Compensation and Firm Performance © Nancy Brown Johnson, 2003

Contingency Theory Greater fit between strategy and compensation, greater performance Otherwise compensation works at cross- purposes Business Strategy Fit Compensation Design Performance

Contingency Theory Implications No one best way to manage Different approaches work equally well under different conditions

Compensation Strategy & Firm Performance Fit between corporate strategies & compensation strategy increases performance Congruency between pay system, organizational characteristics and environment increases performance

Best Practices Theory This theory runs counter to contingency theory ALL Notion that there are just good practices out there that ALL firms would benefit from.

Strategic Management Literature Assumes well defined strategies exist strategy making is deliberate allows flexibility Managers formulate strategies & have own agenda dominant logic: way of looking at the world allows flexibility pay strategies consistent with dominant coalition

Examples IBM loyalty, job security, high performance expectations immediate rewards tight discipline, constant grading 3M “ human beings endowed with the urge to create” high tolerance for failure rewards for innovative products to market rewards tied to successful innovation 15% of individuals time to pursue own projects

Industry Structure Barriers to entry attract and retain HR prevent other companies from getting employees (e.g., stock options) Number of companies in industry more companies less discretion firm will have in implementing compensation

Industry Structure (cont.) Small firms have competitive disadvantage no economies of scale no access to resources Elasticity of demand for final product more volatile industry make pay more variable to absorb fluctuations

Strategic Employee Groups Individuals are difficult to replace Employee performance high influence on firm mission Employees constitute a part of the technical “core” More strategic employee group, the more flexible the pay strategy

The Evidence High Tech firms need to attract & retain tech talent cost of leaving low because same geographical area Compensation aggregate incentives to retain (not bonuses) Team bonuses –bind to team –joint work –cooperation important –profit sharing helps retention

Other Evidence Pay strategies are consistent over time Human capital and job attributes explain 70% of the variance Organization effects: smallest base pay, largest incentives Large firms de-emphasize incentives, emphasize base pay Large differences within industry

Summary In sum, most believe that it is important for firms to consider what their goals when creating their performance system in order to be more effective However, as we will discuss throughout this class context and culture remains very very important.