agents (managers) may

nolonger converge.

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Agency Costs

Agency costs may be minimized by the principal choosing a contracting scheme that alignsagent’s interests with principal's interests.

6 Factors that Influence Type ofContract:1. risk aversion2. outcome uncertainty3. job programmability4. measurable job outcomes5. ability to pay6. tradition

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Programs Recognizing Contributions

Programs differ by payment method,payout frequencyand ways of measuring performance. Potential consequences include employees’ performance

motivation and attraction, culture and costs. Management style and type of work influence whether a pay

program fits the situation.

Merit Pay Incentive Pay

GainSharing

Ownership

ProfitSharing

Skill-based

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Merit Pay

Merit pay programs link performance-appraisal ratings to annual pay increases.

A merit increase grid combines an employee’s performance rating with the employee’s position in a pay range to determine the size and frequency of his or her pay increases.

Some organizations provide guidelines regarding percentage of employees who should fall into each performance category.

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Merit Pay

Edward W. Deming, a critic of merit pay, arguedthat it is unfair to rate individual performance because "apparent differencesbetween people arise almost entirely from the system that they work in, not the people themselves.”

Criticisms of merit pay include: Focus on merit pay discourages teamwork. Measurement of performance is done unfairly and

inaccurately. Merit pay may not really exist.

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Individual Incentives

Individual incentives reward individual performance but payments are not rolled into base pay and performance is usually measured as physical output rather than by subjective ratings.

Individual incentives are rare because: Most jobs have no physical output measure. Many potential administrative problems. Employees may do what they get paid for and nothing

else. Typically do not fit in with team approach. May be inconsistent with organizational goals. Some incentive plans reward output at the expense of

quality or customer service.

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Profit Sharing

Under profit sharing, payments are based on a measure of organization performance (profits), and payments do not become a part of base pay.

Advantage- profit sharing may encourage employees to think more like owners.

Disadvantage-workers may perceive their performance haslessto do with profitthan top management decisions over which they have little control.

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Ownership

Ownership encourages employees to focus onorganization’s success, butmay be less motivational the larger the organization.

One method to achieve employee ownership is through stock options, which give employees the opportunity to buy company stock at a previously fixed price.

Employee stock ownership plans (ESOPs) give employers certain tax and financial advantages when stock is granted to employees.– ESOPs can carry significant risk for employees.

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Gainsharing

Gainsharing programs offer a means of sharing productivity gains with employees and are based on group or plant performance that does not becomepart of the employee’s base salary.

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Gainsharing

8 Conditions for Gainsharing to be Effective:1. management commitment2. need and commitment to change and continuous

improvement 3. management's acceptance and encouragement of

employee input4. high cooperation and interaction5. employment security6. information sharing on productivity and costs7. goal setting8. agreement on a performance standard and calculation

that is undesirable, seen as fair and closely related to managerial objectives

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Group Incentives and Team Awards

Group incentivesmeasure performace in terms of physical output.

Team award plans may use a broader range of performance measures.

Individual competition may be replaced by competition between groups or teams.

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Balanced Scorecard

Some companiesdesign a mix of pay programs.

4 Categories of aBalanced Scorecard:

1. financial

2. customer

3. internal

4. learning and growth

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Managerial and Executive Pay

Top managers and executives are a strategically important group whose compensation warrants

special attention. In some companies rewards for executives are high

regardless of profitability or stock market performance.Executive pay can be linked to organizational

performance (from agency theory). Increased pressure from regulators and shareholders

to better link pay and performance– Securities and Exchange Commission (SEC)

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Process and Context Issues

3 issues represent areas of significant company discretion and pose opportunities to compete effectively:

Employee Participationin Decision Making

CommunicationPay&Process:

Intertwined Effects

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Matching Pay& Organization Strategy

Pay Strategy DimensionsRisk sharing (variable pay)Time orientationPay level (short-run)Pay level (long-run potential)Benefits levelCentralization of pay decisionsPay unit of analysis

ConcentrationLowShort-termAbove marketBelow marketAbove marketCentralizedJob

GrowthHighLong-termBelow marketAbove marketBelow marketDecentralizedSkills

Organization Strategy

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Summary

There are potential advantages and disadvantages of different types of incentive or pay for performance plans.

Pay plans can have both intended and unintended consequences.

Designing a pay for performance strategy typically seeks to balance the pros and cons of different plans and reduce the chance of unintended consequences.

Pay strategy will depend on the particular goals and strategy of the organization and its units.

• Many organizations are working to link pay to performance and reduce fixed labor costs, although sometimes executives appear slow to reduce what are supposed to be performance-based bonuses when firm performance declines.

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