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Learning Objectives

After reading this chapter, you should

be able to: Discuss how pay influences individual

employees and describe three theoriesthat explain the effect of compensationon individuals.

Describe the fundamental pay programsfor recognizing employees contributionsto the organizations success.

List the advantages and disadvantagesof the pay programs.

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Learning Objectives

After reading this chapter, you should

be able to: Describe how organizations combine incentive

plans in a balanced scorecard. Discuss issues related to performance-based

pay for executives.

Explain the importance of process issues suchas communication in compensation

management.

List the major factors to consider in matchingthe pay strategy to the organizations strategy.

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Introduction

Organizations have a relatively

large degree of discretion in

deciding how to pay.

Each employees pay is basedupon 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.

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How Does Pay Influence IndividualEmployees?

Three different theories help explain

compensations effects:

Reinforcement Theory

Agency TheoryExpectancy Theory

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How Does Pay InfluenceIndividual Employees?

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

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

Agency Theory -The interests of the principals(owners) and theiragents (managers) may nolonger converge.

Types of agency costs include:

perquisites attitudes towards risk

decision-making horizons

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Agency Costs

Agency costs may be minimized by theprincipal choosing a contracting schemethat helps align the interests of the agent

with the principal's own interests. The type of contract depends partly on

the following factors: risk aversion

outcome uncertainty job programmability

measurable job outcomes

ability to pay

tradition

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Programs for RecognizingEmployee Contributions

Programs differ by payment method, frequency ofpayout, and ways of measuring performance.

Potential consequences of such programs areperformance motivation of employees, attraction of

employees, organization culture, and costs. Contingencies that may influence whether a pay

program fits the situation are management style, andtype of work.

Merit Pay Incentive Pay

Gain Sharing Ownership

Profit SharingSkill-based

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Merit Pay

Merit pay programs link performance-

appraisal ratings to annual pay

increases.

A merit increase grid combines anemployees performance rating with

the employees 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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Individual Incentives

Individual incentives reward individual performance,but payments are not rolled into base pay, andperformance is usually measured as physical outputrather 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 nothingelse.

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 ofquality or customer service.

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Profit Sharing

Underprofit sharing, payments are

based on a measure of organization

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 drawback is that workers may

perceive their performance has little

to do with profit but is more related totop management decisions over

which they have little control.

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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 ofsharing productivity gains withemployees, and are based on group or

plant performance that does not becomepart of the employees base salary.

Conditions that should be in place forgainsharing to be effective include:

management commitment a need to change or a strong commitment tocontinuous improvement

management's acceptance andencouragement of employee input

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Gainsharing

Conditions that should be in place forgainsharing to be effective include: high levels of cooperation and interaction

employment security information sharing on productivity and costs

goal setting

commitment of all involved parties to theprocess of change and improvement

agreement on a performance standard andcalculation that is undesirable, seen as fair,and closely related to managerial objectives

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Group Incentives and TeamAwards

Group incentives tend to

measure performace in

terms of physical output

Team award plans may usea broader range of

performance measures.

Drawbacks are that

individual competition may

be replaced by competition

between groups or teams.

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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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Managerial and Executive Pay

Top managers and executives are a strategically

important group whose compensation warrants

special attention.

In some companies rewards for executives arehigh regardless of profitability or stock market

performance.

Executive pay can be linked to organizational

performance (from agency theory).

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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Process and Context Issues

Three issues represent areas of significant

company discretion and pose opportunities to

compete effectively:

Employee Participation

in DecisionMaking

Communication

Pay and Process:

Intertwined Effects

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Matching Pay Strategy andOrganization Strategy

Pay Strategy Dimensions

Risk sharing (variable pay)

Time orientation

Pay level (short-run)

Pay level (long-run potential)

Benefits level

Centralization of pay decisions

Pay unit of analysis

Concentration

Low

Short-term

Above market

Below market

Above market

Centralized

Job

Growth

High

Long-term

Below market

Above market

Below market

Decentralized

Skills

Organization Strategy