COMMERCE 2BC3 Chapter Notes - Chapter 9: Downside Risk, Job Satisfaction, Performance Appraisal
4 Jul 2018
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Chapter 9: Recognizing Employee Contributions with Pay
How does pay influence individual employees?
-Reinforcement Theory
oE.L. Thorndike’s law of effect states that a response followed by a reward is more likely to recur
in the future
oThe implication for compensation mgmt. is that high employee performance followed by a
monetary reward will make future high performance more likely
▪High performance not followed by a reward will make it less likely in the future
oThe theory emphasizes the importance of an employee’s actual experience of a reward in terms
of motivating future actions
-Expectancy Theory
oAlso focuses on the link between rewards and behaviors, it emphasizes expected rewards
oIt focuses on the effects of incentives when they are offered by an org
oBehaviors can be described as a function of ability and motivation → motivation is hypothesized
to be a function of expectancy, instrumentality, and valence perceptions
oSome authors say that monetary rewards increase extrinsic but decrease intrinsic motivation
▪Extrinsic motivation depends on rewards controlled by an external force whereas intrinsic
motivation that flow naturally from work itself
-Agency Theory
oFocuses on the divergent interests and goals of all of the org’s stakeholders and the ways that
employee compensation can be used to align these interests and goals
oAn important characteristic of the modern corp is the separation of ownership from mgmt.
oAlthough this separation has important advantages, it also creates agency costs – the interests
of the principals (owners) and their agents (managers) may no longer converge
oAgency costs can arise from 2 factors
▪First, principals and agents may have different goals
▪Principals may have less than perfect info on the degree to which the agent is pursuing and
achieving the principal’s goals
o3 examples of agency costs can occur in managerial compensation
▪Although shareholders seek to max their wealth, mgmt. may spend money on things such as
perquisites or empire buildings
▪Managers and shareholders may differ in their attitudes toward risk. Shareholders can diversify
their investment more easily than managers so managers are usually more averse to risk
▪Decision making horizons may differ → ex: if managers change companies more than owners
change ownership, managers may be more likely to max short run performance perhaps at the
expense of long term success
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oThis theory says that the principal must choose a contracting scheme that helps align interest of
the agent with the principal’s own interest
oWhat type of contract should an org use? It depends on the following factors:
▪Risk aversion
▪Outcome uncertainty
▪Job programmability
▪Measurable job outcomes
▪Ability to pay
▪Tradition
How does pay influence labour force composition?
-Membership behaviors are decisions employees make about whether to join an org or remain
with an org
-However there is increasing recognition that individual pay programs may also affect the nature
and composition of an org’s workforce
oEx: an org that links pay to performance may attract more high performers
Pay for performance programs
-Pay for Performance: variable forms of pay designed to recognize and reward employees’
performance that are based on measures of individual or group contributions to the
organization’s success; sometimes called incentive pay, variable pay, or performance-based pay
-In compensating employees, an org does not have to choose one program over another
oA combo of programs is often the best solution
-Merit pay
oAnnual pay increases are usually linked to performance appraisal ratings
oSome type of merit pay programs exists in almost all orgs
oOne reason for widespread use of merit pay is its ability to define and reward a broad range of
performance dimensions
oMerit Bonuses: merit pay paid in the form of a bonus, instead of a salary increase
oBasic features
▪Many merit pay programs work off a merit increase grid → a grid that combines an employees’
performance ratings with the employee’s position in a pay range to determine the size and
frequency of his pay increases
▪Size and frequency of pay increases are determined by 2 factors:
●Individual’s performance rating
●Position in range
oOne reason factoring in the compa ratio is to control compensation costs and maintain the
integrity of the pay structure
oLarger and more frequent pay increases are necessary to move the employee to the correct
position
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oMerit Increase Grid: a grid that combines an employee’s performance rating with the
employee’s position in a pay range to determine the size and frequency of his or her pay
increase
oMerit pay programs have the following characteristics
▪They identify individual differences in performance which are assumed to reflect differences in
ability or motivation
▪The majority of info on individual performance is collected from the immediate supervisor
▪There is a policy of linking pay increases to performance appraisal results
▪The feedback under such systems tends to occur infrequently often once per year at the formal
performance review session
▪The flow of feedback tends to be largely unidirectional from supervisor to subordinate
oCriticisms of traditional merit pay programs
▪W. Edward Deming, a leader of the tqm movement, argued that it is unfair to rate individual
performance because apparent differences between people arise almost entirely from the
system that they work in, not from the people themselves
●He said performance ratings are the result of a lottery
▪He also argued that the individual focus of merit pay discourages teamwork → everyone
propels himself forward, or tries to, for his own good, on his own life persever. The org is the
loser
▪Deming’s solution was to eliminate the link between individual performance and pay → too
little emphasis on individual performance may leave the org with avg and poor performers
▪The way they measure performance, if the performance measure is not perceived as fair and
accurate, the entire program can break down
▪Process issues appear to be important in administering merit pay. In any situation where
rewards are distributed, employees appear to assess fairness along 2 dimensions:
●Distributive (how much they receive) and procedural (what process was used to decide how
much)
▪Most basic criticism is that merit pay does not really exist
●High performers are not paid significantly more than mediocre → the difference is problem not
significant enough to influence employee behavior or attitude
-Individual incentives
oIndividual incentives reward individual performance, but with two important differences:
▪Payments are not rolled into base pay → they must be continuously earned and re-earned
▪Performance is usually measured as physical output rather than by subjective ratings →
individual incentives have the potential to significantly increase performance
oThey are relatively rare for a few reasons:
▪Most jobs have no physical output measure, they involve what might be described as
knowledge work
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find more resources at oneclass.com
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