Reward Systems I

8/10/2019 Reward Systems I

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MBAO 6030 Human ResourceManagement

Strategic Reward Systems I

HR Management

MBAO 6030


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MBAO 6030 Human Resource

Management

Strategic Reward Systems I:

Pay for Performance

Financial RewardsCompensation

1. Base Salary

2. Pay Incentives

3. Employee Benefits

Reward Systems consist of the following

elements:

Reward Systems consist of the following

elements:

Non-financial Rewards1. Intrinsic Rewardscenters on the work itself

2. Praise, recognition, time off and other rewards

given to the employee by peers or superiors.


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Management


Pay for Performance

Reward Systems in most cases should be

consistent with other HR systems.

The Reward System is a key driver of:

HR Strategy

Business Strategy

Organization Culture


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Management


Need for Consistency with Other HR Systems

Culture

Performance

Management

Employment

Training

Labor

Relation

s

Rewards

Overtime

pay rules incontract

Sign-on BonusMerit Pay

Merit pay reinforcesperformance culture

Skill-based pay


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Management

Strategic Reward Systems I

Critical Thinking Question:

1. Should pay policies lead or lag the

development of other HR systems?


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Management

Theoretical Models of Pay and Performance:

Equity theory (Adams, 1963)

Assumptions:

People develop beliefs about what is a fair

reward for ones job contribution - an exchange

People compare their exchanges with their

employer to exchanges with others-insiders and

outsiders called referents

If an employee believes his treatment isinequitable, compared to others, he or she will

be motivated to do something about it -- that is,

seek justice.


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Management

Theoretical Models of Pay and Performance:

Equity theory (Adams, 1963)

Is/Os versus Ir/Or

O = Outcomes: the type and amount of

rewards received

I = Inputs: employees contribution to

employer

R = Referent: comparison person

S = Subject: the employee who is judging

the fairness of the exchange


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Equity TheoryExchange Scenarios

Case 1: Equity -- pay allocation is perceived to

be 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 equitable

exchange 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 in

absenteeism, tardiness, or quit)


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Equity Theory Implications

There is tension between internal and external

pay equity: Decide where to place the

emphasis. Example: In and out versus

lifelong employment system Let employees know who their pay referents are

in the pay system: identify pay competitors and

internal pay comparators.

Strive for consistent pay allocations

Monitor internal pay structure and position in the

labor market for consistency.


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Agency Theory

Agency theory is a theory of governance in the

workplace.

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 delegate

responsibilities

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 the

agents due to steep agency costs.


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Agency Theory

4. Risk Preferencesprincipals are risk neutral

and willing to bear greater risks than agents

because their asset wealth is more likely to be

diversified between corporate assets and otherequities/investments. Agents are more risk

averse than principals, because most of their

wealth is concentrated in the firm and received

in the form of pay and opportunities forpromotion.


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Agency Theory

5. Moral Hazardagent is tempted (and some

cases succeeds) in taking advantage of

information asymmetry with principal and act

opportunistically (defined as making decisionsnot aligned with principals interests) and use

the firm resources to maximize wealth of the

agent (often at the expense of the principal).


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Agency Theory

6. Agency Contractprovides solution to moral

hazard/agency problem, by establishing rules

of the game to control agent opportunism

agents performance will be judged byoutcomes (often financial benchmarks) not

behaviors (which require direct supervision of

agents actions). These outcomes will reflect

principals goals and risk preferences.


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Agency Theory

7. Incentive alignmentthe agency contract will

specify a compensation plan that aligns the

interests 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-financial

outcomes triggers various forms of

compensation (individual or group-based) forthe agent. Some agency costs are borne by

the principal in the form of financial incentives

for the agent.


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Tournament Theory

1. Tournaments are competitions between peers

to achieve a promotion to a higher rank along

with 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 with

other firms, start own business, receive more

pay with an alternative opportunity) to compete

in the tournament.


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Tournament Theory

4. A high pay differential (such as the CEO

receiving much greater pay than any

subordinates) attracts more players to the

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

less pay, show loyalty to their boss) to enter the

tournamentfirm captures value from these

players, more than what it gives up to the

winner for the prize.


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Controversies that Surround Pay for

Performance Plans

1. Single Mindednessyou get what you pay

for no more, no less. The activities that are

rewarded get done, to the exclusion of other

activities that are not rewarded. Example: Thedysfunctional behaviors that are observed when

a sales representative is put on straight

commission.


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Performance Plans

2. Controlexternalities can control the

outcomes, positive or negative. There can be

windfall affects (the bull market improving the

stock value of all stock options) or negativeexternalities (a bear market or recession that

lowers the value of all stocks). Employee

performance results may be magnified or

diluted by these effects.


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Performance Plans

3. Measurement errorsome measures can be

gamed 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 sales

commissions. Managers can use creative

accounting measures to report greater profits

than were actually experienced by the firm.


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Performance Plans

4. Inflexibilitymanagers or employees may

resist change of the basis of compensation

because they are comfortable with current

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


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Performance Plans

5. Misalignment of incentivesif pay emphasis is

on a goal that is no longer relevant, that goal will

continue 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. The

reward mix for complex jobs with several goals

must reflect the relative value of attaining the

mix of goals.


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Performance Plans

6. Line of Sight problem- division performance

and corporate performance should be reflected

in the pay system. If division performance and

corporate performance are closely linked thanboth division and corporate performance should

contribute incentives to the managers pay for

performance plan. If division performance is

independent of corporate performance, then theemphasis should be on rewards for meeting

division goals.


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Some Suggestions for More Effective Pay For

Performance Plans

Pay and Performance should be Loosely

Coupledthis gives managers more flexibility

to make changes when new situations arise.

Example: a formula with a bonus based on amoving average of a 3-year historical

performance period. A 3-year period smoothes

out performance over a longer cycle.


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Performance Plans

It is Necessary to Nurture the Belief that

Performance Makes a Differencethere are

important cultural values that are supported with

pay for performance even if the accuracy of theperformance metrics and the fairness of the pay

allocations fall short of an ideal situation.

Abandoning pay for performance may be more

problematic than having an imperfect paysystem.


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Performance Plans

Pay for Performance systems should be

designed to fit each firms unique situation

imitation 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 labor

rates.

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

4. Low labor costs are a potent source of competitive

advantage.

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 auto

mechanics a commission based on the volume of

services sold to each customer. This basis of pay

resulted in law suits filed against Sears by angrycustomers who claimed they were over-charged for

services they did not need. Sears was forced to

pay millions of dollars of penalties to these

customers which hurt its reputation. Pfeffer

believes that Sears mistake was that it should

have realized that individual pay incentives are

dysfunctional. Do you agree with this conclusion?


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Critical Thinking Questions

2. Charles Schwab, the discount broker, does notuse commissions as pay incentives for its

brokers, bucking financial services industry pay

practices. 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 than

individual pay for performance plans. What is

the reason behind this? Do you agree?

Reward Systems I

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