Gerhart Compensation 14e Chap009 MHE Accessible

Because learning changes everything.
Chapter 9
Pay-for-Performance:
Theory and Evidence
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
EXHIBIT 9.1 The Cascading Link Between Organization
Strategy and Employee Behavior
Organizational strategy is the guiding force that determines what kinds of

employee behaviors are needed.
Access text alternative for this image.
© McGraw-Hill Education 2
EXHIBIT 9.2 The Big Picture, or Compensation Can’t Do It
Alone!
One way of
looking at this
process says
that behavior is
a function of
the ability,
motivation, and
opportunity to
perform.
EXHIBIT 9.3 Performance Measurement Relationship to
Compensation Strategy
The cells help explain why incentives work in some situations and not in
others.
The rows note that individual employee performance also varies.
What Behaviors Do Employers Care About? Linking Organization
Strategy to Compensation and Performance Management
There are four questions that organizations should address.
• How do we attract good employment prospects to join our company?

• How do we retain these good employees once they join?
• How do we get employees to develop skills for current and future jobs?
• How do we get employees to perform well while they are here?
What Does It Take to Get These Behaviors? What Theory
Says
In the simplest sense, motivation involves three elements:

• What’s important to a person, and
• Offering it in exchange for some
• Desired behavior.
To narrow down employee preferences, there is

flexible compensation. Otherwise, we need to
• Based on the idea that only the individual answer these
employee knows what package of rewards questions by relying
would best suit their personal needs. on theories of
motivation.
• The key ingredient is careful cost analysis.
Motivation Theories
Several theories focus on content—identifying what is important to

people.
• These theories often drive compensation decisions about the breadth
and depth of compensation offerings.
A second set of theories focus on the nature of the exchange – company
rewards in exchange for desired employee behaviors.
• Expectancy theory argues that employers choose behaviors that yield
the most satisfactory exchange.
• Equity theory argues that people are highly concerned about fairness
of the exchange process.
• Agency theory uses compensation to keep employees in line.
Goal setting theory focuses on desired behavior, while self determination

theory looks to integrate motivation theories under a large umbrella.
What Does It Take to Get These Behaviors? What
Practitioners Say
Compensation is but one of many rewards that influence behavior.

• Employers may be overpaying in cash and missing the opportunity to use a
less-expensive reward package.
If employers don’t think about rewards other than money, they may find the
compensation process producing unintended consequences.
• Millennial workers are concerned about compensation at risk.
• The trend is toward less stable, less secure compensation packages.
Risk is variance of income and/or the inability to

predict income level from year to year.
New pay forms are less
• Base pay is the guaranteed portion of income. entitlement-oriented and more
linked to the uncertainties of
• Companies are increasingly using variable
individual, group, and
pay.
corporate performance.
• Which is higher on the risk continuum.
Do People Join a Firm Because of Pay?
Pay is one of the more visible rewards in the recruitment process.
Person Characteristics Preferred Reward Characteristics

Materialistic More concerned about pay level
Low self-esteem Want large, decentralized organization with little
pay for performance
Risk takers Want more pay based on performance
Risk-averse Want less performance-based pay
Individualists Want pay plans based on individual
performance, not group performance
Evidence suggests talented employees are attracted to companies that

have strong links between pay and performance.
Do People Stay in a Firm (or Leave) Because of Pay?
Much of the equity theory research documented that workers who feel
unfairly treated in pay react by leaving the firm.
• Pay for individual performance leads to poor performers leaving.
• Group incentive plans may lead to more turnover of better performers.
Data suggest dissatisfaction with pay can be a key factor in turnovers.

• Even the way an organization pays can impact turnover.
• Bonuses may retain high-performing employees.
• A pay-for-performance combination may appeal to scarce talent.
Besides money, other rewards also influence the decision to stay.

• Job satisfaction, pay and benefits, social, organizational commitment
and/or prestige.
Reminder: not all turnover is bad, and some is necessary.

Do Employees More Readily Agree to Develop Job Skills
Because of Pay?
The answer to this question is not known.

• Skill-based pay is intended to pay employees for learning new skills.
• That hopefully will help them perform better on current jobs.
• And adjust more rapidly to demands on future jobs.
One complaint about skill-based pay centers on cost implications.

• Poorly administered plans creates cost inefficiencies, often leading to
plan abandonment.
• Evidence suggests that while pay for skill may sometimes but not
always increase productivity.
• It does focus people on believing in the importance of quality and in
turning out significantly higher quality products.
Do Employees Perform Better on Their Jobs Because of Pay
for Performance?
A well-designed plan linking pay to behaviors of employees generally

results in better individual and organizational performance.
• Rewarding employees for performance pays off.
One study looking at merit pay shows performance increases when pay
is tied to performance.
• Strong evidence suggests that linking pay to performance does
increase motivation of workers and lead to improved performance.
How does this translate into corporate performance?

• A review of 26 studies gives high marks to profit-sharing plans.
• Organizations with such plans had 3.5 to 5% higher annual
performance.
Pay for Performance: Harmful Effects on Intrinsic Motivation
(Claims and Evidence)
Critics argue that incentives are both morally and practically wrong.
• The counterargument is that employment is a reciprocal arrangement.
Kohn suggests that incentive systems can actually harm productivity.
• Rewarding a person for performing a task reduces interest in that task.
• Extrinsic rewards (money) reduce intrinsic rewards (enjoyment of the
task for its own sake).
Should we tie pay to performance?

• When performance is difficult to measure, employers say “no.”
• Substantial evidence indicates that management and workers alike
believe pay should be tied to performance.
• HR tries to cut costs by creating a greater distinction between high and
low performers.
Sorting and Incentive Effects
Pay for performance generally has a positive effect.

• The incentive effect means pay can motivate current employees to
perform better.
• The sorting effect means people sort themselves into and out of jobs
based on what is important to them.
The most obvious sorting factor is ability.

• Any management practice can cause stress
or other negative reactions. When we look at pay
and group
Sorting effects are more important to the performance, the
degree that high performers create a evidence is more
disproportionately high amount of value for mixed.
organizations.
Risk (Unintended Consequences)
Employers should recognize that variable-pay components in

compensation plans can, and do, fail.
• Sometimes the failure arises, ironically, because the incentive works
too well.
• Poorly implemented incentive pay plans can hurt rather than help.
Designing a Pay-for-Performance Plan Efficiency
Efficiency involves three general areas of concern—strategy, structure,

and standards.
Strategy.
• A pay-for-performance plan must support corporate objectives.
• The plan should address the most difficult question of all—how much
of an increase makes a difference?
Structure.
• Is the organizational structure decentralized to allow operating units to
create flexible variations on a general pay-for-performance plan?
Standards.
• Employers must be concerned with: objectives, measures, eligibility,
and funding – and remember standards are not static.
Designing a Pay-for-Performance Plan Equity/Fairness
Two types of fairness are concerns for employees.

• Distributive justice—fairness in the amount that is distributed to
employees.
• Procedural justice—employees are concerned about the fairness of
the procedures used to determine the amount of rewards they receive.
A key element in fairness is communications.

• Employees want to know in advance what is expected of them.
• They want the opportunity to provide input.
• Employees want a mechanism for appeals.
• Executives perform better when told what the linkage is between pay
and performance.
A pay-for-performance system should comply with existing laws.
Because learning changes everything. ®
www.mheducation.com
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

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Because learning changes everything.

Organizational strategy is the guiding force that determines what kinds of

Access text alternative for this image.

Access text alternative for this image.

Access text alternative for this image.

There are four questions that organizations should address.

• How do we attract good employment prospects to join our company?

In the simplest sense, motivation involves three elements:

To narrow down employee preferences, there is

Several theories focus on content—identifying what is important to

Goal setting theory focuses on desired behavior, while self determination

Compensation is but one of many rewards that influence behavior.

Risk is variance of income and/or the inability to

Pay is one of the more visible rewards in the recruitment process.

Person Characteristics Preferred Reward Characteristics

Evidence suggests talented employees are attracted to companies that

Data suggest dissatisfaction with pay can be a key factor in turnovers.

Besides money, other rewards also influence the decision to stay.

Reminder: not all turnover is bad, and some is necessary.

The answer to this question is not known.

One complaint about skill-based pay centers on cost implications.

A well-designed plan linking pay to behaviors of employees generally

How does this translate into corporate performance?

Should we tie pay to performance?

Pay for performance generally has a positive effect.

The most obvious sorting factor is ability.

Employers should recognize that variable-pay components in

Efficiency involves three general areas of concern—strategy, structure,

Two types of fairness are concerns for employees.

A key element in fairness is communications.

A pay-for-performance system should comply with existing laws.

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