Rewarding Performance HR-Spring Rewarding Performance

Challenges Recognize individual and group contributions to the firm by rewarding high performers. Develop pay-for-performance plans that are appropriate for different levels in an organization. Identify the potential benefits and drawbacks of different pay-for-performance systems and choose the plan that is most appropriate for a particular firm. Design an executive compensation package that motivates executives to make decisions that are in the firm’s best interests. Weigh the pros and cons of different compensation methods for sales personnel and create an incentive plan that is consistent with the firm’s marketing strategy. Design an incentive system to reward excellence in customer service. © 1998 by Prentice Hall

Pay for Performance Systems Pay-for-performance systems, also called incentive systems, reward employee performance on the basis of three assumptions: Individual employees and work teams differ in how much they contribute to the firm—not only in what they do, but also in how well they do it. The firm’s overall performance depends to a large degree on the performance of individuals and groups within the firm. To attract, retain, and motivate high performers and to be fair to all employees, a company needs to reward employees on the basis of their relative performance. In this chapter, we are concerned with how effectively employees within the same job classification perform their tasks. Pay-for-performance systems reward employee performance on the basis of the three assumptions outlined here.

Pay for Performance: The Challenges The “Do Only What You Get Paid For” Syndrome The closer pay is tied to particular performance indicators, the more employees tend to focus on those indicators and neglect other important job components Negative Effects on the Spirit of Cooperation Employees may withhold information from a colleague if they believe that it will help the other person get ahead Lack of Control Employees often cannot control all of the factors affecting their performance Difficulties in Measuring Performance Assessing employee performance is one of the thorniest tasks a manager faces, particularly when the assessments are used to dispense rewards Psychological Contracts Once implemented, a pay-for-performance system creates a psychological contract between the employee and firm, and it is very resistant to change The assumptions of a pay-for-performance system seem straightforward and acceptable. However, it is widely recognized that incentive systems can create negative consequences for firms. These next two illustrations outline some of the most common challenges facing organizations that want to adopt an incentive system.

Pay for Performance: The Challenges (cont.) The Credibility Gap Employees often do not believe that pay-for-performance programs are fair or that they truly reward performance Job Dissatisfaction and Stress Pay-for-performance systems may lead to greater productivity but lower job satisfaction Potential Reduction of Intrinsic Drives Pay-for-performance systems may push employees to the point of doing whatever it takes to get the promised monetary reward and in the process stifle their talents and creativity

Meeting the Challenges of Pay for Performance Systems Link Pay and Performance Appropriately There are few cases in which managers can justify paying workers according to a preestablished formula or measure. Use Pay for Performance as Part of a Broader HRM System Pay-for-performance programs are not likely to achieve the desired results unless they are accompanied by complementary HRM programs Build Employee Trust Even the best conceived pay-for-performance program can fail if managers have a poor history of labor relations or if the organization has a cutthroat culture Properly designed pay-for-performance systems present managers with an excellent opportunity to align employees’ interests with those of the organization. The recommendations in the next two illustrations can help enhance the success of performance programs and avoid the pitfalls we just discussed.

Meeting the Challenges of Pay for Performance Systems (cont.) Promote the Belief that Performance Makes a Difference Unless an organization creates an atmosphere in which performance makes a difference, it may end up with a low-achievement organizational culture Use Multiple Layers of Rewards Because all pay-for-performance systems have positive and negative features, providing different types of pay incentives for different work situations is likely to produce better results than relying on a single type of pay incentive Increase Employee Involvement When employees do not view a compensation program as legitimate, they will usually do whatever they can to subvert the system Use Motivation and Nonfinancial Incentives Some people are more interested in the nonfinancial aspects of their work

Pay-for-Performance Programs Unit of Analysis Microlevel Macrolevel Individual Team Business Unit/Plant Organization Merit pay Bonuses Awards Piece rate Bonuses Awards Gainsharing Bonuses Awards Profit sharing Stock plans A firm may use a variety of approaches to reward performance. As this illustration shows, pay-for-performance plans can be designed to reward the performance of the individual, team, business unit or plant, entire organization, or any combination of these.

Advantages of Individual-Based Pay-for-Performance Plans Performance that is rewarded is likely to be repeated. Individuals are goal-oriented and financial incentives can shape an individual’s goals over time. Assessing the performance of each employee individually helps the firm achieve individual equity. Individual-based plans fit in with an individualistic culture. The four major advantages to individual-based plans are shown in this illustration.

Disadvantages of Individual-Based Pay-for-Performance Plans Tying pay to goals may promote singe-mindedness. Many employees do not believe that pay and performance are linked. Individual pay plans may work against achieving quality goals. Individual-based programs promote inflexibility in some organizations. Many of the pitfalls of pay-for-performance programs are most evident at the individual level. Two particular dangers are that individual plans may (1) create competition and destroy cooperation among peers and (2) sour working relationships between subordinates and supervisors. Other disadvantages of individual-based pay-for-performance plans are listed here.

Conditions Under Which Individual-Based Plans Are Most Likely to Succeed When the contributions of individual employees can be accurately isolated. When the job demands autonomy. When cooperation is less critical to successful performance or when competition is to be encouraged. Despite the challenges they present to managers, rewards based on individual performance can be highly motivating. Individual-based pay-for-performance plans are most likely to be successful under the conditions listed here.

Advantages of Team-Based Pay-for-Performance Plans They foster group cohesiveness. They aid performance measurement. When properly designed, team-based incentives have the two major advantages listed here.

Disadvantages of Team-Based Pay-for-Performance Plans Possible lack of fit with individualistic cultural values. The free-riding effect. Social pressures to limit performance. Difficulties in identifying meaningful groups. Intergroup competition leading to a decline in overall performance. Managers need to be aware of the potential pitfalls with team-based plans. Some of the most significant pitfalls are listed here.

Conditions Under Which Team-Based Plans Are Most Likely to Succeed When work tasks are so intertwined that it is difficult to single out who did what. When the firm’s organization facilitates the implementation of team-based incentives. When the objective is to foster entrepreneurship in self-managed work groups. Although managers need to be aware of the potential disadvantages of team-based plans, they should also be on the lookout for situations conducive to their successful use. These plans are most likely to succeed under the conditions listed here.

Advantages of Plantwide Pay-for-Performance Plans (Gainsharing) Gainsharing plans can provide a vehicle to elicit active employee input and improve the production process. Gainsharing plans can increase the level of cooperation across workers and teams by giving everyone a common goal. Gainsharing plans are subject to fewer measurement difficulties than individual- or team-based incentives. Because gainsharing plans do not require managers to sort out the specific contributions of individuals or interdependent teams, it is easier both to formulate bonus calculations and to achieve acceptance of these plans. Although gainsharing plans have been used mostly in the manufacturing sector, many service-sector companies are developing their own versions of gainsharing. A number of hospitals, for instance, are using gainsharing. Some of the main advantages of using gainsharing plans are listed here.

Disadvantages of Plantwide Pay-for-Performance Plans Protection of low performers. Problems with the criteria used to trigger rewards. Management-labor conflict. Like all other pay-for-performance plans, plantwide gainsharing programs may suffer from a number of difficulties. Three of them are listed here.

Conditions Favoring Plantwide Plans Gainsharing is more likely to work well in small to midsize plants. When technology limits improvements in efficiency, gainsharing is less likely to be successful. If a firm has multiple plants with varying levels of efficiency, the plan must take this variance into account so that efficient plants are not penalized and inefficient plants rewarded. Gainsharing is less likely to be successful in firms with a traditional hierarchy of authority. Gainsharing is most appropriate in situations where the demand for the firm’s product or service is relatively stable. Listed here are a number of factors that affect the successful implementation of gainsharing programs.

Differences Between Gainsharing Plans and Profit Sharing Plans In a profit-sharing program, no attempt is made to reward workers for productivity improvements. Many factors that affect profits have little to do with productivity, and the amount of money employees receive depends on all of these factors. Profit-sharing plans are very mechanistic, and do not attempt to elicit worker participation. In a typical profit-sharing plan, profit distributions are used to fund employees’ retirement plans. As a result, employees seldom receive profit distributions in cash. The most macro type of incentive programs, corporatewide pay-for-performance plans, reward employees based on the entire corporation’s performance. The most widely used program of this kind is profit sharing, which differs from gainsharing in the ways shown here.

Advantages of Corporatewide Pay-for-Performance Plans Financial flexibility for the firm. Increased employee commitment. Tax advantages. Corporatewide pay-for-performance plans have distinct advantages, several of which are economic rather than motivational.

Disadvantages of Corporatewide Pay-for-Performance Plans Employees may be at considerable risk. Limited effect on productivity Long-run financial difficulties. Like all other pay-for-performance programs, corporatewide plans have their drawbacks.

Conditions Favoring Corporatewide Plans Profit sharing and ESOPs are the plans of choice for larger organizations. Corporations with multiple interdependent plants or business units often find corporatewide plans most suitable because it difficult to isolate the financial performance of any given segment of the corporation. Unlike gainsharing, profit-sharing and ESOP programs are attractive to firms facing highly cyclical ups and downs in the demand for their product. When used in conjunction with other incentives, corporatewide programs can promote greater commitment to the organization by creating common goals and a sense of partnership among managers and workers. Listed here are a number of factors that influence the successful implementation of corporatewide pay-for-performance plans.

Key Strategic Pay Policy Questions in the Design of Executive Long-Term Income Programs 1. How long should the time horizon be for dispensing rewards? 2. Should length of service be considered in determining the amount of the awards? 3. Should the executive be asked to share part of the costs and, therefore, increase his or her personal risk? 4. What criteria should be used to trigger the award? 5. Should there be a limit on how much executives can earn or a formula to prevent large unexpected gains? 6. How often should the awards be provided? 7. How easy should it be for the executive to convert the award into cash? Designing long-term incentive plans involves many judgment calls, and these are not always addressed in a manner consistent with achieving the firm’s long-term strategic objectives. The major questions that firms should address in designing executive long-term programs are listed here.

Most Common Perks Received by U.S. Senior Executives Percentage of Surveyed Companies Offering to Senior Executives Perk Physical Exams 85% Financial Counseling 70% Company Car 63% Club Memberships 62% First-Class Air Travel 57% Company Plane 53% Personal Liability Ins. 47% Cellular Phone 45% Chauffeur Service 35% In addition to cash incentive, many executives receive a large number perquisites or “perks”. These may keep the executive happy, but they are seldom linked to business objectives. They are also an easy target of criticism for those who feel that executive compensation is already excessive. This illustration shows the most common perks received by U.S. executives. Airline VIP Clubs 30% Reserved Parking 29% Home Security System 26% Executive Dining Room 20% Home Computer 9% Loans 6%