Reward Systems and Legal Issues

 

10.1.	Traditional And Contingent Pay Plans A traditional approach in implementing reward systems is to reward employees for the positions they fill as indicated by their job descriptions and not necessarily by how they do their work. In other words, employees are rewarded for filling a specific slot in the organizational hierarchy. In such traditional pay systems, one’s job directly determines pay and indirectly determines benefits and incentives received. Typically, there is a pay range that determines minimum, midpoint, and maximum rates for each job. For example, a university may have five ranks for professors who have just been hired :
	1.	Instructor (pay range : $ 30,000 _ $ 45,000)
	2.	Senior instructor (pay range : $ 40,000 _ $ 55,000)
	3.	Assistant professor (pay range: $ 60,000 _ $ 90,000)
	4.	Associate professor (pay range: $ 85,000 _ $ 105,000)
	5.	Professor (pay range : $ 100,000 _ $ 140,000)
	As noted above, in a traditional reward system, each of these positions would have a minimum, midpoint, and the maximum salary. For assistant professors, the minimum is $ 60,000 per year, the midpoint is $ 75,000, and the maximum is $ 90,000. Salary increases at the end of the year would be determined by seniority or by a percentage of one’s base salary (and the same percentage would be used for all workers). Rewards would not be based on teaching quality, as indicated by student teaching ratings, or research productivity, as indicated by the number and quality of publications. If an assistant professor’s base salary is $ 90,000, she cannot realize an increase in her salary unless she is promoted to associate professor because $ 90,000 is the maximum possible salary for this job title. In short, in traditional reward systems, the type of position and seniority are the determinants of salary and salary increases, not performance. In such reward systems, there is no relationship between performance management and rewards. This type of system is quite pervasive in numerous organizations, particularly outside of North America. Korea is one country where systems based on seniority are still quite pervasive. In Korea, as is the case in other collectivistic cultures (e.g., China), employees tend to avoid confrontation for fear of losing face. Thus, supervisors may be reluctant to give employees unsatisfactory performance ratings or ratings based on individual performance because this would single out individuals. Instead, systems that measure and reward team performance may be more appropriate in collectivistic cultures It is possible, however, to move away from more traditional systems based mainly on seniority by establishing clear links between performance management and other functions such as training When such links have been clearly established, employees are more likely to see the benefits of the performance management system and believe that the system is fair. Contingent pay (CP), also called pay for performance, means that individuals are rewarded based on how well they perform on the job. Thus, employees receive increases in pay based wholly or partly on job performance. These increases can either be added to an employee’s base salary or be a one time bonus When increases are not added to an employee’s base salary, as in the case of one-time bonuses, they are called variable pay. Originally, CP plans were used only for top management. Gradually, the use of CP plans extended to sales jobs. Currently, CP plans are more pervasive. For example, in 2001, 70 % of workers in the United States were employed by organizations implementing some type of variable pay plan, and many of these organizations tie variable pay (e.g., bonus, commission, cash award, lump sum) directly to performance. Similarly, a study of human resources (HR) practices worldwide found that organizations in Canada, Latin America, Taiwan, and the United States generally emphasize the link between performance and pay. Finally, even universities, which typically have traditional organizational cultures for which pay for performance can be quite a foreign concept, are adopting CP plans for their staff. For example, results of a survey of 129 higher education institutions in the United Kingdom revealed that 77 % of universities are using some type of CP plan and only 6% of universities have decided not to implement such plans. Let’s return to the example of salaries for university professors. When a CP plan is implemented, pay raises are determined in part or wholly based on performance. For example, two assistant professors may be hired at the same time at the same salary level (e.g., $ 75,000). If one of them outperforms the other year after year for several years, then eventually the better performing assistant professor may make $ 110,000, which may be a higher level of pay than most associate professors make. This is because every year this assistant professor receives a substantial salary increase, part of which may be added to the base salary, based on her outstanding teaching and research performance. On the other hand, the other assistant professor may still be making the same amount, or close to the same amount, he was making when he was first hired. Under a traditional pay plan, an assistant professor would not receive a higher salary than most associate professors. Under such a plan, the assistant professor would have to be promoted to associate professor before she could receive a salary of $  110,000, which is outside the traditional range for assistant professors.

10.2 .

Reason For Introducing Contingent Pay Plans Why are organizations embracing CP plans? The results of a recent survey of Fortune 500 companies indicated that performance management systems are more effective when results are directly tied to the reward system. When the performance management system has a direct relationship with the reward system, performance measurement and performance improvement are taken more seriously. In other words, CP plans force organizations to define effective performance clearly and to determine what factors are likely to lead to effective performance. When a CP plan is implemented, organizations need to make clear what is expected of employees, what specific behaviors or results will be rewarded, and how employees can achieve these behaviors or results. This, in and of itself, serves an important communication goal because supervisors and employees are better able to understand what really matters. Also, high-achieving performers are attracted to organizations that reward high-level performance, and high level performers are typically in favor of CP plans. This tendency is called the sorting effect: top performers are likely to be attracted to and remain within organizations that have implemented CP plans. An organization’s ability to retain its top performers is obviously crucial if an organization wants to win the talent war and have a people-based competitiveadvantage. For example, a study conducted at a glass installation company found that productivity improved by 44 % when the compensation system was changed from salaries to individual incentives. Acloser look at the data indicated that about 50 % of the productivity improvement was due to the current employees being more productive, whereas the other 50 % improvement was due to less productive employees quitting and the organization’s ability to attract and recruit more productive workers. Consequently, CP plans can serve as a good tool to recruit and retain top performers as a result of the sorting effect, which, in turn, can lead to greater productivity. Finally, CP plans can project a good corporate image because the organization has implemented a system of rewards that is fair and based on clearly communicated expectations and standards. Hicks Waldron, former CEO of cosmetics giant Avon, in an eloquent statement, explained why CP plans are becoming so popular: “It took me 30 years to figure out that people don’t do what you ask them to do; they do what you pay them to do.” How about organizations that are struggling financially? Can they still implement CP plans? Can they afford to give performance-based rewards to their employees? The answer is yes to both questions. Making sure that top performers are rewarded appropriately can help keep them motivated and prevent them from leaving the organization in difficult times. It is these top performers who are the organization’s hope for recovery in the future. In fact, giving rewards to poor performers means that these rewards are taken away from high-level performers. Consider the case of Corning, Inc., a fiber-optic cable manufacturer (http://www.corning.com/). In 2002, sales were at an unprecedented low level, and the stock price was just over $1, which was about 1% of its value in 2000. Corning had slashed more than 16,000 jobs in two years and had not been profitable since early 2001; nevertheless, they gave bonuses to employees who met performance goals during the year. Overall, CP plans enhance employee motivation to accomplish goals that match organizational needs. More specifically, CP plans have the potential to help people change behavior and improve performance. For example, assume an organization is trying hard to improve customer satisfaction. Some units in this organization decide to implement a CP plan that awards cash to employees who improve their customer satisfaction ratings. By contrast, other units continue with a traditional pay plan in which there is no clear tie between performance levels and rewards. Who do you think will perform better employees under the CP plan or those under the traditional plan? Well, if all other things are equal, it is likely that employees under the CP plan will improve the service they offer to customers.  In fact, a review of several studies concluded that using individual pay incentives increased productivity by an average of 30 %. Similarly, a study of 21 fast-food franchises showed a 30 % increase in average profits and a 19% decrease in the drive-through times as a result of the implementation of a CP plan.  These figures, of course, are averages, and productivity and profits do not necessarily improve by 30 % in every case. An employee’s performance is determined by the joint effects of declarative knowledge, procedural knowledge, and motivation. CP plans address the motivational component. In other words, employees are likely to choose to expend effort, choose to expend a high level of effort, and choose to persist in this high level of expenditure of effort in the presence of financial incentives. The fact that employees are trying hard to provide good customer service does not mean, however, that they will necessarily succeed. They still need the declarative and procedural knowledge to do so. If they do not know how to please customers, then they won’t be able to satisfy them no matter how hard they try.

	CP plans can help improve the motivation of employees when each of the following conditions is present :
	1.	Employees see a clear link between their efforts and the resulting performance (expectancy).
	2.	Employees see a clear link between their performance level and the rewards received (instrumentality).
	3.	Employees value the rewards available (valence).
	There is a multiplicative relationship among these three determinants of motivation so that Motivation = Expectancy * Instrumentality * Valence
	If the expectancy, instrumentality, or valence conditions are not met, the CP plan is not likely to improve performance. For example, consider the situation in which the instrumentality condition is not present. Employees may value the rewards available and may want to get them (valence). They may also see that if they exert sufficient effort, they will be able to achieve the desired performance level (expectancy). They believe, however, that the rewards received are not necessarily related to their performance level (i.e., no instrumentality). In this situation, employees are not likely to choose to exert effort because this will not get them the desired rewards. CP plans and pay in general should not be regarded as the Holy Grail of employee performance. First, pay can affect only the motivation aspect of performance. If an employee is not performing well, pay may not solve the problem if poor performance results from a lack of declarative or procedural knowledge as opposed to a lack of motivation. All of the three conditions must be present for CP plans to have an impact on employee motivation. We should be aware that pay is not necessarily the perfect solution and that giving people more money will not automatically solve performance problems.

10.3.	Possible Problems Associated With Contingent Pay Plans In spite of the potential positive impact of CP plans, we should be aware that not all CP plans work as intended. For example, in the 1990s, Hewlett Packard implemented CP plans in 13 separate sites ; however, the plans were eventually abandoned in all but one. Hewlett Packard decided to abandon CP because the benefits did not outweigh the costs. Why is it that CP plans may not succeed? Consider the following reasons.
	-	A poor performance management system is in place. What happens when a CP plan is paired with a poorly designed, poorly implemented performance management system, one that includes biased ratings and the measurement of unrelated performance dimensions? This situation may lead some employees to challenge the CP plan legally. Also, rewarding behaviors and results that are not job related is likely to cause good performers to leave the organization. Finally, those who stay are not likely to be motivated to perform well.
	-	There is the folly of rewarding A while hoping for B. What happens when the system rewards results and behaviors that are not those that will help the organization succeed? Employees are likely to engage in these often counterproductive behaviors when this behavior is what will earn them the desired rewards. One such example is the hope that executives will focus on long-term growth and environmental responsibility when, in fact, they are rewarded based on quarterly earnings. Given this situation, what are these executives likely to do? Will they think in the long term or quarter by quarter? A second example is an organization that would like its employees to be more entrepreneurial and innovative, but it does not reward employees who think creatively. What are employees likely to do? Will they be innovative and risk not getting rewards, or will they continue to do things the old way? Athird example is an organization that would like employees to focus on teamwork and a one for all spirit, but it rewards employees based on individual results. This happens in many professional sports teams. What are professional athletes likely to do? Will they pass the ball, or will they try to score themselves to improve their own individual statistics?
	-	Rewards are not considered significant. What happens when a CP plan includes pay increases and other rewards that are so small that they don’t differentiate between outstanding and poor performers? For example, what happens when the top performers receive a 5% pay increase and an average performer receives a 3% or 4% pay increase? In this context, rewards are not viewed as performancebased rewards, and they do not make an impact. The message sent to employees is that performance is not something worth being rewarded. For rewards to be meaningful, they need to be significant in the eyes of the employees. Usually, an increase of approximately 12 % – 15 % of one’s salary is regarded as a meaningful reward and would motivate people to do things they would not do otherwise.
	-	Managers are not accountable. What happens when managers are not accountable regarding how they handle the performance and the performance evaluation of their employees? They are likely to inflate ratings so that employees receive what the manager thinks are appropriate rewards. Similarly, employees may set goals that are easily attainable so that performance ratings will lead to the highest possible level of reward. In other words, when managers are not held accountable, rewards may become the driver for the performance evaluation instead of the performance evaluation being the driver for the rewards.
	-	There exists extrinsic motivation at the expense of intrinsic motivation. What happens when there is so much, almost exclusive, emphasis on rewards? Employees may start to lose interest in their jobs, which, in turn, can decrease motivation. In some cases, the extrinsic value of doing one’s job (i.e., rewards) can supersede the intrinsic value (i.e., doing the work because it is interesting and challenging). Sole emphasis on rewards can lead to ignoring the fact that employee motivation can be achieved not only by providing rewards but also by creating a more challenging, more interesting work environment in which employees have control over what they do and how they do it.
	-	Rewards for executives are disproportionately large compared to rewards for everyone else. In many organizations, executive rewards are disproportionately large compared to the rewards received by everyone else in the organization. A study conducted by Pearl Meyer & Partners in 2004 revealed that the average compensation received by CEOs in major U.S. corporations was US $9.84 million, compared to an average compensation for employees in nonsupervisory roles of $ 27,485. The compensation for these CEOs was more than 360 times that of their employees! Such a large difference, particularly when the performance of the organization is not stellar, can lead to serious morale problems. CEOs should be compensated according to their performance, and an important indicator of CEO performance is overall firm performance (e.g., stock price in the case of publicly traded organizations).