Download - MBAO 6030 Strategic Reward Systems I
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Strategic Reward Systems I
HR Management
MBAO 6030
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Strategic Reward Systems I:Pay for Performance
Financial Rewards Compensation
1. Base Salary
2. Pay Incentives
3. Employee Benefits
Reward Systems consist of the followingelements:
Reward Systems consist of the followingelements:
Non-financial Rewards1. Intrinsic Rewards centers on the work itself
2. Praise, recognition, time off and other rewards
given to the employee by peers or superiors.
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Strategic Reward Systems I:Pay for Performance
Reward Systems in most cases should beconsistent with other HR systems.
The Reward System is a key driver of:
HR Strategy
Business Strategy
Organization Culture
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Strategic Reward Systems I:Need for Consistency with Other HR Systems
Culture
Performance
Management
Employment
Training
Labor
Relation
s
Rewards
Overtime
pay rules incontract
Sign-on Bonus
Merit Pay
Merit pay reinforces
performance culture
Skill-based pay
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Strategic Reward Systems I
Critical Thinking Question:
1. Should pay policies lead or lag the
development of other HR systems?
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Theoretical Models of Pay and Performance:Equity theory (Adams, 1963)
Assumptions:
People develop beliefs about what is a fairreward for ones job contribution - an exchange
People compare their exchanges with theiremployer to exchanges with others-insiders andoutsiders called referents
If an employee believes his treatment isinequitable, compared to others, he or she willbe motivated to do something about it -- that is,seek justice.
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Theoretical Models of Pay and Performance:Equity theory (Adams, 1963)
Is/Os versus Ir/Or
O = Outcomes: the type and amount ofrewards received
I = Inputs: employees contribution toemployer
R = Referent: comparison person
S = Subject: the employee who is judgingthe fairness of the exchange
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Equity Theory Exchange Scenarios
Case 1: Equity -- pay allocation is perceived tobe to be fair - motivation is sustained
Case 2: Inequity (Underpayment) -- Employee
is motivated to seek justice. Work motivation isdisrupted.
Case 3: Inequity (Overpayment) -- Could be
problem. Inefficient. In other culturesemployees lose face.
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Consequences of Inequity
The employee is motivated to have an equitableexchange with the employer.
To reduce inequity, employee may
Reduce inputs (reduce effort)
Try to influence manager to increase outcomes(complain, file grievance, etc.)
Try to influence co-workers inputs (criticize others
outcomes or inputs)
Withdraw emotionally - or physically (engage inabsenteeism, tardiness, or quit)
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Equity Theory Implications
There is tension between internal and externalpay equity: Decide where to place theemphasis. Example: In and out versus
lifelong employment system Let employees know who their pay referents are
in the pay system: identify pay competitors andinternal pay comparators.
Strive for consistent pay allocations
Monitor internal pay structure and position in thelabor market for consistency.
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Agency Theory
Agency theory is a theory of governance in theworkplace.
It tries to solve the problem of separation of
ownership (atomistic shareholders) and control(professional executives and non-owners)
It also tries to solve conflicts of interest between
managers and employees with delegatedresponsibilities.
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Agency Theory
1. Principals = owners or managers who delegateresponsibilities
2. Agents = managers or employees who manage
firm assets for owners or other principals.3. Information asymmetry = managers or other
agents have greater access to strategic
information than principals, who are not willingto bear the cost of directly monitoring theagents due to steep agency costs.
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Agency Theory
4. Risk Preferences principals are risk neutraland willing to bear greater risks than agentsbecause their asset wealth is more likely to be
diversified between corporate assets and otherequities/investments. Agents are more riskaverse than principals, because most of theirwealth is concentrated in the firm and received
in the form of pay and opportunities forpromotion.
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Agency Theory
6. Agency Contract provides solution to moralhazard/agency problem, by establishing rules
of the game to control agent opportunism
agents performance will be judged byoutcomes (often financial benchmarks) notbehaviors (which require direct supervision ofagents actions). These outcomes will reflect
principals goals and risk preferences.
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Agency Theory
7. Incentive alignment the agency contract willspecify a compensation plan that aligns theinterests of the principal and agent. This
agency contract will be a type of pay forperformance plan. Meeting or exceeding pre-agreed upon financial or non-financialoutcomes triggers various forms of
compensation (individual or group-based) forthe agent. Some agency costs are borne bythe principal in the form of financial incentivesfor the agent.
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Tournament Theory
1. Tournaments are competitions between peersto achieve a promotion to a higher rank alongwith the pay and perks that go with it.
2. Tournaments are likely to result in a winnertake all outcome.
3. Managers who enter the tournament must
forego other alternatives (such as jobs withother firms, start own business, receive morepay with an alternative opportunity) to competein the tournament.
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Tournament Theory
4. A high pay differential (such as the CEOreceiving much greater pay than anysubordinates) attracts more players to the
tournament.5. Players must invest (work long hours, accept
less pay, show loyalty to their boss) to enter thetournament firm captures value from theseplayers, more than what it gives up to thewinner for the prize.
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Controversies that Surround Pay forPerformance Plans
1. Single Mindednessyou get what you payfor no more, no less. The activities that arerewarded get done, to the exclusion of other
activities that are not rewarded. Example: Thedysfunctional behaviors that are observed whena sales representative is put on straightcommission.
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Controversies that Surround Pay forPerformance Plans
2. Control externalities can control theoutcomes, positive or negative. There can bewindfall affects (the bull market improving the
stock value of all stock options) or negativeexternalities (a bear market or recession thatlowers the value of all stocks). Employeeperformance results may be magnified or
diluted by these effects.
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Controversies that Surround Pay forPerformance Plans
3. Measurement error some measures can begamed or manipulated and may not reflect
true performance. Sales reps can withhold
sales and report it in a different period so theyare not penalized by a cap on salescommissions. Managers can use creative
accounting measures to report greater profits
than were actually experienced by the firm.
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Controversies that Surround Pay forPerformance Plans
4. Inflexibility managers or employees mayresist change of the basis of compensationbecause they are comfortable with current
basis for pay and want to avoid risk of takingreduction in earnings in new system.
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Controversies that Surround Pay forPerformance Plans
5. Misalignment of incentives if pay emphasis ison a goal that is no longer relevant, that goal willcontinue to be emphasized until the pay system
places emphasis on a different objective.For example, managers may emphasize short-term
goals, even if long-term goals are more relevant,until the pay system recognizes long-term goals
to a greater extent than short-term goals. Thereward mix for complex jobs with several goalsmust reflect the relative value of attaining the
mix of goals.
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Controversies that Surround Pay forPerformance Plans
6. Line of Sight problem - division performanceand corporate performance should be reflectedin the pay system. If division performance and
corporate performance are closely linked thanboth division and corporate performance shouldcontribute incentives to the managers pay for
performance plan. If division performance is
independent of corporate performance, then theemphasis should be on rewards for meetingdivision goals.
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Some Suggestions for More Effective Pay ForPerformance Plans
Pay and Performance should be LooselyCoupled this gives managers more flexibilityto make changes when new situations arise.
Example: a formula with a bonus based on amoving average of a 3-year historicalperformance period. A 3-year period smoothesout performance over a longer cycle.
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Some Suggestions for More Effective Pay ForPerformance Plans
It is Necessary to Nurture the Belief thatPerformance Makes a Difference there areimportant cultural values that are supported with
pay for performance even if the accuracy of theperformance metrics and the fairness of the payallocations fall short of an ideal situation.Abandoning pay for performance may be more
problematic than having an imperfect paysystem.
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Some Suggestions for More Effective Pay ForPerformance Plans
Pay for Performance systems should bedesigned to fit each firms unique situationimitation of other firms plans should be avoided
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Six Myths about Pay (Pfeffer, 1998)
1. Labor rates and labor costs are the same thing.
2. Labor costs can be reduced by lowering laborrates.
3. Labor costs are a significant portion of total costs.
4. Low labor costs are a potent source of competitiveadvantage.
5. The most effective way to work productively isthrough individual incentive compensation.
6. People work primarily for money.
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Critical Thinking Questions
1. Sears Roebuck Auto Center paid its automechanics a commission based on the volume ofservices sold to each customer. This basis of pay
resulted in law suits filed against Sears by angrycustomers who claimed they were over-charged forservices they did not need. Sears was forced topay millions of dollars of penalties to thesecustomers which hurt its reputation. Pfefferbelieves that Sears mistake was that it should
have realized that individual pay incentives aredysfunctional. Do you agree with this conclusion?
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Critical Thinking Questions
2. Charles Schwab, the discount broker, does notuse commissions as pay incentives for itsbrokers, bucking financial services industry paypractices. Why do you think Schwab did this?
3. Do you think that the point of view of the author(of the 6 Myths of Pay) would work at a Wall
Street investment bank such as Morgan Stanley?
4. The author of the 6 Myths of Pay article prefersgroup-based pay for performance rather thanindividual pay for performance plans. What isthe reason behind this? Do you agree?