1
Chapter
12
Recognizing Employee
Contributions with Pay
After reading this chapter, you should be able to:
Describe the fundamental pay programs for recognizing
employees' contributions to the organization's success.
List the advantages and disadvantages of the pay programs.
List the major factors to consider in matching the pay
strategy to the organization's strategy.
Chapter
12
Recognizing Employee
Contributions with Pay
Explain
the importance of process issues such as
communication in compensation management.
Describe how U.S. pay practices compare with those of
other countries.
Introduction
 Organizations
have a relatively large
degree of discretion in deciding how to
pay.
 Differences in performance by an
individual, group, organization, seniority,
or skills determine the pay.
 Regardless of cost differences, different
pay programs can have very different
consequences for productivity and return
on investment.
How Does Pay Influence Individual
Employees?
Three different theories help explain compensation’s effects:
Reinforcement Theory
Expectancy Theory
Agency Theory
How Does Pay Influence 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 -The interests of the principals
(owners) and their agents (managers) may not
converge.
 Types
of agency costs include:
perquisites
 attitudes towards risk
 decision-making horizons

Agency Costs
 Agency
costs may be minimized by the principal choosing
a contracting scheme that helps align the interests of the
agent with the interests of the principals.
 The type of contract depends partly on the following
factors:
 risk
aversion
 outcome uncertainty
 job programmability
 measurable job outcomes
 ability to pay
 tradition
Programs for Recognizing
Employee Contributions
 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.
Merit Pay
Incentive Pay
Profit Sharing
Skill-based
Gain Sharing
Ownership
Merit Pay
 Merit
pay programs link performanceappraisal 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.
Merit Pay
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.
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.
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.
 An
advantage is that profit sharing may
encourage employees to think more like
owners.
 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.
Ownership
 Ownership
encourages employees to focus on the success
of the organization as a whole, but, like profit sharing, may
not result in motivation for high individual performance.
 One method to achieve employee ownership is through
stock options, which give employees the opportunity to
buy company stock at a 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.
Gainsharing
Gainsharing programs offer a means for 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
 the need to change or a process of continuous improvement
 management's acceptance and encouragement of employee input
 high levels of cooperation and interaction
 employment security
 information sharing on productivity and costs
 goal setting
 commitment and agreement of all parties
 standards that are understandable, fair, and related to objectives.

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 teams.
Balanced Scorecard
Some
companies design plans that combine
various elements of the above programs that are
appropriate to the situation.
The four categories of a balanced scorecard
include:
 financial
 customer
 internal
 learning
and growth
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 organizational performance.
 Executive pay can be linked to organizational performance
(from agency theory).
 There has been increased attention to executive pay from
regulators.
 The Securities and Exchange Commission (SEC)
Process and Context Issues
Three issues represent areas of significant company
discretion and pose opportunities to compete effectively:
Employee Participation
in Decision Making
Intertwined Effects of
Pay and Process
Communication
Matching Pay Strategy and
Organization Strategy
Pay Strategy Dimensions
Risk Sharing
Time Orientation
Pay Level (short-run
Pay Level (long-run)
Benefit Level
Centralization of Pay Decisions
Pay Unit of Analysis
Organization Strategy
Concentration
Growth
Low
High
Short-term
Long-term
Above Market
Below Market
Below Market
Above Market
Above Market
Below Market
Centralized
Decentralized
Job
Skills