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Human resource management gaining a competitive advantage 2014 chapter 12

• Organizations have a relatively
large degree of discretion in
deciding how to pay.
• Each employee’s pay is based
upon individual performance,
profits, seniority, or other factors.
• Regardless of cost differences,
different pay programs can have
very different consequences for
productivity and return on

How Does Pay Influence Individual
Three different theories help explain compensation’s effects:

Reinforcement Theory

Expectancy Theory

Agency Theory


How Does Pay Influence
Individual Employees?
• Reinforcement Theory - A response followed by
a reward is more likely to recur in the future.
• Expectancy Theory - Motivation is a function of
valence, instrumentality, and expectancy.
• Agency Theory -The interests of the principals
(owners) and their agents (managers) may no
longer converge.
– Types of agency costs include:
• perquisites
• attitudes towards risk
• decision-making horizons


Agency Costs
• Agency costs may be minimized by the
principal choosing a contracting scheme that
helps align the interests of the agent with the
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

Programs for Recognizing
Employee Contributions
• Programs differ by payment method, frequency of
payout, and ways of measuring performance.
• Potential consequences of such programs are
performance motivation of employees, attraction of
employees, organization culture, and costs.
• Contingencies that may influence whether a pay program
fits the situation are management style, and type of work.

Merit Pay

Incentive Pay
Profit Sharing

Gain Sharing


Merit Pay
• Merit pay programs link performanceappraisal ratings to annual pay
• A merit increase grid combines an
employee’s performance rating with
the employee’s position in a pay range
to determine the size and frequency of
his or her pay increases.
• Some organizations provide guidelines
regarding the percentage of
employees who should fall into each
performance category.

Merit Pay
• Edward W. Deming, who is a critic of merit pay,
argues that it is unfair to rate individual
performance because "apparent differences
between people arise almost entirely from the
system that they work in, not the people
• Criticisms of merit pay include:
– The focus on merit pay discourages teamwork.
– The measurement of performance is done unfairly
and inaccurately.
– Merit pay may not really exist.


Individual Incentives
• Individual incentives reward individual performance,
but payments are not rolled into base pay, and
performance is usually measured as physical output
rather than by subjective ratings.
• They are relatively rare because:
– Most jobs have no physical output measure.
– There are many potential administrative problems.
– Employees may do what they get paid for and nothing
– They typically do not fit in with the team approach.
– They may be inconsistent with organizational goals.
– Some incentive plans reward output at the expense of
quality or customer service.


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.
– 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 to
top management decisions over
which they have little control.


• 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
• Employee stock ownership plans (ESOPs) are
employee ownership plans that give employers certain
tax and financial advantages when stock is granted to
– ESOPs can carry significant risk for employees.

• Gainsharing programs offer a means of
sharing productivity gains with employees,
and are based on group or plant
performance that does not become part of
the employee’s base salary.
• Conditions that should be in place for
gainsharing to be effective include:
– management commitment
– a need to change or a strong commitment to
continuous improvement
– management's acceptance and encouragement
of employee input

• Conditions that should be in place for
gainsharing 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 the
process of change and improvement
– agreement on a performance standard and
calculation that is undesirable, seen as fair,
and closely related to managerial objectives

Group Incentives and Team
• Group incentives tend to
measure performace in
terms of physical output
• Team award plans may use
a broader range of
performance measures.
• Drawbacks are that
individual competition may
be replaced by competition
between groups or teams.

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


Managerial and Executive Pay
• Top managers and executives are a strategically
important group whose compensation warrants
special attention.
• In some companies rewards for executives are high
regardless of profitability or stock market
• 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
– The Securities and Exchange Commission (SEC)


• Great Britain 3-1
• Japan 7-1
• USA 450 -1


Process and Context Issues
Three issues represent areas of significant company
discretion and pose opportunities to compete effectively:

Employee Participation
in Decision Making

Pay and Process:
Intertwined Effects



Matching Pay Strategy and
Organization Strategy

Organization 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

Above market
Below market
Above market

Below market
Above market
Below market


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