35
How Changes in Compensation Plans Affect ' '' Employee Performance, Recruitment, and Retention: An Empirical Study of a Car Dealership* JOANNA L. Y. H O , University of California. In>ine ' • LING-CHU LEE, National Pingtung Institute of Commerce ANNE WU, National Chengchi University 1. Introduction Economic theory argues that performance-based compensation contracts increase employees' incentives to exert effort, resulting in improved performance (Baker. Jensen, and Murphy 1988; Milgrom and Roberts 1992; Prendergast 1999). Previous empirical and laboratory studies on this topic have covered various compensation schemes and examined how changes to a more performance-sensitive incentive scheme influence employees' compensation and performance (Waller and Chow 1985; Lazear 2000; Banker, Lee, Potter, and Srinivasan 2001). However, compan- ies may also switch from more to less performance-sensitive incentive schemes. For example, prior to 1992, Sears adopted a commission-based compensation sys- tem for auto repair salespersons. This compensation scheme enticed salespersons to falsely diagnose brake and alignment problems, which cost Sears $15 million in refunds and other settlement costs. Consequently, Seais discontinued tlie conmiis- sion system (DriscoU 1994). Furthermore, during the 1990s, most shoe manufacturers adopted u survival strategy by shifting from a piece-rate to an hourly-rate compensation system (Free- man and Kleiner 1998). In 2001 Fujitsu also changed its compensation system from performance-based to nonperformance-based (Tanikawa 2001 ) because under the perform anee-based system, workers tended to set goals as low as possible in order to receive raises and promotions. Surprisingly, no research has addressed the impact of changes to less performance-sensitive plans on employee performance. Our study provides evidence on how a change to a less performance-sensitive incentive scheme affects individual employee productivity and compensation.' in * Accepted by Alan Webb. We gratefully acknowledge the thoughtful and helpful cumnicnts ut twu anonymous reviewers and especially Ahm Webb (associate editor). We also acknowlcdjji: ihc help- ful comments of Rajiv Banker. Chce Chow. Mahenclra Gupla. Yuhchang Hwang. ChHsln Karutia. Thom as Lin, Taylor Randall, Jae Yong Shin, ati d workshop participants at the Paul M erage School of Business, University of California, Irvine, the International Association for Accounting Educa- tion and ReseaR'h (lAAER) World Congress oF Accounting Educators, the American Accounting

Compensation EBSCO

Embed Size (px)

Citation preview

Page 1: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 1/34

How Changes in Compensation Plans Affect ' ''•

Employee Performance, Recruitment, and Retention:An Empirical Study of a Car Dealership*

JOANNA L. Y. HO, University of Ca lifornia. In>ine ' • •

LING-CHU LEE, National Pingtung Institute of Commerce

ANNE WU, National Chengchi University

1. Introduction

Economic theory argues that performance-based compensation contracts increase

employees' incentives to exert effort, resulting in improved performance (Baker.

Jensen, and Murphy 1988; Milgrom and Roberts 1992; Prendergast 1999). Previous

empirical and laboratory studies on this topic have covered various compensation

schemes and examined how changes to a more performanc e-sensitive incentive

scheme influence employees' compensation and performance (Waller and Chow1985; Lazear 2000; Banker, Lee, Potter, and Srinivasan 2001). However, compan-

ies may also switch from more to less performance-sensitive incentive schemes.

For example, prior to 1992, Sears adopted a commission-based compensation sys-

tem for auto repair salespersons. This compensation scheme enticed salespersons

to falsely diagnose brake and alignment problems, which cost Sears $15 million in

refunds and other settlement costs. Consequently, Seais discontinued tlie conmiis-

sion system (DriscoU 1994).

Furthermore, during the 1990s, most shoe manufacturers adopted u survivalstrategy by shifting from a piece-rate to an hourly-rate compensation system (Free-

man and Kleiner 1998). In 2001 Fujitsu also changed its compensation system

from performance-based to nonperformance-based (Tanikawa 2001 ) because under

the perform anee-based system , workers tended to set goals as low as possible in

order to receive raises and promotions. Surprisingly, no research has addressed the

impact of changes to less performance-sensitive plans on employee performance.

Our study provides evidence on how a change to a less performance-sensitive

incentive scheme affects individual employee productivity and compensation.' in

* Accepted by Alan Webb. We gratefully ackno wledge the thoughtful and helpful cumnicnts ut twu

Page 2: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 2/34

168 Contem porary Accoun ting Research

addition, we examine whether employee ability affects productivity in light of the

plan change and which employee group is affected the most by such a change.

In addition to influencing employees, the compensation plan can affect com-

pany performance by influencing recruitment and retention (Stiglitz 1975; Salop

and Salop 1976; Dem ski and Feltham 1978; M ilgrom and Roberts 1992). For

example, performance-based compensation contracts can attract and retain high

performers and differentiate high from low performers (e.g.. Baron and Kreps

1999; Banker et al. 2001 ). A company benefits when lower-performing emp loyees

leave, but can suffer a setback when higher-performing employees depart. Thus, it

is important to consider who will join or leave a company when the performance

sensitivity of the compensation contract is changed. This study examines the types

of employees who are attracted to the firm, or who leave, when the compensationplan becomes less performance sensitive. In addition, we investigate causes (e.g.,

compensation loss) that may account for employee turnover.

Our study focuses on a car dealership in Taiwan that changed its compensation

scheme from totally com mission-based to a mix of fixed salary and lower comm is-

sion rates. This change was in response to the requirement of the 1998 Taiwanese

Labor Law amendment. Our database includes 4,392 individual-level observations

(e.g., em ploye es' com pensation, sales quantities, performance ratings, and dem o-

graphic information) as well as firm-level data (e.g., turnover rates, new hires, reve-nues, income) for a 56-month period. We find that the change in com pensation plan

lowered individual productivity and compensation, especially for higher-performing

employees. As predicted by theory, we also observe that the less performance-

sensitive plan attracted low performers and retained fewer high-ability performers.

Interestingly, we do not find that the decrease in individual productivity translates

into poor overall company performance. Our interviews with managers and addi-

tional analyses suggest that in light of the decreased individual sales productivity, the

company hired more employees and also changed its sales mix by giving employees

more incentives to sell cars that had higher margins and faced more competition.

Th is study adds to the extant hterature by being the first to examine the impact

of a change to a less performance-sensitive compensation scheme on low-level

employee productivity. We directly measure the impact of a plan change (i.e., from

more to less performance-sensitive) on individual productivity and the adverse

selection effects by using data both prior to and after the plan change. Prior empir-

ical work in this area tends to be experimental in nature and tests for only one of

the two effects (Young and Lewis 1995). However, in this study we are able to

examine both incentive and adverse selection effects simultaneously. Furthermore,Banker et al. (2001) examine how implementing a more performance-sensitive

Page 3: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 3/34

Employee Performance, Recruitment, and Retention 169

In our study, the availability of employee-level data before and after the plan

allows more robust conclusions about effects on employee recruiting and turnover.

Furthermore, this study goes beyond related prior studies by investigating how

employee ability affects performance when a company changes to a less performance-

sensitive cotnpensation plan. We measure employee ability by using a factor analysis

of three proxies for ability: employee annual performance rating, nutnber of cars

sold, and tbe reciprocal of time to the first promotion since the etnployee joined the

dealership. Our employee ability measure not only helps us identify specific per-

fortnance groups that are most affected by tbe compensation plan change, but also

provides additional insights into causes of employee turnover after tbe plan

cbange. Tbese findings also have practical implications because they tnay help top

management anticipate tbe effects of a cbange to a less performance-sensitivecompensation plan on incentives and efforts of different etnployee groups as well

as the effects of a change on employee recruitment and turnover.

Tbe remainder of tbis paper is organized as follows. Section 2 describes the

field site and tbe nature of the changes made in the etnployee comp ensation plan.

We develop our hypotheses in section 3. Data and empirical models are discussed

in section 4. Section 5 presents the empirical results, and section 6 summarizes our

results w itb concluding rem arks.

2. Field site

The field site we studied is the largest car dealership in Taiwan, where tbe domestic

autotnobile market has been nearly 400,000 car sales per year.^ In 2001, tbe car

dealership had 1,248 sales representatives and 87 sales outlets located throughout

Taiwan and mainland China.

The details concerning tbe field site reported in this section are based on both

interviews and archival data from the company. Our relationship witb tbe field site

allowed u.s to interview tbe chief executive officer (CEO), senior and branch manag-ers, and salespersons to get information about the compensation scheme, employee

reactions, tbe legal environment, competition, and various management-related

issues. Tn total, we spent roughly 220 hours in site visits, data collection, and con-

ducting more than 20 in-depth interviews, ranging from 50 minutes to two hours.

Eor eacb interview, we sent questions to tbe interviewees at least one week before

the meeting.

The car dealership carries various m odels of sedans and trucks and has a hetero-

geneous g roup of customers. For sedans, annual salary is a major factor in determin-

ing which model (economy versus luxury) a customer buys. However, customers

Page 4: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 4/34

170 Contemp orary Accounting Research

alternatives based on those needs. The time spent by an employee to close a deal

ranges from one week to one month, depending on experience, ability, and the type

of car being sold. In general, junior employees spend twice the amount of timeclosing a deal than senior employees, and it takes more time to sell sedans than

trucks. Furthermore, an employee handles each sale entirely by himself or herself

and does not share sales skills or customer information because he or she does not

want to risk having customers "stolen" by colleagues.

In early 1998, the Taiwanese Labor Law amendment required that, by the end

of 1998, companies pay a minimum wage (around U.S.$466 per month) for all

forms of employee-employer relationships.-^ At that time, the CEO of the field site

learned that some competitors would superficially comply with the law's require-

ment by providing a base salary while maintaining the same commission rates.However, they would potentially impose a penalty by taking away the base salary

from employees not meeting the minimum sales requirement. Family competitors

(i.e., those selling the same brand of cars) and two nonfamily competitors (i.e.,

those selling different car brands but competing for the same customer groups) did

not change their compensation contracts after the implementation of the new regu-

lation."^ The CEOs of these companies were concerned about the possible negative

impacts of a switch to a less performance-sensitive scheme on individual produc-

tivity as well as a potential loss of good employees.^ The Taiwanese governmenthas not strictly enforced all of the new regulations, and the penalty associated with

a failure to comply with the regulations is not severe. As such, most companies

would rather risk paying the noncompliance penalty than suffer a short-term loss

due to the change of compensation plan.

However, the situation is different for our field site because it is the largest

dealership in Taiwan, which makes it the most likely target for government investi-

gation to see whether the industry is complying with the law. After considering all

factors (e.g., potential government investigation and penalty, high political costs,etc.), the CEO decided not to follow competitors' actions, but instead chose to

comply with the law's requirement by adding a base salary and reducing commis-

sion rates for all levels of employees. The reason for lowering commission rates

was to keep total compensation expenses at the pre-plan change level.^ In May

1998, the field site announced the new plan, which became effective on July 1,

1998. This plan was implemented throughout the company rather than on a

regional or phased-in basis. As such, we found a unique setting to study employee

recruitment and turnover because the field site and some of its competitors useddifferent compensation plans in response to the government regulation. Further-

Page 5: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 5/34

Em ployee Perform ance, Recruitment, and Retention 171

cars every three months instead of three cars each month. This average was insti-

tuted because in Taiwan, the car industry normally performs best in January when

individuals receive their annual bonus and celebrate the Chinese new year holiday.

Conversely, the industry's worst month is August, perhaps because some Taiwanese

believe it is unlucky to conduct any major activities, including making personal

decisions such as getting married, during this period. So, for example, if an

employee sells zero, zero, and nine cars in November, December, and January,

respectively, he or she will not be terminated in February or Marcb because he or

sbe sold nine cars in January. If an employee does not attain the minimum

requirement after three months, he or she receives an initial warning and will be

terminated if bis or her performance does not improve in the following two

months.We chose this field site for three reasons: (a) tbe change in its compensation

scheme from totally commission-based to a less performance-sensitive plan (base

salary plus lower commission rates) was not voluntary, but in response to the 1998

law's requirements;^ (b) it is the largest dealership in tbe Taiwanese automobile

market, with nearly 18 percent of tbe market share over the past five years: and

(c) tbe company agreed to provide us with an extensive arcbival database containing

4.392 sales representatives and 87 branches over a 56-month period. Top manage-

ment also allowed us to review most documents and to interview managers andsales force personnel.

3 . Hypotheses development

The premise of agency theory is that a principal designs a contract to align an

agen t's actions w itb the principa l's best interests (e.g., Holmstrom 1979; Feltham

and Xie 1994; Prendergast 1999; Lambert 2001). Classic agency models bave

focused primarily on the design of performance-based contracts to motivate

employee effort (i.e.. incentive effect) (e.g.. Baker et al. 1988; Baiman 1990; Mil-grom and Roberts 1992). Also, prior studies bave suggested selection effects,

where performance-based compensation contracts can attract and retain bigh per-

formers (e.g., Milgrom and Roberts 1992; Baron and Kreps 1999; Lazear 2000;

Banker et al. 2001). Below, we discuss both tbe incentive and adverse selection

effects and the related bypotbeses to be tested.

Incentive effect

Agency theory identifies the circumstances under wbicb fixed (base salary) and

variable (comm issions and other forms such as bonuses or options) components can

Page 6: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 6/34

172 Contemporary Accoun ting Research

y ' = a + b'x, where a is base salary, b' is the new commission rate, and b' < b.

The graphical presentations of the old and new compensation contracts, C and C .

are summarized in Figure 1.

Since the company implemented the Improvement of Low Performance Plan,

an employee must sell al least nine cars every three months (or an average of three

cars each month) to remain on the job. The fixed pay under the new plan is technic-

ally not a guaranteed salary. In essence, the new plan can be thought of as consisting

of two components: "a" is paid when employees sell a minimum of an average of

three cars per month, and "Z?" is paid per unit after the employees achieve the min-

imum requirement and are paid for all the units sold. As pointed out by Demski

and Feltham 1978. the requirement of achieving a minimum number of car sales

imposes some risk on the employees as an inducement to expend some agreedlevel of effort.

Empirical studies have supported the effects of performance-based incentives

on employee behavior (e.g.. Banker. Lee, and Potter 1996; Bailey, Brown, and Coceo

1998; Lazear 2000). Banker et al. (1996) report that implementitig a performance-

based compensation plan increases sales and that the effect persists and grows over

time. Bailey et a l. (1998) find that improvem ent rates in ind ividuals' initial and over-

all performances of an assembly task are higher when an incentive plan is in place.

Similarly, Lazear (2(X)0) examines the impact of piece rates on the performance ofworkers who install auto windshields. He finds that worker output increased after

the company switched its compensation scheme from hourly wages to a piece rate

plan. Conversely, these findings suggest that if a company switches from contract

C (performance-sensitive plan) to contract C (less performance-sensitive plan ), a

lower h' may induce less effort from employees to work hard, resulting in.ï' < jc.

In light of the arguments and empirical findings that performance-based incen-

tives affect employee behavior, our first hypothesis is as follows:

Figure 1 Compensation and sales productivity under the commission-based and base

salary plus lower commission plans

Compensation (y ) Commission-based plan ( Q

Base salary pluscommission plan ( C )

Page 7: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 7/34

Em ployee Performance, Recruitment, and Retention 173

HYPOTHESIS 1. Employees ' average sales productivity (cars sold) will decrease

after the company changes its compensation plan to a less performance-

sensitive scheme.

Figure 1 shows the relationship between compensation and cars sold underboth the C and C compensation schemes. Clearly, when sales productivi tyincreases, the differences in compensation {y — y') under the two schemesincrease, which suggests that switching from compensation plan C to C will causehigher-performing employees to lose more compensation (due to lower commis-sion rates) than lower-performing employees. In light of this greater compensationloss, higher-performing employees will reallocate their efforts, expend less elfort,

and enjoy more leisure time than lower-performing employees, which will result incomparatively lower sales productivity, leading to the following hypothesis:

HYPOTHESIS 2 . The decrease in sales productivity (cars sold) of higher-performing

employees after a company chan ges to a less performance-sensitive com-

pensation scheme will be greater than that of lower-performing employees.

Adverse selection effects

Com panies design compensation schemes not only to induce more employee effortbut also to attract and retain high-potential employees (Baker et al. 1988). Adverseselection effects include recruiting and tumover effects. The former relates to tbetype of employees who join the company and the latter to the type of employeeswho leave. For example, contracts with higher piece rates attract high-abilityemployees (Lazear 2000), and adding a performance-based bonus attracts higher-ability employees (Banker et al. 2 001). Prendergast (1999) argues that compensationcontracts are an important means for a company to recruit higher-ability workers.

Employing a perfonTiance-sen.sitÍve contract will benefit high-ability workers morethan low-ability workers, resulting in an increase in the percentage of high-abilityemployees who are attracted to the com pany.

Conversely, when a company changes compensation schemes from C to C , itis likely that the guarantee of a base salary will attract lower-ability employees.Therefore, the recruiting effect suggests that the sales productivity of employeeshired after the change to contract C will be lower than that of employees hiredbefore the plan change. These aiguments lead to the following hypo thesis;

HYPOTHESIS 3. T he average sales productivity (cars sold) of employees hired

Page 8: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 8/34

174 Contemporary Accoun ting Research

that poorer performers tended to leave when pay was ba.sed on performance and to

stay wben it was not. The implication of their findings is that performance-based

compensation plans can lead to functional turnover. Lazear (2000) reports that

about one-third of improved performance can be attributed to selection effects (i.e.,

less productive workers leave the company and are replaced by more productive

workers). In Banker et al. 20 01 , results sbow that a performance-based scheme in a

retail firm attracts and retains more productive employees, while the performance

of the less productive sales staff declines before they leave.

When the company changes from a linear system to a less performance-based

system scheme with a kink — that is, a nonlinear segment in the pay-for-performance

function — it is likely to create turnover am ong employees (Jensen 2003).** Feed-

back on compensation could help employees learn how they are affected by a less

performance-sensitive compensation plan. Higher-performing employees who

continually compare tbeir compensation with past levels and outside opportunities

are likely to be dissatisfied with tbeir compensation. As discussed earlier, some of

tbe field site's competitors did not lower tbeir commission rates. It is likely that

som e unsatisfied higb-perform ing em ployees cbose to join tbese com petitors to

increase their compensation. Tb is is consistent witb Jensen 's 2003 argument tbat if

the commission rate does not sufficiently reward employees for tbeir extra effort,

the company will likely lose high performers to competing firms. Therefore, weexpect the sales productivity of employees wbo were hired under contract C and

left under contract C to be higher than that of employees wbo left before the plan

change. Regarding employees wbo were hired and left under contract C. their

departure may be attributed to either disappointment witb tbe compensation or

being forced out by the Improvement of Low Performance Plan. Because these two

groups' sales productivity may offset each other, we expect no difference in sales

productivity be tween those who were hired and left under contract C and tbose

who left under contract C. Taken together, we expect sales productivity of etnployees

who left after the change in compensation scheme from C to C to be higher than

that of employees who left before the change. We propose the foiiowing hypothesis

concerning turnover effects: i

HYPOTHESIS 4. The average sales productivity (cars sold) of employees who

leave under the ¡ess performance-sensitive compen sation scheme will be

higher than that of employees who leave u nder the performance-sensitive

compensation scheme.

Page 9: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 9/34

Em ployee Performance, Recruitment, and Retention 175

diverse distribution (i.e., the true variance is greater than the mean), we develop a

negative binominal (NB) regression model to examine the impact of the com pensa-

tion plan change on employee productivity.

The sampling period covers 97.541 person-months and 5,121 branch-monthsof data from January 1996 to April 2001 (56 months).^ We partition the sample

into two subsamples: (a) before the change to the new plan (a total of 28 months —

from January 1996 to A pril 1998),'** and (b) after the change to the new p ian

(a total of 28 months — from January 1999 to April 2001 ). The models' parameters

are estimated using pooled time-series data over a 56-month period and cross-

sectional data for the 4,392 individuals and 87 branches. Below is the NB regression

model:

-h \^^B_EMPLOY¡, + ^ÎM^,+ s¡, (1),m = I

where / = {1, ... , 4,392}. a subscript to denote employee i, í = { 1 . . . . , 56 }. a sub-

script to denote the time period in which the employee works, and ei¡ is a randomerror term. We measure employee sales productivity iIND_PROD) as the number

of cars sold per person-month. PLAN is equal to 1 if the employee was on the new

plan during the given month. Hypothesis 1 (hypothesized incentive effect on sales

productivity) is tested by examining whether the coefficient of PIAN (aj) is nega-

tive in (1). Also , to rule out the possibility that the effect on sales productivity was

due to employees' being hired at different times, we include EXPER (number of

months em ployed) as a control variable.

In the model, we also include two types of competition control variables (com -

petition type and competition intensity) to capture the general economic condi-tions. There are two types of competitors in our field site: family competitors

{FAM_COMP) and nonfamily competitors {NON_FAM_COMP). Regarding com-

petition intensity, we use CITYJSALE (i.e., total monthly sales of competitors in

the same city) as a proxy. The log forms of monthly car sales for FAM^COMP,NON_FAM_COMP, and CITY_SALE are used. We expect positive coefficients for

both FAM_COMP and NON_FAM_COMP because good economic conditions

help employees sell cars more easily, thereby increasing their productivity. How-

ever, we cannot predict the sign of CITY_SALE because it not only captures thecompetition intensity among car dealers in a specific city, but also reflects the pur-

Page 10: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 10/34

176 Contemporary Accoun ting Researcb

four control variables (FAM^COM P, NON_FAM _COM P, CITY^SALE, M„j) are atthe market level. Finally, to control for tbe impact of hiring additional salespeopleon productivity, we include a brancb-level control variable, ^B_EMPLOY (i.e., tbe

log form of number of employees in eacb month). We expect a negative sign for#B_EMPLOY because a bigher number of employees implies more intense compe-tition among tbe employees, resulting in lower individual productivity. A list ofvariable definitions is included in tbe Appendix.

Because ( 1 ) explores how the compensation plan change affects all employees,we do not include employees' ability. To examine whether the bigher-abilityemployees are more likely to be affected by the plan change, we include em ployees'ability (ABILITY) in (2).

= OQ + a^PLANi, + ßyEXPERi, +Yj, X PLAN , + Á^FAM^COMP,

11

+ ^ Í M ^ , + Si, (2).m = 1

We take three steps to measure employee ability. First, we collect differentmeasures that can capture employee ability: the annual performance rating, tbenumber of cars sold prior to tbe month of interest, and tbe reciprocal of time totbe first promotion since they joined the dealership. Gibbs (1995) argues that tbeemployee performance rating is a logical proxy for expected ability and thatexpected ability declines monotonically with tbe number of promotions employeesreceive over time. In tbe dealership, each employee is evaluated by the branchmanager annually on a four-point scale, with "4" being the best performance. Tbe

average number of cars sold reflects changes in an employee's productivity fromthe first month in whicb the em ployee joined the dealership to the preceding monthof interest. Similar to Gibbs 1995, we also use tbe reciprocal of time to the firstpromotion since tbe employees joined the dealership, as the tbird measure.Because of the high turnover rate, we do not use tbe number of promotionsemployees received over time. Second, to preserve a degree of freedom, we usefactor analysis to collapse our three measures into one variable ABILITY, whichdoes not vary between tbe pre- and post-new-plan periods." Finally, we use therank order oí ABILITY to classify employees into the following three groups:HIGH^ABIUTY (in the first quartile), MEDIUM_ABILITY (in tbe second and tbird

Page 11: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 11/34

Em ploy ee Perform ance, Recru i tment , and Retent ion 177

OldPlanQuitBefore {D^Q^ = 1 , 0 o the rwise ) : employees who jo ined the dea le r ship

before the change to the new plan and left before July 1, 1998.

OldPlanQuitAfter (D^Q^ = 1 , 0 o th e rw i s e ) : e m p lo y e e s w h o jo in e d th e d e a le r s h ip

before the change to the new plan and left after July 1, 1998 but before the end of

our sample per iod .

NewPlan {D^^^ = 1 . 0 o the rwise ) : employees w ho jo ined the dea le r sh ip af te r the

change to the new plan .

NewPlanQuitAfter {D^Q^ = 1,0 otherwise): employees who joined the dealership

after the change to the new plan and left after July I, 1998. but before the end ofour sample period.

To avoid potentially large variation in individual monthly data, we use the

moving average of sales productivity to capture trend and direction. Figure 2 dis-

plays the three-month moving average of sales productivity for different employee

types from January 1996 to April 2001. As seen in panel A of Figure 2. the average

sales productivity of the old plan is better than that of the new plan, suggesting that

the less performance-sensitive plan attracts more low performers. Furthermore,

panel B of Figure 2 shows that the average sales productivity of OldPlanQuitAfter

is higher than that of OldPlanQuitBefore, implying that more high performers left

the firm after the plan change.

To test hypothesized adverse selection effects, we specify the following NB

regressions (3) and (4):

IND_PROD¡, = «0

11

^ ^M^, + e,, (3),

m = 1

IND_PRODi, = 00 + ßiEXPERj, + r2D^Q'^ + r^D^QA -\- \yFAM_COMP,

It

^iM^^+Bi, (4).

m = 1

Page 12: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 12/34

178 Con tem pora ry Accoun t ing Resea rch

Figure 2 Sales productivity by timing of employee employm ent and tumover

Panel A: Employees by different time of employment

• SaoS

u

•S

6 -

5 -

4 -

9 _

M

OldPlan

NewPlan

~T 1 r 1 1 1 1 r 1 1 1 1 1 1 r-

-30-26-22-18-14-10 -6 -2 3 7 11 15 t9 23 27 31

Month before (-30 t o - 1 )/a fte r PLANPanel B: Em ployees by different time of tumover

7 - 1

6 -

5

2 -

1 -

- OldPlanQuitBefore

- OldPlanQuitAfter

" NewPlanQuitAfler

|Vv'\

n [ I I I I 1 1 1 1 1 \ \ 1 1 r

-30-26-22-18-14-10 -6-2 3 7 II 15 19 23 27 31

Page 13: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 13/34

Em ployee Performance, Recruitment, and Retention 179

no difference in sales productivity between NewPlanQuitAfter and OldPlanQuit-

Before. Thus, we expect that the coefficient of r^ will be greater than zero and r2

will be equal to zero. In botb (3) and (4), we do not include ABILITY, PLAN, or

tbeir interaction variable, because in these models we test only for the differencesbetween the groups (i.e.. new plan versus old plan. D^Q^ versus D^Q^, and D^^^

versus D^Q^). Because employees may have different times of employment and

departure, we also include EXPER as a control variable.

5. Results

Descriptive statistics

Table 1 summarizes the descriptive statistics of tbe key variables. Means (standard

deviations) for tbe entire period and the two subperiods are presented in panel A ofTable 1. The average num ber of cars sold per month per employee {IND_PROD) is

3.30, wbicb is slightly higher than 3. the minimum requirement under the Improve-ment of Low Performance Plan. The turnover rate per month (MTHJTURNOVER)

is 2.31 percent (or 27.45 percent per year), which is the lowest rate in the car sales

industry.'2 This high turnover rate suggests that we are able to examine adverse

selection effects. Further analysis shows that the turnover rate for employees with-

out dismissal threat is only 0.34 percent, which is similar to other industries. On

the other band, the turnover rate for employees with dismissal threat is 1.97 per-cent. Furthermore, the turnover rate increases slightly for both employee subgroups

after tbe plan change; however, the difference is statistically insignificant. Also, the

average age of employees hired under the new plan (32.88) is older than tbat under

tbe old plan (31.46).

As seen in panel A of Table 1, the average of IND_PROD under tbe new plan

(3.15) is significantly (p < 0.0001) lower tban that under the old plan (3.49), sug-

gesting tbat the change to a less performance-sensitive compensation plan decreased

individual sales productivity. Under the new plan, the fixed pay is $466 and tbeaverage commission rate is $225 (s.d. = $250). which is significantly lower than

tbat under tbe old plan (mean = $495; s.d. = $287;p < O.OOOl).'^ This shows tbat

the plan change causes a significant decline in the average monthly compensation

from $1,612 to $1,255 ($357; p < 0.0001), which can bave a significant impact on

employees' living standards.''* Furthermore, these results suggest tbat the Improve-

ment of Low Performance Plan was effective. Eor example, as seen in panel A of

Table 1, the standard deviation of IND_PROD significantly decreased (from 4.09

to 3.45; p < 0.0001) after the change in compensation plans. Also, additional data

sbow that, in general, the average sales productivity of NewPlanQ ititAfter is belowtbree cars over the 34-month period. Eurtbermore, tbe monthly employee turnover

Page 14: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 14/34

180 Con temporary Accoun ting Research

a.O

11

.1o -s

oBU

aesU

B

p

a

cnp

ion

ñ

1o• p

§

1a•aa

Xi

3 "a

i ."i— ._ ._ .5 ä•p "o 73 'S "O "5

B c e es c c—I >~ iS h3 H n

JO

Page 15: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 15/34

Em ployee Performance, R ecruitment, and R etention 181

iQ

a.•o

O

I £.

^ .2o tí

o

U

— r - o —

o — o o o o — — o t o t s m

- ' - ' " - ' l i l i l í

•— r - - r ' i ( N o o r - . ( S O v ' o o o p í N \ o o \C S Ö Ö Ö - — o o ó — r - ^ ö ö o ^ ' t ^

ä & ^ ^ ^ # ? ^ ^ ^ ^ —- - o O ' ^ O N r ^ o o ' / i i o " ' t ' C J - " t N o o o

[ I .I I

Page 16: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 16/34

182 Contem porary Accoun ting Research

Q .

•2 2

a.<

IO NO s

a.

•n"Ô

• S

u•T3C

• oO

Q .T3

5

n

1c

^ r n Ö c s Ö Ö Ö Ö Ö O Ö Ö

I I I

a

1 3

É

p «n p pO ^

m r i — — *

Page 17: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 17/34

Employee Performance, Recruitment, and Retention 183

ü

c

s

IZ

Ö

I I

•— \^ ^ 00 o

" V Ö -I: <^

TT

m o

(/5 de

„ : — 00 N£I

' _r rn rj, „• a - —

CO

Ii'

t ^

§

iiI

Ii

E

O

£o

ot n

•So

rson-

p o

c

S.a .

ned 

etess

th

1 ^

Ö

•ss

•aunto

u

;or

£0

c

O

s'S

:he

anta

c

Page 18: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 18/34

184 Contemporary Accounting Research

7.50 to 7.39) and also for nonfamily competitors (NON_FAM_COMP; from 10.01

to 9.96). Panel B of Table 1 presents tbe distribution of individual sales productiv-

ity for both the old-plan and new-plan periods. These are the actual numbers of

cars sold by the employees, including those wbo sell more than 10 cars. As shown

in panel B of Table 1. the change to a less performance-sensitive plan caused a

decrease in sales productivity. Eor example, there are more employee-montbs with

no cars sold under the new plan (24.8 percent) than under the old plan (20.1 per-

cent). However, there is a slightly higher percentage of employee-months where

three cars were sold under tbe new plan than under the old plan ( 15.7 percent versus

13.7 percent). This suggests that lower-ability employees exerted greater effort to

meet tbe minimum sales burdle to avoid job loss. Regarding the high performers,

after the plan change there was a decrease (from 20.6 percent to 17.3 percent) inthe percentage of employee-months wbere six or more cars were sold and also a

slight decrease in the employee-months where 10 or more cars were sold (from 4.5

percent to 3.4 percent). It is possible tbat lower commission rates discouraged top

employees from exerting effort.

To examine tbe impact of the plan cbange on different groups, we present

means (standard deviations) of cars sold and compensation by ability group in

panel C of Table 1. These results sbow that the new plan has a negative impact on

sales productivity for the HIGH_ABILTTY group (from 6.2 to 5.9; p = 0.051). anda positive impact on the MEDIUM_ABILnYemployees (from 3.3 to 3.4;;; < 0.00! ).

MEDIUM_ABILITY emp\oyeea may have worked harder to compensate for tbeir

loss in income due to lower commission rates. Although the average sales produc-

tivity for the LOW_ABILITY group is still less tban tbe minimum requirement of

three cars after the plan change, ii increases from 1.3 to 1.7 (/? < O.OOOI), None-

theless, all three groups have significant decreases In compensation ($518 for

HIGH_ABILITY; $303 for MEDIUM _ABIUTY; $92 for LOW_ABILITY).

Tests of incentive effects (Hypothesis i and Hypothesis 2)

Hy pothesis 1 predicts tbat em plo yee s' average sales productivity w ill decrease

after the plan cbange. Panels A and B of Table 2 show NB regression results with

individual sales productivity (¡ND_PROD) as the dependent variable. As discussed

above, we expect a negative coefficient of PLAN ( a ,) . Panel A of Table 2 (column 1)

shows that aj is negative and significant (-0.153;/) < O.OOOI).'-'^

Recall that the dealership also introduced an Improvement of Low Perfor-

mance Plan. Therefore, the overall impact of contract C on sales productivity maynot necessarily be negative because the Improvement of Low Performance Plan

Page 19: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 19/34

Employee Performance, Recruitment, and Retention 185

but it is not significantly less than zero (p = 0.0923). This suggests that the threat

of dismissal under the Improvement of Low Performance Plan does not improve

the productivity of employees with poor performance. One explanation is that indi-

vidual productivity is jointly determined by effort and skills (Demski and Feltham

1978; Gibbs 1995), and incentives do not aiways work when the tasks require skills

TABLE 2

Negative binomial regression results of hypotheses testing

(dependent variable: ¡ND^PROD')

Panel A: Test of incentive effects {Hypothesis 1 ) — The plan change decreases average

sales productivityModel 1

n

Intercept

PLANEXPER

EAMJCOMP

NON_FAM_COMP

CITY_SALE

m_EMPLOY

Goodness-of-fit (LR statistic)

p-value

Full sample

(1)

76.850

-5 .290f

-0.153+0.062t

0.023t

0.524+

0.046+

- 0 . 0 0 5

47,135

0.0001

Subsamplewithout

dismissal threat

(2)

40,082

-5.149+

- 0 . 1 3 2 t0.017+

0.02+

0.568+

0.057+

- 0 .0 3 3 *

21,961

0.0001

Subsample withdismissal threat

(3)

36,768

-4.615+

- 0 . 0 2 70.008*

0.032+

0.446+

-0.035+

0.061*

10,177

0.0001

Panel B : Test of incentive effects (Hypothesis 1) — Short-term versus long-term effects of

the plan change

Model I

Sample

n

Intercept

PLAN

EXPER

Adjustment period(from - 2 to 16 months)

62.988

- 7 . 3951 +-0.0794+

0.0701+0.025 It

Status quo period

(from 17 to 34 months)

60,915

-5.2658+

-0.1514+

0.0614+

0.0242+

Page 20: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 20/34

186 Contemporary Accounting Research

TABLE 2 (Continued)

Panel C: Test of incentive effects Hypothesis 2 (model 2 for the effects of the plan change

on employee groups with different levels of ability)Model 2

n

InterceptPLAN

ABILITY

ABIUTY*PLAN

EXPER

FAM_COMP

NON_FAMjCOMP

CITY^SALE

m_EMPLOY

Goodness-of-fit (LR statistic)/?-value

73,239

- 5 . 7 4 9 t0.225t

1.987t

- 0 . 4 2 7 t

- 0 . 0 1 3 t

O.O35t

0.495t

0.05 It

- 0 . 0 2 8 Í

26,0000.0001

Panel D: Tests of Hypothesis 3 (model 3 for recruiting effect) and Hypothesis 4 {model 4

for turnover effects)Model 3 Model 4

Sample

n

Intercept[)NEW

QNQA

OOQA

EXPER

EAMJOOMP

NON_FAM_COMP

CITY_SALE

#B_EMPLOY

Goodness-of-fit

Fullsample

(1 )

76,850- 6 . 0 8 6 t- 0 . 2 2 6 t

0.053t0.018t0.6 i Ot0.046t

-o .o i o

T\imover

samp le

(2)

3 7 , 6 7 0- I 2 . 3 6 0 t

0 .013

0.484t

0.045t

- O . O I 8 t

1.225^

0.0135

- 0 . 0 3 0 5

Turnoversamp lewi thout

re t i rementpossibi l i ty

(3 )

3 7 , 5 6 8- 1 2 . 2 9 9 t

0 .014

0.484t

0.046t

- 0 . 0 1 8 t

1.2I9Í

0.0138-0 .033§

Turnoversamplewithout

dismissalthreat

(4 )

9.534-1 0 . 0 7 8 t

0.0640.231 +

-O.O34t

-0 .00111.108t

0.014- 0 . 1 1 4 t

Page 21: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 21/34

Em ployee Performance, Recruitmen t, and Retention 187

TABLE 2 (Continued)

Notes:

* Variables are as defined in the Appendix.

t Statistically significant at or less than the 0.0001 level (two-tailed).

t Statistically significant at the 0.01 level (two-tailed).

§ Statistically significant at the 0.05 level (two-tailed).

or experience (Ashton 1990; M erchant, Van der Stede, and Zheng 200 3). Skills are

normally developed over time and cannot be changed in the short run. As such,

while the new plan may encourage employees with a threat of dismissal to exertmore effort, the increased effort may not always translate into an increase in sales

productivity if the required skills are not possessed. Furthermore, one branch man-

ager made a comment that the new compensation contract is more risky for junior

employees than for senior employees. This is especially the case for employees

who recently joined the car sales industry. Therefore, the minimum requirement for

car sales may impose more risk for poorly performing employees but it did not

improve productivity. Collectively, our results suggest that the new plan had a nega-

tive effect on employees and therefore the results support Hypothesis 1.Some studies in the organizational behavior literature indicate initial reactions

to changes in compensation plans that tend to stabilize over time (Lazear 2000).

Therefore, we also analyze the short-term (or adjustment period) versus long-term

(status quo period) effects of the change in compensation plan on individual

productivity. Specifically, we separate the sample period into two stages: initial

adjustment period ( - 2 through 16 m onths) and status quo period (17 to 34

months). As shown in panel B of Table 2, in both subperiods we observe significant

negative coefficients of PLAN (-0.0794 in the ini t ial adjustment period and

-0.1514in the status quo period).'^ These results suggest that the negative effects

of the plan change are stronger in the status quo period, which is consistent with

Banker et al. 1996, who report that the compensation plan change effect grew over

time.

Hypothesis 2 predicts that the magnitude of the negative impact of the com-

pensation plan change on sales productivity is greater for higher-performing

employees than it is for lower-performing employees. Therefore, we expect the

coefficient of ABILITY X PLAN, ßj, to be negative. As d iscussed earlier, ABILITY

is derived through a factor analysis and is a continuous variable. Panel C of Table 2shows that the coefficient oí ABILITY X PLAN has a significant (p < 0.0001 ) neg-

Page 22: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 22/34

188 Contem porary Accounting Research

than that of employees hired under the old plan.'8 in (3), we include onlyavoid potential multicollinearity problems. The average sales productivityis «o , and the average sales productivity of D^^^ is «Q -I- y ,. Th us, H ypothesis 3 is

tested by examining the following inequality: (a ^ + Ti) - «o = Ti < 0. As seen incolumn 1 of Table 2, panel D, yi is -0.226, which is significantly less than zero (atthe 0.0001 level), which suggests that sales productivity was higher for employ-ees hired under the old plan than for those hired under the new plan, thereby sup-porting Hypothesis 3.

To test turnover effects (Hypothesis 4) , we first compare the differences in thesales productivity of those who left before the change in compensation plans (Old-

PlanQuitBefore, D^QB ) with those of employees who were hired under the old plan

and left after the change {OldPlanQuitAfter, D^Q^). We expect that the coefficientof average sales productivity oíD<^Q^ («Q) will be less than that of 0^0-4 (^Q -I - ^3).In other words, jy will be greater than zero. As shown in column 2 of Table 2,panel D, 73 is 0.484 (significantly greater than 0 at the 0.0001 level).'^ Recall thatthe higher 73, the higher the chance that the dealership will lose higher-performingemployees by implementing the new plan. We then compare the sales productivityof DOQB with that of NewPlanQuitAfter (D^Q^ ) (i.e., those who were hired underthe new plan). Recall that we expect the coefficient of average sales productivities

of D^Ö^ (öQ + 72) will not be different from that of D^Öß (OQ) (i.e., 73 wü ' not bedifferent from zero). As shown in column 2 of panel D, 73 (0.013) is not signifi-cantly greater than zero.

Employee tumover may not be caused by disappointment with the compensa-tion plan change, but instead by retirement or threat of dismissal. While dismissalis related to poor performance, retirement is not. Furthermore, after working for 25years employees can decide when they want to retire, but dismissed employees areforced to leave immediately after they receive the dismissal notice. Thus, to rule

out the possibility that our tumover results may be confounded by employee retire-ment and threat of dismissal, we conduct two additional analyses to measure thesepotential effects on tumover. O ur interviews with m anagers indicate that employ-ees can receive all retirement benefits if they serve tbe company for 25 years. Tbeycan receive partial retirement benefits if they serve the company at least 10 years.Because the company was established in 1975, fewer than five employees were eli-gible to receive full retirement benefits in 2001. Therefore, we use employee tenureof more than 10 years as a proxy for possible retirement to further separate tbesample. As seen in column 3 of panel D , the results for the tumover sam ple w ithout

retirement possibility are similar to those of the entire tumover sample. Specifically,73 is positive and significant (0 .484;/^ < O .O O O i) and 72 (0.014) is not significantly

Page 23: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 23/34

Employee Performance, Recruitment, and Retention 189

Also, the new compensation plan may force lower-performing employees to leave

due to tbeir lack of ability and experience. To examine the effects of compensation

loss (COMP_LOSS) and an em ployee's experience (EXPER) and ability (ABILITY)

on employee departures, with and witbout the threat of dismissal, we ran logitregression models separately for tbese two employee groups. COMP_LOSS is the

difference between the average new com pensation minus the average old com pen-

sation, divided by the average old compensation. Therefore, we only include

employees who joined the dealership in the old plan and separate them into two

groups : employees wi tb and wi thout d i smissa l th rea t . Also , we inc lude

0B_EMPLOY, a brancb-level variable, because a higher number of employees

enhances the intensity of competition among the employees, which may increase

tbe l ikel ihood of employee turnover. As such, we expect a posi t ive sign ofm_EMPLOY.

Table 3 summarizes tbe logit regression results. Model A shows that wben

employees face a threat of dismissal, their departure decisions are not influenced by

compensation loss but their level of experience does matter (-0.392; p < 0.0001).

Conversely, as seen in model B, departure decisions by em ployees who are not facing

the threat of dismissal are affected by botb compensation loss (-2.329; p < 0.0(X)1 )

and experience (-0.252; p < 0.0001).

In sum, our additional analyses provide deeper insights into H ypothesis 4. Thehigher average sales productivity of employees who leave under tbe new plan ver-

sus the old plan is attributable more to the departure of high-ability employees

because of greater compensation loss than to the departure of employees witb less

experience and lower ability.

TABLE 3

Results of logit regression of employee turnover (dependent variable: LEFT)

Model A Model B

w ith dismissal withou t dismissal

threat threat

Intercept

COMF_LOSS*EXPER

291 (LEFT =

80 (LEFT =

1.232

- 0 . 1 5 9- 0 . 392*

1)

0)

1 4 9 ( L £ / T =

472 (LEFT =

- 1 . 0 8 2

- 2 . 3 2 9 '- 0 . 2 5 2 "

1)

0)

Page 24: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 24/34

190 Contem porary Accou nting Research

Additional analysis of the impact of the change in compensation plan oncompany overall performance

An optimal compensation contract needs to balance the benefits of increased firm

performance resulting from additional employee efforts and the compensation costsincurred (Abowd 1990, 55). As discussed earlier, the change to a less performance-

sensitive compensation plan hurts individual sales productivity. Nonetheless, the

decreased individual sales productivity may not result in lower overall company

performance. This change occurs because the new compensation plan may bring

cost savings, and management may take actions to mitigate the negative impact of

decreased individual sales productivity (e.g., hiring more workers). Due to the lack

of data, prior research has focused on individual effort and pay perfonnance (e.g.,

Banker et al. 2001) and also assumed a positive relationship between individualproductivity and company performance (e.g., Lazear 2000). Because we were able

to gain access to data at both individual and division levels, we also investigated

the relationship between individua! productivity and overall company performance.

To study that relationship, w e collected additional company-level performance

(PERFORM) data as follows: revenues (REVENUE), gross profits (GS_PROFIT),income before headquarter expenses allocation (INCOME), and number of cars

sold (CAR_SOLD). To control for possible infiation over the sample period, all

financial performance variables are deflated by the monthly consumer price indexin Taiwan. Also, we include two comp etition-type control variables (FAMjCOMPand NON_FAM_COMP), the number of emp loyees at the field site (i^F_EMPLOY),and sales mix of sedans versus trucks (SALES_MIX) to capture the general eco-

nomic condition. Our model is:

PERFORM, = «0 + (XiPLAN, + \^FAM^COMP, +

II

+ ÁiSALES_MIX, + X^#F_EMPLOY, + V ^A i^ , + e, (5).

HI = I

Table 4 summarizes the regression results. None of the coefficients for PLANis significantly less than zero (except for CAR_SOLD), suggesting that the change

in compensation plan does not negatively affect overall company performance. To

shed light on why the negative effects of the plan change on individual productivity

did not translate into poor company performance, we interviewed two branch man-

agers. One manager attributed the lack of negative impact on the company's overall

performance to hiring more employees and lower compensation costs. His explan-ation is consistent with our finding that on average there is a 7.81 percent increase

Page 25: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 25/34

Em ployee Performance, Recruitment, and Retention 191

Other possible explanations for the lack of negative impact on company per-formance include change in sales mix, more effort by etnployees leading to highercustomer satisfaction ratings, and more repeated sales. Branch managers suggested

that sales mix can be measured either by type of car (i.e.. high-margin sedans versuslow-margin trucks) or by exclusive versus nonexclusive cars. Exclusive cars arethose that can be sold only by the field site and nonexclusive cars are those that canbe sold by both the field site and family competitors. In general, compared withexclusive cars, nonexclusive cars have higher profit margins and more intense com-petition. The managers we interviewed mentioned that in response to different levelsof competition, the field site has significantly lowered the commission rates forexclusive cars but not for nonexclusive cars. However, the company only had sales

data on exclusive and nonexclusive cars from September 1997 to April 2001.Results (not tabulated) based on these limited data show that the plan change causeda significant increase in sales of nonexclusive cars (from 40.71 percent to 50.24percent; p < 0.001). This increase suggests that employees allocated more effort toselling higher-margin and m ore competitive nonexclusive cars under the new plan,which mitigates the loss resulting from selling fewer cars. Regarding the sales mixof sedans and trucks, our additional analyses (not tabulated) show that the percent-age of sedans did not change significantly (from 73.43 percent under the old planto 72.55 percent under the new plan;/? = 0.2547) during this sample period.

TABLE 4Regression results at the company level (n— 64)*

Dependent variablet

InterceptPLAN

FA M COMP

NON FAM COMP

SALES MIX

F EMPLOY

Adjtisted R~

CAR SOLD

(1 )

-30 ,084*- 4 6 5 Í Í

153,5lli

-7 . 7 0 13*

0.902

REVENUE

(2)

- 57 . 395*2.956

2.568*56,182*

-49 ,60758*

0.877

GS PROFiT

0)

-37.0485- 4 3 6

215"3,1741,481

0.665

INCOME

(4J

-5 . 6 1 1-3.52

44385

- 2 , 2 7 02

0.354

Notes :

We carry out the Diirbin-Watson fDW) test for AR 1 — that is, first-order serial

correlation. Our results show that DW is close to 2, and there is no serious first-order serial correlation. Also, we find that all variance inflation factors at^ less

Page 26: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 26/34

192 Contemporary Accoun ting Research

6. Concluding remarks

Because of a lack of access to objective, individual-level performance data, prior

empirical studies of compensation schemes have been limited in their ability to fur-

ther our knowledge of how an incentive plan affects employees' selection of

employment and effort level (Banker et al. 2001). In this study, we have used data

at both the individual and company levels to empirically test how a company's

change to a less performance-sensitive compensation plan affected employee per-

formance, recruitment, and retention. Our empirical results support predictions based

on econom ic theory that a change to a less performance-sensitive com pensation

scheme reduces individual sales productivity but not overall company performance.

Consistent with Banker et al. 1996, we also observe that the negative impact of the

plan change on individual productivity was higher in the status quo period than inthe adjustment period. Furthermore, our findings suggest that while lower com mis-

sion rates reduce the incentive for employees to work hard after meeting the mini-

mum requirement, the hurdle rate motivates some employees to exert more effort to

avoid losing their job s. In addition, we found that lower-performing em ploye es

were attracted to the company while fewer high performers were retained.

This study also extends prior research by investigating the employee groups

most affected by the change to a less performance-sensitive plan. As predicted, we

find that higher-performing employees were affected more than lower-performingemployees. These findings suggest that managers should anticipate the impact of

alternative compensation plans on the efforts of different employee groups (e.g..

ones with different levels of ability). As such , top management may need to refine

the compensation contracts or take various actions to mitigate potential dysfunc-

tional impacts.

Furthermore, our results support the recruiting effect; that is, the average sales

productivity was higher for those hired under the old plan than for those hired

under the new pian. Our results also support the turnover effect. We find thatemployees who were hired under the old plan and quit after the plan change had

higher average sales productivity than those who left before the plan change. How-

ever, we find no significant difference in sales productivity between those who

were hired and left under the less performance-sensitive plan and those who were

hired and left before the change. Results from additional analyses show that turn-

over occurs either when employees experience higher compensation loss or have

less experience and poor performance, causing them to fail to meet the minimum

requirement of productivity. These results may help management anticipate that

employees with certain characteristics will be more likely to leave if the compensa-

Page 27: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 27/34

Em ployee Performance, Recruitment, and Retention 193

to sell higher-margin, more competitive nonexclusive cars. However, why the

increased sales mix of higher margin cars did not increase the company's overall

revenue is an open question. Although we find an increase in the proportion of

high-margin cars being sold, the total num ber of cars sold decreases significantlyafter the change to the new plan. As such, the increase in revenues due to a favor-

able sales mix change may have been offset by the decrease in the number of cars

sold, resulting in no change to the com pany 's overall revenue.

Although our study has advanced the understanding of tbe effects of perfomiance-

based incentive schemes, it is important to recognize some limitations. First, due to

the lack of nonfinancial measures (e.g., customer surveys) at the field site, we can-

not measure other goals for employees to achieve and therefore bave to limit our

analyses to sales productivity and compensation. Second, like prior studies onchanges of incentive schemes (e.g.. Banker et al. 1996; Lazear 20(X); Banker et al.

2001; Brickley and Zimmerman 2001), our analysis was restricted to a large data

set from one organization. Therefore, our results may have low generalizability to

otber organizations and contexts. Finally, although we have included both com petitor

performance and local competition intensity in our m odels, we do not have informa-

tion about the competitors' strategy, which may have also affected the performance

of our field site.

To shed more light on the change to a less performance-sensitive plan, futurestudies could examine optimal contracts for employees with different levels of

ability. Our results show that the change to a less performance-sensitive compensa-

tion scheme has a greater negative impact on tbe productivity of high-ability

employees and that tbe threat of dismissal does not improve the productivity of the

poorest performers. Future studies could examine tbe best incentive schemes when

companies are under different competitive circum.stances. For example, what are

the benefits and costs associated with different types of contracts (e .g., higher fixed

salary associated with a higher hurdle; same fixed salary with higher commission

rates)? Finally, worker heterogeneity (i.e., workers with different skill levels) com-monly exists, and companies may use team-based compensation plans to motivate

employees to share their knowledge (Hamilton, Nickerson, and Owan 2003). As

such, future studies could investigate bow team-based compensation plans can reap

the benefits of worker heterogeneity by motivating higher-ability workers to teach

lower-ability workers how to deal with customers more effectively, thereby

improving their performance.

Page 28: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 28/34

194 Contem porary Accounting Research

APPENDIX

Variable definitions

Variables Definition

ABIUTY

AGE

CARJSOLD

C¡TY_SALE

COMMISSIONJiATE

COMPENSATION

COMP_L0SS

zyVEW (NewPlan)

D^Q^ (NewPlanQuitAfter)

DOLD (OldPlan)

DOQA {OldFlanQuitAfter) =

DOQB (OldPlanQuitBefore) -

EXPER

FAM COMP

FIXED_PAY

GS_PROFIT

HIGHJiBIUTY

= employee's ability

= average age of employee

= number of cars sold per month

= log of monthly market sales of local com petitors. The

hranch and its local comp etitors are located in the same

city

= the dollar comm ission per car

= compen sation per person-month

= (the average compensation after the new plan - the

average compensation before the new pian)/the average

compensation before the new plan

= an employee w ho joined the dealership after the new plan

= anemployee who joined the dealership after the new plan

and who left the dealership after July 1, 1998 and beforethe end ofotir sample period

= an employee who had joined the dealership before the

change to the new plan (July 1. 1998)

= an employee w ho joined the dealership before the change

to the new plan and who left the dealership after July 1,

1998 and before the end of our sample period i

^ an employee who had joined the dealership before the

change to the new plan and left before July I. 1998

= number of years given employee had been employed

= log of monthly m arket sales of family com petitors that sell

the same brand of cars

= fixed salary per person-month

= gross profit per month

= a dummy set equal to 1 if em ployees' ability is in tbe first

quartile

Page 29: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 29/34

Em ployee Perform ance, Recru itment, and Retention 195

APPENDIX (Continued)

Variables Definition

LOW_ABIUTY

MARKET_SHARE

MEDWMJiBlLlTY

MTH_TURNOVER

NON_FAM_COMP

PERFORM

PLAN

REVENUE

SALES_MIX

m_EMPLOY

#F EMPLOY

- a dummy set equal to 1 if employ ees' ability is in the

fourth quartile

= market share in Taiwan car market

= a dumm y set equal to 1 if employees' ability is in the

second and third quartiles

^ turnover rate per month

= log of monthly market sales of nonfamily com petitors that

sell different car brands but comp ete for the same cu stomergroups

= company-level performance

= a dumm y set equal to 1 if the emp loyee is on the new plan

during given month

= revenue per month

= sales mix of sedans versus trucks

= log of monthly head count of employees in a branch, notincluding the administrative staff

= log of monthly head count of employees in the company

Endnotes1. We use the term "less performance-sensitive plan" because the comm ission under the

new plan is lower for each car sold, which is generally the case for employees whose

productivity is far greater than the required m inimum num ber of cars sold each m onthand who have a low risk of falling below the minimum threshold.

2. Quantities of sale are 361,615, 374,955 , 394,160, 357,63 4. and 350,461 from 1996 to

2000, respectively (source: Taiwanese D irectorate General of H ighwa ys).

3. For presentation purposes, throughout the paper we have converted Taiwanese do llars

to U.S . dollars with an exchange rate of 34 to 1.

4. According to the CEO , family co mpetitors m ake up the major com petition. In Taiwan,

the top five car brands (i.e., Toyota, Mitsubishi, Nissan, Ford /M azda , and Honda) have

more than 80 percent of the market share, and each car manufacturer has at least twodealerships.

Page 30: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 30/34

196 Con temporary Accoun ting Research

learning about new cars and recruiting new customers and also incur an opportunity

cost of lo.sing existing custom ers w ho are loyal to the car brand of the field site. The

third employment alternative is to work for noncar industries such as real estate and

life/product insurance. Although employees can use their general sales skills, they need

to invest a tremendous amount of time learning about new products and new industries.

6. At that time (before the implem entation of the new compensation plan), fewer than

three cars were sold in 45.2 percent of the em ployee-m onths (i.e., no cars were sold in

20.1 percent of the employ ee-months; one car in II .3 percent of employee-months;

and two cars in 13.8 percent of emp loyee-m onths). Because fewer than three cars were

sold in almost half of the employee-months, the total compensation costs will increase

dramatically if the company were to pay a base salary on top of the old (higher)

commission rates. Therefore, to control total compensation costs, the CEO decided tolower the commission rates.

7. The field site was forced to include fixed pay by governm ental regulation. As a result,

this plan was implemented throughout the company rather than on a regional or

phased-in basis, which can avoid po tential selection bias of employee s with specific

risk preferences choosing to work for different regions or branches. In addition , as

discussed earlier, som e of the field site's competitors did not lower their com mission

rates, which also allows us to examine how the change in compensation plan affects the

retention or turnover of em ployees with different ability levels.8. As shown in Figure 1, there is a kink at the minimum requirement in the new con tract

( C ) . Specifically, employees receive a base salary before they reach the minimum

requirement but are paid additional commission after the minimum requirement is met.

9. The company did not have a com plete data set available until January 1996. To make the

monthly data covered in the two subsam ples equal, we only include data up to April 2001 .

10. We exclude eight months (May to December) in 1998 from our sample for two

reasons. First, we want to avoid a possible man ipulation of the sales timing . There w ere

two months between the announcement date of the new plan (MayI )

and the effectivedate (July 1 ). During these two months, in light of the future decrease in commission

rates, it is likely that some employees boosted sales to earn higher compensation.

Second, we controlled for possible seasonal-month-sales effects.

11. The eigenvalues of these three factors are 1.77, 0.85, and 0.38 . Following Ka iser's

1960 rule (i,e., eigenvalue greater than un ity), we use factor 1 as the ability proxy. The

factor loadings for the number of cars sold, employee annual performance rating, and

reciprocal of time to the first promotion since he or she joined the dealership are 0.8719.

0.8416, and 0.5516. Including the number of cars sold prior to the month of interest may

confound our measu re of ability because the new plan results in lower productivity.

Therefore, we ran a robustness check excluding the number of cars sold prior to the

Page 31: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 31/34

Em ployee Performance, Recruitmen t, and Retention 197

— that is. b> b' + alx for x > 3 cars. Recall that b {b') is the average com mission

rate under the old (new) plan, x is the number of cars sold, and a is fixed salary. As seen

in Table 1, 6 is $495 , b' is $225, and a is $466. Therefore, an employee w ho sells three

cars receives an average compensation rate of $495 under the old plan, but reeeives alower compensation of $380 ($225 + $46 6/3 ) under the new plan. Similarly, an

employee who sells 10 cars receives an average compensation of $495 per car under

the old plan, but receives only $271.6 ($225 -\- $466/10) under the new plan. As such,

our assumption that all employees receive lower compensation rates under the new

plan is supported.

14. According to the D irectorate G eneral of Budget, Accounting and Statistics of

Executive Yuan in Taiwan, the average national income per capita in Taiwan from 1996

to 2001 is $12,292. The national income per capita from 1996 to 2001 is $12,418,$12,707, $11,522, $12,324, $13,090, and SI 1,692, respectively. The decline in the

average annual incom e per capita at our field site during this period is 35 percent

($357*12/$12,292).

15. Because of repeated observations on the same set of cross-section units (Johnston and

Dinardo 1997, 388), Hypothesis 1 can also be tested by examining w hether a , is

negative in panel data with the employee fixed effects model. We observe qualitatively

similar results by using panel data with tixed effects.

16. We cannot directly compare the coeffieients for PLAN betvi-een the adjustment and the

status quo periods because they are estimated in two different regressions. Therefore,

we include the two proxies (PLAN_Adjustment and PLAN_ StatusQuo) in one

regression and then use an F-test to compare the two coefficients. Our results show that

the coefficient on the status quo period (-0.1237,;? < 0.0001) significantly (p =

0.0036) differs from that on the initial adjustment period (-0.0736./) < 0.0001).

17. To test the robustness of (2), we also use dummy variables for ability (i.e., classifying

employees into HIGHjKBlUTY, MEDIUM_ABILITY, or LOW_ARIUTY group).

Compared with the LOW_ABlLny group, the plan change had a significantly higher

negative impact on the MEDlUM_ABILnY group (the coefficient of

MEDWM_ABIUTY X PLAN is - 0 . 5 4 3 ; / ; < 0.0001) and on the HIGH_ABILITY

group (the coefficieni of HIGH_ABILITY X PL\N is -0.736;/) < 0.0001).

18. The fixed-effects model using panel data is not feasible for testing adverse selection

effects because there was a high em ployee turnover rate, with som e employe es leaving

the dealership and new entrants joining the tirm at the same time.

19. We also include the coefficient of variation of sales to control for a possible effect of

unstable sales over time on employee turnover. We find similar results tbat y^ is 0.486

(significantly greater than Oat the 0.0001 level) and 72 is 0.012 (not significant atconventional levels).

Page 32: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 32/34

198 Con temporary Accoun ting Research

Bailey C , L. Brown, atid A. Coceo. 1998. The effects of monetary incentives on worker

learning and performance in an assembly task. Journal of M anagement Accounting

Research 10: 119-31 .

Baiman, S. 1990. Agency theory in managerial accounting: A second look. Accounting,

Organizations and Society 15 (4): 3 4 1 - 7 1 .

Baker, G. P., M . C. Jensen, and K. J. M urphy. 1988. Com pensation and incentives: Practice

vs. theory. The Journal of Finance 43 (3) : 593 -616 .

Banker, R. D., S. Lee, and G . Potter. 1996. A field study of the impact of a performance-

based incentive plan. Journal of Accounting and Economics 21 (2): 195-226.

Banker, R. D., S. Lee, G. Potter, and D . Srinivasan. 2001. An empirical analysis of

continuing improvements following the implementation of a performance-based

compensation plan. Journal of Accounting and Econom ics 30 (3) : 31 5-5 0.Baron , J. N., and D. M. Kreps. 1999. Strategic human resources — Frameworks for general

managers. New York: John Wiley & Sons.

Brickley, J. A., and J. L. Zimmerman. 2001. Changing incentives in a multitask

environment: Evidence from a top-tier business school. Journal of Corporate Finance

1 (4) : 367 -96 .

Cam eron. A. C . and P. K. Trivedi. 1998. Regression analysis of count data. New York:

Cambridge University Press.

Demski, J., and G. Feltham. 1978. Economic incentives in budgetary control systems. TheAccounting Review 53 (2): 33 6-5 9.

Driscoll, P. A. 1994. Sears to link incentives for auto service sales to customer satisfaction.

Marketing News 28 (8): 8.

Feltham, G., and J. Xie. 1994. Performance measure congruity and diversity in multi-task

principal/agent relations. The Accounting Review 69 (3) : 42 9- 53 .

Freeman, R. B., and M . M. Kleiner. 1998. The last American shoe manufacturers: Changing

the method of pay to survive foreign competition. Working paper. National Bureau of

Economic Research.

Gibbs, M. 1995. Incentive compensation in a corporate hierarchy. Journal of Accounting

and Economics 19 (2-3 ) : 247 -77 .

Greene, W. H. 200 0. Econometric analysis. Upper Saddle River, NJ: Prentice Hall.

Hair, J., R. Anderson, R. Tatham, and W. Black. 1998. Multivariate data analysis, 6th ed.

Upper Saddle River, NJ: Prentice Hall.

Hamilton, B. H., J. A. Nickerson. and H. Owan. 2003. Team incentives and worker

heterogeneity: An empirical analysis of the impact of teams on productivity and

participation. Journal of Political Economy 111 (3): 46 5- 97 .

Hoilenbeck, J. R., and C R. W illiams. 1986. Tum over functionality versus tumover

frequency: A note on w ork attitudes and organizational effectiveness. Journal of

Page 33: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 33/34

Em ployee Performance, Recruitmen t, and Retention 199

Kaiser. H. F. 1960. The application of electronic com puters to factor analysis. Educational

and P sychological Measure 20 (1): 1 41 - 51 .

Lambert, R. A. 200 1. C ontracting theory and accounting. Joumal of Accounting and

Economics 32 (1-3 ) : 3 -8 7 .

Lazear, E. P. 2000 . Performance and productivity. American Economic Review 90 (5):

1346-61.

Long, J. S, 1997. Regression models for categorical and limited dependent variables.

Advanced quantitative techniques in the social sciences. Thousand Oaks, CA: Sage.

Maddala, G. S. 1992. Introductions to econometrics. Englewood Cliffs, NJ: Prentice Hall

Intemational.

M erchant. K. A .. W. A. Van der S tede. and L. Zheng . 2003. Disciplinary constraints on the

advancement of knowledge: The case of organizational incentive systems. Accounting.Organizations and Society 28 (2-3 ) : 251 -86 .

Milgrom, R, and J. Roberts. 1992. Economics, organization and management. Englewood

Cliffs, NJ: Prentice Hall.

Rrendergast, C. 1999. The prov ision of incentives in firms. Joumal of Economic Literature

37( 1 ): 7 - 63 .

Salop, J., and S. Salop. 1976. Self-selection and turnover in tbe labor market. Quarterly

Journal of Economics 90 (4): 619- 27 .

Stiglitz, J. 1975. Incentives, risk, and inform ation: N otes toward a theory of hierarchy. Bell

Joumal of Economics 6 (2): 552 -79 .

Tanikawa, M. 2001. Fujitsu decides to backtrack on performance-based pay. New York

Times, late ed., East coast, Marcb 22, W.I.

Waller, W. S., and C. W. Chow. 1985. The self-selection and effort effects of standard-based

employment contracts: A framework and some empirical evidence. The Accounting

Review 60 (3): 45 8- 76 .

W illiams. C. R., and L. P. Livingstone. 1994. Another look at the relationship between

[jerformance and voluntary turnover. Academy of Management Journal 37 (2): 26 9-9 8.

Young, S. M .. and B . Lew is. 1995. Experim ental incentive-con tracting research in

management accounting. In Judgment and Decision-Making Research in Accounting

and Auditing, eds. R. H. Ashton and A. H, Ashton, 5 5 - 7 5 . New York: Cambridge

University P ress.

Page 34: Compensation EBSCO

8/3/2019 Compensation EBSCO

http://slidepdf.com/reader/full/compensation-ebsco 34/34