Human Resource Management: Gaining a Competitive Advantage Chapter 12 Recognizing Employee Contributions with Pay McGraw-Hill/Irwin Copyright © 2010 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 the importance of process issues such as communication in compensation management  List major factors in matching pay strategy to the 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 Theories Explain Compensation’s Effects: Reinforcement Theory Expectancy Theory Agency Theory 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, instrumentality, and expectancy Agency Theory- interests of the principals (owners) and their agents (managers) may nolonger converge 12-6 Agency Costs Agency costs may be minimized by the principal choosing a contracting scheme that alignsagent’s interests with principal's interests 6 Factors that Influence Type ofContract: risk aversion outcome uncertainty job programmability measurable job outcomes ability to pay tradition 12-7 Programs Recognizing Contributions  Programs differ by payment method,payout frequencyand 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 Merit Pay Incentive Pay Profit Sharing Skill-based Gain Sharing Ownership 12-8 Merit Pay Merit pay programs link performance-appraisal ratings to annual pay increases A merit increase grid combines an employee’s performance rating with the employee’s position in a pay range to determine the size and frequency of his or her pay increases Some organizations provide guidelines regarding percentage of employees who should fall into each performance category 12-9 Merit Pay Edward W Deming, a critic of merit pay, arguedthat it is unfair to rate individual performance because "apparent differencesbetween 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 12-10 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  Individual incentives are rare because:  Most jobs have no physical output measure  Many potential administrative problems  Employees may what they get paid for and nothing else  Typically 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 12-11 Profit Sharing  Under profit sharing, payments are based on a measure of organization performance (profits), and payments not become a part of base pay  Advantage- profit sharing may encourage employees to think more like owners  Disadvantage-workers may perceive their performance haslessto with profitthan top management decisions over which they have little control 12-12 Ownership  Ownership encourages employees to focus onorganization’s success, butmay 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 12-13 Gainsharing Gainsharing programs offer a means of sharing productivity gains with employees and are based on group or plant performance that does not becomepart of the employee’s base salary 12-14 Gainsharing Conditions for Gainsharing to be Effective: management commitment need and commitment to change and continuous improvement management's acceptance and encouragement of employee input high cooperation and interaction employment security information sharing on productivity and costs goal setting agreement on a performance standard and calculation that is undesirable, seen as fair and closely related to managerial objectives 12-15 Group Incentives and Team Awards Group incentivesmeasure 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 12-16 Balanced Scorecard Some companiesdesign a mix of pay programs 4 Categories of aBalanced Scorecard: financial customer internal learning and growth 12-17 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 performance Executive pay can be linked to organizational performance (from agency theory) Increased pressure from regulators and shareholders to better link pay and performance – Securities and Exchange Commission (SEC) 12-18 Process and Context Issues issues represent areas of significant company discretion and pose opportunities to compete effectively: Employee Participation in Decision Making Pay&Process: Intertwined Effects Communication 12-19 Matching Pay& 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 Concentration Low Short-term Above market Below market Above market Centralized Job Growth High Long-term Below market Above market Below market Decentralized Skills 12-20 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 performancebased bonuses when firm performance declines 12-21 [...]... Incentives and Team Awards Group incentivesmeasure 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 12-16 Balanced Scorecard Some companiesdesign a mix of pay programs 4 Categories of aBalanced Scorecard: 1 financial 2 customer 3 internal 4 learning and growth 12-17 Managerial... with team approach  May be inconsistent with organizational goals  Some incentive plans reward output at the expense of quality or customer service 12-11 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... ownership plans (ESOPs) give employers certain tax and financial advantages when stock is granted to employees – ESOPs can carry significant risk for employees 12-13 Gainsharing Gainsharing programs offer a means of sharing productivity gains with employees and are based on group or plant performance that does not becomepart of the employee’s base salary 12-14 Gainsharing 8 Conditions for Gainsharing to... 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 performance Executive pay can be linked to organizational performance (from agency theory) Increased pressure from regulators and shareholders to better link pay and performance... Effective: 1 management commitment 2 need and commitment to change and continuous improvement 3 management's acceptance and encouragement of employee input 4 high cooperation and interaction 5 employment security 6 information sharing on productivity and costs 7 goal setting 8 agreement on a performance standard and calculation that is undesirable, seen as fair and closely related to managerial objectives... 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 12-20 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...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  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... performance – Securities and Exchange Commission (SEC) 12-18 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 12-19 Matching Pay& Organization Strategy Organization Strategy Pay Strategy Dimensions Risk sharing (variable pay) Time... Disadvantage-workers may perceive their performance haslessto do with profitthan top management decisions over which they have little control 12-12 Ownership  Ownership encourages employees to focus onorganization’s success, butmay 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