1. Week 10: Compensation & Benefits
Agenda for Today
Discuss reasons why pay sometimes motivates and sometimes it does not
Discuss Pay-for-performance plans from individual, group and corporate perspectives
Discuss major approaches to making compensation decisions
In-class exercise: Ethical Compensation Dilemmas

2. Compensation and Rewards
Extrinsic Rewards
Monetary
Wage and salary
Commissions and bonuses
Benefits
Intrinsic Rewards
Recognition, promotion opportunities, working conditions, nature of work

3. Objectives of Good Compensation
Attract Good Applicants
Market competitiveness
Wage surveys
External equity
Retain Good Employees
External and internal equity
Procedural Justice: perceived fairness of the process and procedures used to make decisions about employees
Distributive Justice: Perceived fairness in the distribution of outcomes
Job evaluation
Motivate Employees??

4. Does Pay Motivate?? YES! Reinforcement Theory Expectancy Theory
Pay is positive reinforcement
Expectancy Theory
Motivation: Expectancy * Instrumentality * Valence (E*I*V)
High Effort High Perf. (Expectancy link)
High Perf.Valued Monetary Rewards (Instrumentality link)
Valued Monetary RewardsPay Satisfaction (Valence Link)
Equity Theory
Social comparison of inputs and outputs
If paid less for same or more effort = less effort
Actions to restore equity

5. Does Pay Motivate?? NO! Maslow’s Need Hierarchy Theory
Pay is lower-order need, once it is satisfied it no longer motivates, move on to higher order needs
Herzberg’s Two-Factor Theory
Motivators and Hygiene factors
Pay is Hygiene Factor – presence will not motivate
Motivation comes from presence of motivators (recognition, job enrichment)
Deci’s Theory of Intrinsic Motivation
Intrinsic rewards are gained from certain activities
Extrinsic rewards decrease intrinsic motivation

6. Does Pay Motivate?? COMPROMISE
Individual differences in response to pay as a motivator
Need pay, but don’t rely on it as a sole motivator
Pay loses potency over time
Establish clear performance-reward contingencies
Good performance appraisal system; feedback
Make sure employees have skills, abilities, and resources needed to do the job (selection; training, development)
Ensure Equity (perceived and actual)
Money is not for everyone: determine individual reinforcers (reinforcement buffet)

7. Major Issues in Compensation: Overview
Pay-for-Performance
Fixed vs. variable Pay
Performance vs. Membership
Job vs. Individual Pay
Open vs. Secret Pay Policy
Egalitarianism vs. Elitism
Monetary vs. Nonmonetary Rewards
Below-Market vs. Above Market Compensation
Centralizations vs. Decentralization of Pay Decisions

8. Pay-for-Performance Incentive system that rewards employee performance
Performance rather than entitlement orientation
Assumptions:
Individuals and teams differ in their contributions to firm
Performance based pay will affect attraction, retention, and motivation of high-performing employees
Assumes that performance appraisals are done well

9. Pay-for-Performance – Advantages & Disadvantages
Merit based
Based on objective rather than subjective criteria
Disadvantages:
“Do only what you get paid for” syndrome
Employee focus on rewarded measures of job & ignore other important aspects of work (e.g., quality or service)
Possibly manipulate the system
Negative effects on cooperation: increases competition
Lack of control over factors affecting performance
Performance of other group members, job support, materials
Leads to job dissatisfaction and stress
Difficulties in measuring performance (individual and team)
Encourages short-term orientation (performance over a year)
Psychological contracts may be broken when system changed
Lack of confidence in the system (“is it really fair?”)

10. How to Establish Effective Pay-for-Performance Incentive Systems
Determine if it is appropriate for the job
Is it piece rate? -- absolutely
Other knowledge-based work? What is the product?
Reinforce with other HR systems
E.g., performance appraisals, selection, employee training
Build Employee Trust
Does it pay for me to work harder?
Does anyone notice extra efforts?
Promote belief that performance makes a difference
Use multiple layers of rewards (individual and team)
Involve employees in design of play plan
Complement with non-financial rewards

11. Pay-for Performance (P-F-P) Plans : Individual
Examples: merit pay, piece-rate, commissions, bonuses
Advantages:
Helps achieve individual equity
Ties with expectancy theory, goal theory, reinforcement theory
Fit in well with individualistic cultures
Disadvantages:
Creates competition and destroys cooperation among peers
General pitfalls of P-F-P plans most evident at individual level
Conditions under which most likely to succeed:
When contributions of individual employees can be accurately isolated
When job demands autonomy
When cooperation is less critical; competition is encouraged

12. Pay-for-Performance Plans: Team Incentives
Advantages:
Fosters group cohesiveness
Reflects current work performance more realistically: more effective measurement tool
Disadvantages:
Lack of fit with individualistic corporate cultures
Free-riders
Social pressures to limit performance
Difficulties in identifying meaningful groups
Intergroup competition leading to a decline in overall perf.
Conditions under which most likely to succeed:
When high task interdependence within group
When there are independent tasks between groups
When objective is to foster self-managed work groups

13. Pay-for-Performance Plans: Organizational
Examples: gainsharing, profit-sharing, ESOP
Advantages:
Increases employee commitment; promotes employee ownership
Provides financial flexibility for firm (cost is automatically adjusted downward during economic downturn)
Tax advantages to the firm
Disadvantages:
Profits vary from year to year – employees financial well-being may be at considerable risk
Payoff removed from employee efforts
Stock risks – long-run financial difficulties
Conditions under which most likely to succeed:
Large corporations with interdependent business units (difficult to target contributions of individual business units)
Along with other individual and team incentive programs

14. Job vs. Individual Pay
Knowledge-based or skill-based pay: employees paid on the basis of jobs they can do
Base level of pay increased with ability to do other jobs
Employees move from job to job as needed
Advantages:
Increases staffing flexibility
Reduces costs of turnover and absenteeism
Motivational effects: job rotation
Disadvantages:
Loss of labor specialization
Greater difficulty in selecting applicants because qualifications are less specific
Workplace chaos if not managed properly

15. Job vs. Individual Pay (contd.)
Knowledge-based systems work best when:
There are limited opportunities for upward mobility
There is high change in technology and organizational structure
The workforce is educated and has the ability and willingness to learn new jobs
Teamwork and participation is stressed
There are opportunities to learn new skills
There are high costs associated with absenteeism and turnover

16. Open vs. Secret Pay Policy
Advantages to Open Pay Policy:
When compensation is secret, people believe they are more underpaid than they really are
Forces managers to be more fair and effective in administering compensation
Bad decisions cannot be hidden
Good decisions motivate others
Disadvantages:
Managers forced to defend decisions publicly
May give everyone the same raise to avoid conflict; demotivates high performers
Pay becomes political – unleashes jealousy, conflict
Use Open Pay Policy:
Egalitarian culture with employee involvement
Cultures with trust and commitment

17. Elitism vs. Egalitarianism
Egalitarianism: employees under the same compensation system (i.e., all employees eligible for stock options)
Reduces barriers between employees
Allows reassignment of employee to different area without changing compensation package
More common in highly competitive environment
Elitism: different compensation systems for different groups
Increases stability; have to stay in organization and move up through the ranks to get stock options
More common in older, well- established firms with mature products

18. Other Compensation Questions
Monetary vs. Nonmonetary Rewards?
Non-monetary rewards: interesting work, job security, work sabbaticals, flexible work, benefits, overseas transfers, extensive training and development
Use combination; contingent upon employee, position, company orientation and culture
Below Market vs. Above Market Compensation?
Depends on labor market, position, technology, geographical location
Implications for turnover, organizational commitment, getting and keeping top performers
Pay Decisions Centralized vs. Decentralized?
Centralizations may be cost-effective; hire compensation specialist
Centralization increases internal equity, but may be less in touch with external market
Decentralization better in large and diverse organizations