592:Recognizing Employee Contributions with Pay
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Human Resource Management
Gaining a Competitive Advantage
Chapter 12
Recognizing Employee Contributions with Pay
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, All Rights Reserved.
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I. Introduction
- In order to gain a competitive advantage, organizations want to compensate employees in a way that motivates them, while controlling fixed compensation costs.
- Variable compensation helps with this.
- The compensation program has to align with the organization’s human resource strategy and its overall business strategy.
- If you will compete with teams, team compensation is the way to go.
- If high productivity is the goal, give bonuses for achieving high numbers.
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This chapter focuses on the design and administration of programs to reward individuals for their contribution to organizational success. Organizations have a relatively large degree of discretion in deciding how to pay. Differences in performance (by an individual, group, or the organization), seniority, or skills are used as a basis for differentiating pay among employees. Regardless of cost differences, different pay programs can have very different consequences for productivity and return on investment.
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I. Introduction
- Organizations have a relatively large degree of 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 very different consequences for productivity and return on investment.
Multimedia Lecture Support Package to Accompany Basic Marketing
Lecture Script 6-*
This chapter focuses on the design and administration of programs to reward individuals for their contribution to organizational success. Organizations have a relatively large degree of discretion in deciding how to pay. Differences in performance (by an individual, group, or the organization), seniority, or skills are used as a basis for differentiating pay among employees. Regardless of cost differences, different pay programs can have very different consequences for productivity and return on investment.
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II. How Does Pay Influence Individual Employees?
The Three Theories that Help Explain Compensation’s Effects
Reinforcement
Theory
Agency Theory
Expectancy Theory
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Besides the equity theory, described in the previous chapter, there are other theories that influence compensation's effects. There are three theories that help to explain compensations effects. These are the reinforcement theory, expectancy theory and the agency theory.
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II. How Does Pay Influence Individual Employees?
- Reinforcement Theory: A response followed by a reward is more likely to recur in the future (Thorndike’s Law of Effect).
- Expectancy Theory: Motivation is a function of valence, instrumentality, and expectancy (Vroom’s VIE Theory).
- Agency Theory: The interests of the principals (owners) and their agents (managers) may no longer converge.
- Types of agency costs include:
- Perquisites.
- Attitudes towards risk.
- Decision-making horizons.
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The Reinforcement Theory—In Thorndike's Law of Effect, a response followed by a reward is more likely to recur in the future. The importance of a person's actual experience in receiving the reward is critical. If high performance is followed by a reward, high performance is likely to be repeated.
The Expectancy Theory—This theory says that motivation is a function of valence, instrumentality, and expectancy.
The Agency Theory—This theory focuses on divergent interests and goals of the organization's stakeholders and the ways that compensation can be used to align these interests and goals.
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- Traditionally, we viewed pay as a way to influence employee behaviors and attitudes.
- Individual pay programs may also affect the nature and composition of an organization’s workforce.
- Different pay systems appear to attract people with different personality and trait values.
- The design of the compensation program needs to be carefully coordinated with the organization and human resource strategy.
- Create a strong link between pay and performance.
III. How Does Pay Influence Labor Force Composition?
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IV. Pay for Performance Programs
- A combination of programs is often the best solution.
- Programs differ by design features such as payment method, frequency of payout, and ways of measuring performance.
- Potential consequences of such programs are performance motivation of employees, attraction of employees, organization culture, and costs.
- Contingencies that may influence whether a pay program fits the situation are management style and type of work.
Table 12.1
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Table 12.1 in the text provides an overview of some programs and potential contributions. The programs differ by payment method, frequency of payout, and ways of measuring performance. Potential consequences of such programs are performance motivation of employees, attraction of employees, organization culture, and costs. Contingencies that may influence whether a pay program fits the situation are management style, and type of work.
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IV. Programs
Programs for Recognizing Employee Contributions
Merit Pay
Incentive Pay
Gain Sharing
Ownership
Profit Sharing
Skill-Based
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Table 12.1 in the text provides an overview of some programs and potential contributions. The programs differ by payment method, frequency of payout, and ways of measuring performance. Potential consequences of such programs are performance motivation of employees, attraction of employees, organization culture, and costs. Contingencies that may influence whether a pay program fits the situation are management style, and type of work.
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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 the percentage of employees who should fall into each performance category.
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Merit pay programs, annual pay increases are usually linked to performance appraisal ratings. The size and frequency of pay increases are most often determined by performance rating (since better‑performing employees should be rewarded more than low performers) and position in range (compa‑ratio). Table 12.3 in your text indicates how compa‑ratio targets and performance ratings might be combined.
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Merit Pay
- Edward W. Deming, who is a critic of merit pay, argues that it is unfair to rate individual performance because "apparent differences between people arise almost entirely from the system that they work in, not the people themselves.”
- Criticisms of merit pay include:
- The focus on merit pay discourages teamwork.
- The measurement of performance is done unfairly and inaccurately.
- Merit pay may not really exist.
- Are high performers really paid that much more than mediocre performers?
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Deming, who is a critic of merit pay, argues that it is unfair to rate individual performance because "apparent differences between people arise almost entirely from the system that they work in, not the people themselves." Examples of system factors are co‑workers, the job, materials, equipment, customers, management, supervision, and environmental conditions. These factors are the responsibility of management.
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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.
- They are relatively rare because:
- Most jobs have no physical output measure.
- There are many potential administrative problems.
- Employees may do what they get paid for and nothing else.
- They typically do not fit in with the team approach.
- They may be inconsistent with organizational goals.
- Some incentive plans reward output at the expense of quality or customer service.
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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. Monetary incentives increased production by 30 percent in a study by Locke. Individual incentives are relatively rare.
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Profit Sharing
- Under profit sharing, payments are based on a measure of organizational performance (profits), and payments do not become a part of base pay.
- The advantage is that profit sharing may encourage employees to think more like owners.
- The fundamental drawback is that workers may perceive their performance has little to do with profit but is more related to top management decisions over which they have little control.
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Under profit sharing, payments are based on a measure of organization performance (profits) and do not become part of the employees’ base salary. An advantage is that profit sharing may encourage employees to think more like owners and take a broad view of what needs to be done, labor costs are reduced in difficult economic times, and organizations may not have to rely on layoffs. A second advantage is that because payments do not become part of base pay, labor costs are automatically reduced during difficult economic times, and wealth is shared during good times. The drawback is that workers may perceive their performance has little to do with profit but is more related to top management decisions over which they have little control. Another motivational problem is that most plans are deferred.
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Ownership
- Ownership encourages employees to focus on the success of the organization as a whole, but, like profit sharing, ownership may 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) are employee ownership plans that 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 become part of the employee’s base salary.
- Conditions that should be in place for gainsharing to be effective include:
- Management commitment.
- A need to change or a strong commitment to continuous improvement.
- Management's acceptance and encouragement of employee input.
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Group Incentives and Team Awards
- Group incentives tend to measure performace in terms of physical output.
- Team award plans may use a broader range of performance measures.
- Drawbacks are that individual competition may be replaced by competition between groups or teams.
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Group incentives and team awards typically pertain to a smaller work group. Group incentives tend to measure performance in terms of physical output, whereas team award plans may use a broader range of performance measures. Drawbacks are that individual competition may be replaced by competition between teams. In addition, dimensions must be perceived as fair by employees, and these standards must not exclude important dimensions such as quality.
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Balanced Scorecard
- Some companies find it useful to design a mix of pay programs.
- The four categories of a balanced scorecard include:
- Financial
- Customer
- Internal
- Learning and Growth
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Some companies find it useful to design a mix of pay programs. Relying exclusively on merit pay or individual incentives may result in high levels of work motivation but unacceptable levels of individualistic and competitive behavior and too little concern for broader plant or organization goals. Table 12.7 in your text shows how a mix of measures might be used be a manufacturing form to motivate improvements in a balanced set of key business drivers.
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V. 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.
- There has been increased pressure from regulators and shareholders to better link pay and performance.
- The Securities and Exchange Commission (SEC)
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Because of their significant ability to influence organization performance, top managers and executives are a strategically important group whose compensation warrants special attention. One concern appears to be that in some companies rewards for executives are high regardless of organizational performance.
Organizations vary a great deal in the extent to which they use both short‑term and long‑term incentive programs.
There has been increased pressure from regulators and shareholders to better link pay and performance. The Securities and Exchange Commission (SEC) requires companies to report compensation level for the five highest paid executives and the company’s performance relative to that of competitors over a five-year period.
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VI. Process and Context Issues
Three issues represent areas of significant company discretion and pose opportunities to compete effectively:
Employee Participation
in Decision Making
Communication
Pay and Process:
Intertwined Effects
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Process and context issues consider employee participation in decision making and its potential consequences.
Involvement in the design and implementation of pay policies has been linked to higher pay satisfaction and job satisfaction.
Communication is critical since change in any part of the compensation system is likely to give rise to employee concerns.
It is suggested that changing the way workers are treated may boost productivity more than the way they are paid.
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VI. Process and Context Issues
- Employee Participation in Decision Making
- Typically linked to higher pay and job satisfaction.
- Communication
- Communicating pay decisions and changes helps with perceptions of procedural fairness.
- Pay and Process: Intertwined Effects
- Pay decisions are highly intertwined with the other HR functions; Cannot make decisions in isolation.
Multimedia Lecture Support Package to Accompany Basic Marketing
Lecture Script 6-*
Process and context issues consider employee participation in decision making and its potential consequences.
Involvement in the design and implementation of pay policies has been linked to higher pay satisfaction and job satisfaction.
Communication is critical since change in any part of the compensation system is likely to give rise to employee concerns.
It is suggested that changing the way workers are treated may boost productivity more than the way they are paid.
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VII. Organization Strategy and Compensation Strategy: A Question of Fit
PAY STRATEGY ORGANIZATION STRATEGY
DIMENSIONS CONCENTRATION GROWTH
Risk Sharing (Variable Pay) Low High
Time Orientation Short-Term Long-Term
Pay Level (Short Run) Above Market Below Market
Pay Level (Long Run) Below Market Above Market
Benefits Level Above Market Below Market
Pay Decisions Centralized Decentralized
Pay Unit of Analysis Job Skills
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Organization Strategy and Compensation Strategy: A Question of Fit— In choosing a pay strategy, one must consider how effectively it will further the organization’s overall over all business strategy. Table 12.11 shown on this slide and found in your text suggests some matches of strategies.