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  1. Pay-for-Performance: The Evidence
  2. Exhibit 9.1: The Cascading Link Between Organization Strategy and Employee Behavior Nordstrom’s Organization Strategy • extremely good quality merchandise • high levels of customer satisfaction Exhibit 9.1
  3. Exhibit 9.2: The Big Picture, or Compensation Can’t Do It Alone! His performance depends on three things: 1. Physical abilities and skills 2. Motivation 3. Absence of environmental obstacles Exhibit 9.2
  4. In the 1980s, Nabisco was slow to recognize customer demand for cookies. Why? They had a centralized organization structure that took a long time to get sales information up to the top decision makers. What did Nabisco do? They decentralized (organization design) the company, creating divisions responsible for different product lines. Now when sales people say consumer preferences are changing, response is much more rapid.
  5. COMPENSATION CAN’T DO IT ALONE • Compensation should be sufficient for recruiting and hiring. • Compensation needs to retain good employees. • After hiring and retaining, focus on building knowledge and skills. • Employers must motivate employees to perform well on their jobs.
  6. Exhibit 9.3: Performance Measurement Relates to Compensation Strategy
  7. WHAT BEHAVIORS DO EMPLOYERS CARE ABOUT? 1. Attract of good employment prospects to join the company. 2. Retain good employees once they join. 3. Get employees to develop competencies for current/future jobs. 4. Get employees to perform well while at the company.
  8. WHAT BEHAVIORS DO EMPLOYERS CARE ABOUT? (cont.) 1. How do we attract good employment prospects to join our company? • The long-run success of any company depends on getting good people to accept employment.
  9. WHAT BEHAVIORS DO EMPLOYERS CARE ABOUT? (cont.) 2. How do we retain these good employees once they join? • It doesn’t do much good to attract exceptional employees to the company only to lose them a short time later. • Once the compensation practices get a good employee in the door, company needs to figure out ways to ensure it’s not a revolving door.
  10. WHAT BEHAVIORS DO EMPLOYERS CARE ABOUT? (cont.) 3. How do we get employees to develop skills for current and future jobs? • The compensation challenge is to get employees, traditionally resistant to change, to willingly develop skills that may not be vital on the current job but are forecast to be critical as the company’s strategic plan adjusts to change.
  11. WHAT BEHAVIORS DO EMPLOYERS CARE ABOUT? (cont.) 4. How do we get employees to perform well on their current job? • The compensation challenge is to design rewards that enhance job performance.
  12. WHAT DOES IT TAKE TO GET THESE BEHAVIORS? WHAT THEORY SAYS In the simplest sense, motivation involves three elements: 1. what is important to a person, and 2. offering it in exchange for some 3. desired behavior As to the first element, what’s important to employees, data suggest employees prefer pay systems that are influenced by: • Individual performance • Changes in cost of living • Seniority • Market rate
  13. WHAT DOES IT TAKE TO GET THESE BEHAVIORS? WHAT THEORY SAYS (cont.) Content Theories (what is important to a person) Hertzberg’s Two Factor Theory Maslow’s Hierarchy of Needs
  14. WHAT DOES IT TAKE TO GET THESE BEHAVIORS? WHAT THEORY SAYS (cont.) Process Theories (the nature of the exchange) Expectancy Theory Equity Theory Agency Theory
  15. • In the past, compensation people didn’t ask this question very often. • Now, progressive companies ask, “What do we want our compensation package to do?” WHAT DOES IT TAKE TO GET THESE BEHAVIORS? WHAT PRACTITIONERS SAY
  16. WHAT DOES IT TAKE TO GET THESE BEHAVIORS? WHAT PRACTITIONERS SAY (cont.) Exhibit 9.4: Components of a Total Reward System
  17. WHAT DOES IT TAKE TO GET THESE BEHAVIORS? WHAT PRACTITIONERS SAY (cont.) Recently completed a worldwide “employment branding” exercise. Three things emerged as strengths at McDonald’s: 1. An emphasis on family and friends in a social work environment 2. Flexibility in work assignments and work schedules 3. Development of skills that helped launch future careers Promotes a business culture of fun and encourages employees to find ways to make their jobs more interesting and relevant to them personally. • Southwest “pays by the trip,” meaning employees earn more the more flights they work. • Employees also have significant ownership in the company through a discount stock purchase program and receive profit- sharing checks when the airline is profitable, which is has been for 45 years in a row. • In one year, Southwest paid out $543 million in profit-sharing to its 56,110 employees, working out to an average of almost $10,000 per employee.
  18. WHAT DOES IT TAKE TO GET THESE BEHAVIORS? WHAT PRACTITIONERS SAY (cont.) Wage Components A variety of wage components, listed from least risky to most risky (stability of income):
  19. DOES COMPENSATION MOTIVATE BEHAVIOR? • Do people join a firm because of pay? • Do people stay in a firm (or leave) because of pay? • Do employees more readily agree to develop job skills because of pay? • Do employees perform better on their jobs because of pay?
  21. DO PEOPLE STAY IN A FIRM (OR LEAVE) BECAUSE OF PAY? • Poor performers leave when pay is based on individual performance. • Group incentives may lead to more turnover of better performers. • Dissatisfaction with pay may cause turnover. • Even the way an organization pays may impact turnover. DOES COMPENSATION MOTIVATE BEHAVIOR? (cont.)
  22. Other rewards also influence the decision to stay Job Satisfaction Socializatio Organizationa commitment Organizationa Prestige DOES COMPENSATION MOTIVATE BEHAVIOR? (cont.) DO PEOPLE JOIN A FIRM BECAUSE OF PAY? (CONT.) Besides money, other rewards also influence the decision to stay (retention) in a firm.
  23. DO EMPLOYEES MORE READILY AGREE TO DEVELOP JOB SKILLS BECAUSE OF PAY? • The answer is not known. • New skills will help employees on current and future job demands. • Evidence points to paying for skill may not increase productivity but may improve quality. DOES COMPENSATION MOTIVATE BEHAVIOR? (cont.)
  24. DO EMPLOYEES PERFORM BETTER ON THEIR JOBS BECAUSE OF PAY? DOES COMPENSATION MOTIVATE BEHAVIOR? (cont.) Research Studies Result of the Study Study at the HR practices of over 3,000 companies Organizations significantly above the mean (by one standard deviation) on these and other “high- performance work practices” had annual sales that averaged $27,000 more per employee Heneman Comprehensive Review Heneman reports that 40 of 42 studies looking at merit pay show performance increases when pay is tied to performance. One study of 841 union and nonunion companies They found that gain-sharing and profit- sharing plans (both designed to link pay to performance) increased individual and team performance 18 to 20%. Review of 26 studies The study gives high marks to profit-sharing plans: Organizations with such plans had 3.5 to 5% higher annual performance. Practitioner/s Practitioners' Perception Gerhart and Milkovich Across 200 companies they found a 1.5% increase in return on assets for every 10% increase in the size of a bonus. Numerous critics, led by Alfie Kohn His conclusion, based heavily on the work of Deci and colleagues, is that 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). Employees/Managers Perception Dyer and colleagues Substantial evidence indicates that management and workers alike believe pay should be tied to performance. Dyer and colleagues asked 180 managers from 72 different companies to rate nine possible factors in terms of the importance they should receive in determining the size of salary increases. This group believed the most important factor for salary increases should be job performance. Other research supports these findings Both college students and a second group of managers ranked job performance as the most important variable in allocating pay raises. Another way to make the pay-for-performance argument is to look at the ways HR professionals try to cut costs. At the top of the list: Create greater distinction between high and low performers! In other words, really pay Employee responses overwhelmingly say yes. Research overwhelmingly says yes. Practitioner perceptions overwhelmingly say yes.
  25. DESIGNING A PAY-FOR-PERFORMANCE PLAN The pay model suggests effectiveness depends on three things: 1. Efficiency. 2. Equity. 3. Compliance.
  26. DESIGNING A PAY-FOR-PERFORMANCE PLAN (CONT.) EFFICIENCY Efficiency involves three areas of concern: 1. Strategy: The plan must support corporate objectives. E.g., organizational strategies fit the compensation strategy and HR plan. 2. Structure: The organizational structure and the compensation plan should be aligned. E.g., decentralized structure and flexible plans. 3. Standards: E.g., objectives, measures, eligibility, and funding.
  27. DESIGNING A PAY-FOR-PERFORMANCE PLAN (CONT.) EQUITY/FAIRNESS There are two types of equity, or fairness: 1. Distributive justice: Amount that is distributed to employees. 2. Procedural justice: Procedures used to determine the amount of rewards. A key element in fairness is communication.
  28. DESIGNING A PAY-FOR-PERFORMANCE PLAN (CONT.) COMPLIANCE • A pay-for-performance system should comply with existing laws. • Firms want a reward system that maintains and enhances their reputation.