Human Resource Management:
Gaining a Competitive Advantage
Chapter 12
Recognizing Employee Contributions
with Pay
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
12-2
Learning Objectives
 Describe how organizations combine
incentive plans in a balanced scorecard.
 Discuss issues related to executives’
performance-based pay.
 Explain importance of process issues such
as communication in compensation
management.
 List major factors in matching pay strategy
to organization’s strategy.
12-3
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.
12-4
Pay Influences Individual Employees
3 Theories Explain Compensation’s Effects:
12-5
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 (utility, personal value of reward),
instrumentality (perceived link between
performance and pay) and expectancy (link
between effort and performance).
It has been argued that monetary rewards may increase
extrinsic motivation while decreasing intrinsic motivation.
Agency Theory- interests of principals (owners)
and their agents (managers) may no longer
converge.
12-6
Agency Costs
Agency Costs can arise from goal incongruence
between agents and principles and from information
asymmetry with regard to what goals the agent is
pursuing
Agency costs may be minimized by principal choosing a
contracting scheme that aligns agent’s interests with
principal's interests.
Issues:
1. Managers (agents) may not be focused on
maximizing shareholder (principal) wealth.
2. Managers may be more risk adverse that principals to
protedt their income
3. Decision making horizons may differ (long term vs.
short term)
 Outcome oriented contracts focus on results,
behavior based contracts focus on actions
12-7
Agency Costs
6 Factors that Influence Type of Contract:
1. risk aversion – preference towards behavior based
2.
3.
4.
5.
6.
compensation
outcome uncertainty – variables in compensation
beyond agent’s control
job programmability – portion of job that is based
upon routine, predictable portion of job
measurable job outcomes – may be difficult to
specify
ability to pay – easier to fulfill with outcome oriented
contracts
Tradition – what has been used in the past
12-8
Programs Recognizing Contributions
 Programs differ by payment method, payout frequency and 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.
12-9
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Merit Pay
Merit pay programs link performanceappraisal ratings to annual pay increases.
A merit increase grid combines an
employee’s performance rating with employee’s
position in a pay range to determine size and
frequency of his or her pay increases.
12-11
Merit Pay
 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, argued
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:
 Focus on merit pay discourages teamwork.
 Measurement of performance is done unfairly and
inaccurately.
 Merit pay may not really exist.
12-13
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 (ex. – piecework).
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.
12-14
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 has
less to do with profit than top management decisions over
which they have little control.
12-15
Ownership
Ownership encourages employees to focus on
organization’s success, but 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) give employers
certain tax and financial advantages when stock is granted to
employees.
 ESOPs can carry significant risk for employees.
12-16
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.
12-17
Sample Modified Scanlon Gainsharing Plan
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Employee Involvement Plans
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9 Conditions for Effective Gainsharing
1. management commitment
2. need to change or commitment to continuous
3.
4.
5.
6.
7.
8.
9.
improvement
management's acceptance and encouragement of
employee input
high cooperation and interaction
employment security
information sharing on productivity and costs
goal setting
Commitment of all involved to the process
agreement on a performance standard and calculation
that is understandable, seen as fair, and closely related
to managerial objectives
12-20
Group Incentives and Team Awards
 Group incentives measure 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.
12-21
Balanced Scorecard
Some companies design a mix of pay programs.
4 Categories of a Balanced Scorecard:
1.
2.
3.
4.
financial
customer
internal
learning and growth
12-22
Sample Balanced Scorecard
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Managerial and Executive Pay
Top managers and executives are a strategically
important group whose compensation warrants
special attention.
Some companies' rewards for executives are high
regardless of profitability or stock market
performance.
Executive pay can be linked to organizational
performance (agency theory).
Increased pressure from regulators and
shareholders to better link pay and performance.
 Securities and Exchange Commission (SEC)
12-24
Process and Context Issues
3 issues represent areas of significant company discretion
and pose opportunities to compete effectively:
Employee Participation
in Decision Making
Pay&Process:
Intertwined Effects
Communication
12-25
Matching Pay & Organization Strategy
Organization Strategy
Pay 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 potential) Below market
Above market
Benefits level
Above market
Below market
Centralization of pay decisions Centralized
Decentralized
Pay unit of analysis
Job
Skills
12-26
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.
12-27