Date post: | 24-Dec-2014 |
Category: |
Business |
Upload: | biju-menon |
View: | 229 times |
Download: | 2 times |
ABSTRACT
Compensation is an integral part of human resource management which helps in motivating the
employees and improving organizational effectiveness. All organizations pay according to some
underlying philosophy about jobs and the people who do them.
Compensation management is more than providing a paycheck and cost of living increases. In
many organizations, employee performance relative to organizational goals serves as the basis
for compensation. The compensation systems have changed from traditional ones to strategic
compensation systems. Whether brought on by economic difficulties, changes in technology or
other business factors, compensation remains a human resources challenge.
Pay-for-performance has become increasingly popular. Companies use compensation to reward
and boost the morale of high-performing employees.
The pay-for-performance works best because there are no comparisons, no complaints, and
better results.
Biju Chandramohan AIT
INTRODUCTION
A major goal of any compensation program should be to motivate employees to perform their
best. This goal gained importance in the United States when organizations realized they were in
danger of losing markets to foreign competitors. Many programs were launched to elicit
employee cooperation and increased effort on the job, in order to make American products better
and more competitive. These programs go under a number of names, such as variable pay, merit
pay, alternative pay, incentive systems and pay-for-performance. Merit pay was introduced
based upon making pay increases within pay grades contingent upon performance. This form of
pay goes beyond pay increases within the pay grade to set up a new form of pay; a bonus based
upon a measure of performance.
Paying for performance is not ordinarily as complete a wage structure as paying basically for the
job or possibly competencies can be. Instead paying for performance is integrated within or
added to wage structures primarily based upon performance criteria. With merit pay,
performance becomes the standard by which the employee moves upward within the pay grade
for the job. In most variable pay plans performance is a factor that leads to an addition to base
pay or base pay is lowered to make room in the compensation budget for a performance reward.
DESIRABILITY
The idea of relating pay to performance is highly attractive to most managers – so much so that
almost all organizations claim that they have pay for performance at least in the form of a merit
pay system. But there is a great deal of evidence that pay for performance is not easy to
implement, not always desirable, and not as prevalent as the surveys would indicate.
Both management and employees agree that tying pay to performance is desirable. Studies do
show that managerial employees feel that their level of performance should be the most
important variable in establishing the amount of a pay increase. While not all groups of
employees rank performance that highly, to most employees performance is a significant
indicator of how much pay they should receive.
Organizations clearly perceive that pay for performance is important. Most organizations
surveyed claim that they do connect pay with performance in setting pay rates for employees.
Biju Chandramohan AIT
Furthermore, the practice is spreading to more employee groups. Whereas managers have always
worked under merit pay systems, the emphasis for other employee groups has usually been
equity. But more and more emphasis on performance is extending to such nontraditional groups
as teachers.
Despite its obvious appeal, not all aspects of pay for performance are desirable. First of all, a
focus on performance often conflicts with the compensation goal of equity: in a pay-for-
performance system, employees in the same work group doing the same work may be earning
greatly different pay rates. Feelings of inequity can always arise in this situation, especially if the
program is not well designed and communicated or where people do not perceive performance as
a proper variable by which to set pay.
A second reason that pay-for-performance may not be desirable stems from the first one. The
program implicitly or explicitly puts people in competition with each other. Yet what is needed
for the work of the organizational unit to be accomplished is cooperation. Where everyone has to
work together, differential pay can have a divisive effect that may produce lower and not higher
performance for the group as a whole. This may explain why first-line supervisors are often not
as enthusiastic about pay-for-performance as higher-level managers.
A third reason that pay-for-performance may not be desirable is administrative. As will be seen
in this chapter, pay-for-performance takes managerial time and effort and must be designed and
administered carefully. Failure to put forth the managerial and staff effort required will lead to a
program that does not in fact tie pay to performance and will make employees distrust
management.
This leads to the fourth and last reason that pay-for-performance may not be desirable – lack of
trust. Pay-for-performance most often relies on the judgments of managers about the level of
performance of employees. Unless employees trust the judgment of the manager and perceive
that it is in fact their performance that is being rewarded, there is a good possibility that they will
see the program as manipulation of employees by management. The problem is that trust cannot
be entirely created by the compensation program.
Biju Chandramohan AIT
PREREQUISITES
A pay-for-performance program requires a compatible organizational situation if it is to succeed.
To examine the feasibility of having pay-for- performance, it is useful to review the three
components of expectancy theory.
Valence
The first part of expectancy theory says that people must feel that the reward being offered – in
this case money – is important in satisfying their needs. Although an argument can be made that
money is the most universal instrument for need satisfaction, it is clear that its value to different
people is different. A pay-for-performance program is going to work best where pay is highly
valent to the people covered by it. This valence cannot be assumed, it must be determined by
research.
As an example, a researcher was called in to a company where a group of women seemed unable
to meet production standards despite the attractiveness of the incentives provided. He discovered
that this was a group of traditional women who believed they should not make more money than
their husbands and felt guilty about not being at home when their children got out of school. The
researcher suggested to management that the women be allowed to go home as soon as they had
met their standard for the day. The suggestion was accepted and the productivity of the group
improved immediately. These workers were not completely motivated by money. Lawler
suggests that programs such as pay for performance be installed only in units where the
employees clearly have a high need for money. In circumstances where management wants the
motivational force of pay-for-performance, then it is useful to select people who clearly have a
need for money.
The Performance-Reward Connection
It should be obvious that for pay-for-performance to work there must be a connection between
pay and performance. This is easy to say but very difficult to achieve. Organizations are complex
social systems whose members are subject to many influences on their performance at any one
Biju Chandramohan AIT
time. To isolate a simple pay-performance connection is not possible. A number of problems
increase the complexity of the connection.
First of all, any compensation program tries to achieve a number of things at the same time, and
these goals are not always consistent. Second, even if the program does make the connection, the
employees must perceive the connection. Secrecy in pay is a factor that leads employees to guess
at this connection, usually inaccurately. The connection is not always a comfortable one to
employees, who may therefore try to assume it does not exist. Third, pay-for-performance is
only as good as performance appraisal – the system that defines "good" performance. A
perception that the performance-appraisal system is biased or does not appraise actual
performance destroys the connection for the employee. Performance appraisal will be discussed
later in this text.
A serious complication is that management and employees may not agree on the performance
level of the latter. Meyer studied a number of occupational groups and found that people tend to
rate their performance higher than does management. Specifically, he found that over 95 percent
of his respondents rated their performance above average; and 68 percent thought they were in
the top 25 percent in performance. If we compare such findings with the assumption of pay-for-
performance – that performance is a normal distribution – then we can see that a great many
employees are not going to perceive that their pay is related to their performance.
The Performance-Effort Connection
Employees must perceive that their effort leads to performance. A pay-for-performance program
assumes that performance varies among employees and that this difference is observable. But in
many jobs, variation is impossible or is so little that it is unrealistic to try to measure it for pay
purposes. Even if there are differences, measuring them or attributing them to the effort of the
employee may be difficult. For instance, the efforts of an individual in a group project may not
be able to be divorced from the efforts of the other members of the group. The employee may
not feel he or she controls the important measures of performance. Teachers, for example, realize
that for them the important measure is student learning, but they feel only minimal control over
that variable.
Biju Chandramohan AIT
The main point is that pay-for-performance is not a solution for all motivation and performance
problems in organizations. It can be very effective where the requirements of expectancy theory
can be met. But in many circumstances its application is likely to lead to frustration and other
problems within the organization.
Defining Performance
The first two definitions of performance in the dictionary are: (1) The execution of an action, and
(2) something accomplished. In terms of an employee this would suggest that performance has to
do with what the employee accomplishes and what actions or behaviors go into creating the
accomplishment. From this, performance criteria may fall into three categories: inputs, activities
and outcomes.
Inputs
An input is what the person brings to the job. This includes the employee's knowledge, skills,
abilities and effort. A pay for knowledge plan may define performance as developing or
increasing knowledge, skills or ability, but this plan must specify exactly what is to be learned or
improved. Effort is controllable by the employee and may be a good performance factor if it can
be measured and known to lead to a desired outcome. (Note the bias toward outcomes in this
statement.)
A real problem is when the performance definition is a personal characteristic. It is common to
have such factors in performance appraisal. But the employee who is told that he/she rates low
on such a factor feels personally attacked and rated down on something that is hard to change at
best.
Behaviors
Behaviors focus on what the employee does at the job. They measure the way the job is done.
Again, the thought behind this is if the employee does the job correctly, then the desired outcome
will occur. The advantage of defining performance as a behavior is that it is more observable
than other criteria. Doing the job the way it needs to be done is very important in organizations
Biju Chandramohan AIT
where work must be coordinated between employees. Some performance appraisal techniques,
such as BARS (to be discussed later), focus clearly on this definition of performance.
Outcomes
This is what usually comes to mind when the word performance is used. Outcomes are the
productivity measure of the employee, group or organization. As an example, in a conversation
with the woman who ran the Faculty Club, she said that she had four waiters and one of them
could handle more than twice the tables of any of the other three. That one waiter was clearly
more productive. Why don’t we just use outcomes as the measure of performance in all cases?
There are three reasons:
Identifying and measuring desired outcomes can be very difficult for many jobs.
The outcome may be achieved but in ways that are unacceptable. A sales person who sells a
large quantity of goods to a customer with poor credit creates more problems than the value of
the sales.
How one goes about doing the job may also be important. A bank teller who treats customers
politely is valuable to the bank, but this is not an outcome of doing the job.
Differential Performance
Differential performance is assumed to occur in organizations. It is usually desired but is also
restricted by the way jobs are designed. Assembly-line jobs are often designed so that variation
in performance is impossible or irrelevant to the desired outcomes. Variation in performance
where tight coordination of activities is necessary creates trouble and does not necessarily
increase productivity. On the other hand, jobs such as sales, engineering, and management have
a great deal of latitude in their effects on outcomes.
There is also an intermediate position between these two extremes that may be very common in
organizations. Most raters can identify those few employees who are doing an outstanding job.
Likewise, they can identify those few who are doing very poorly. But most performance-
appraisal systems ask that performance distinctions be made among all employees. It is very
likely that not only is making distinctions in the middle of the performance scale very difficult,
but also that the differences are so small as to not warrant differentiation.
Biju Chandramohan AIT
Differential performance is not just an ideal; it is a fact. Some people are capable of producing
two or three times what others are, and the best as much as five or six times more than the worst.
These findings indicate that the reward system of organizations could create much higher levels
of performance and therefore productivity in employees, if it were clear to the employees that
they would be rewarded for the increased productivity. But it should be kept in mind that not all
jobs permit differences in performance and not all organizations require or desire them.
The preceding comments assume that good performance means higher output. This is certainly
an important definition of good performance, but it is not the only one. How the job is done may
also be very important. The organization may wish to reward a series of behaviors as well as the
productivity of the employee. A focus strictly on the outcomes of work, such as sales volume,
allows the organization to pay directly for those outcomes. This type of payment system – a
variable system. If the organization wishes to focus on more than just outcomes or finds it
difficult to measure the outcomes, then performance appraisal comes into play and the pay-for-
performance programs discussed here are appropriate. The distinction between these two
systems can also be seen as that between measurement and appraisal.
Program Development
A merit pay system is a particular method for determining the movement of employees within a
pay range. The goal of the program is to match employee performance levels with position in the
pay range over time.
Biju Chandramohan AIT
Figure 1. The Concept of Merit Pay
Movement upward in the rate range occurs only if the employee's wage rate is lower in the pay
range than his or her performance is on the performance scale. Employees whose wage rate
exceeds their performance standing receive no increase. Merit Pay allows the organization to
move high performers upward in the rate range very fast by giving large increases to these
employees. It also allows movement downward in the rate range if the employee's performance
level goes down by freezing the wage rate at the current level.
A merit pay program requires the use of an open rate range, a good performance appraisal
system, and a guide chart for pay increases.
Open Rate Range
A pay-for-performance program relies on an open rate range. Such a rate range defines only the
minimum, the maximum, and the midpoint of the range. This rate range needs to be broad
enough so that it is possible to give large pay increases to good performers. Movement within
the pay grade is determined strictly by the performance of the employee, and the position of the
employee within the range is maintained only by good performance over time. Having reached a
particular point in the range, the employee may slip back the next time the pay structure is
adjusted if his or her performance is not as good as in the present period.
Biju Chandramohan AIT
The starting point for determining a pay increase is the position of each employee in the rate
range after a pay structure adjustment has been made.
Figure 2. Pay structural adjustment in a pay-for-performance system
In this illustration there are three employees: A, B, and C. Before the structure adjustment, A
was between the first and second quartiles, B was just above the midpoint, and C was at the top
of the pay grade. After the adjustment A is at the bottom of the pay grade, B is in the second
quartile, and C is between the third and fourth quartiles. It is the newly adjusted positions that
are the starting points for determining the pay increases for the next period.
Performance-Appraisal Rank
It must be possible to place each employee upon a distribution of performance. This distribution
is assumed to be divisible into segments such as quartiles, and each individual can be identified
as being within a particular segment. This system does not allow for everyone being rated high
or low; it assumes that there is an even spread of performance – a normal distribution. If this
distribution does not appear in the ratings, spreading out the ratings along the continuum will
develop it.
Guide Chart
Rate range and performance rank are combined in a guide chart,
Biju Chandramohan AIT
Figure 3. Example of a Pay-for-Performance Guide Chart
The horizontal dimension of this chart is the present position of an employee in the rate range.
The vertical dimension is the performance ranking of the employee. Each employee can be
placed in a box on the guide chart if these two dimensions are known about him or her.
The boxes in a guide chart indicate the appropriate percentage of increase that should be given to
any employee in the current period. The amounts are determined by the budgetary process and
the amount of adjustment that has been made in the wage structure. As an example, suppose that
the wage structure adjustment illustrated in figure 2 was 6 percent. If employee C's performance
during the period just ended was outstanding, then we would want to move his/her wage rate
again to the top of the rate range, a 6 percent increase. If B's performance was below average, no
increase would be called for. Finally, if A's performance was outstanding, then a maximum
increase should be granted: 12 percent according to figure 3. Note that even this increase would
probably not fully equate A's salary with his/her current performance. A continued high level of
performance would lead to larger increases and a matching of performance rating and position in
the rate range. In general, then, employees whose combination of wage rate and performance
places them on the left upper portion of figure 3 will receive above-average increases, while
those in the lower-right areas will receive small increases or no increase.
Biju Chandramohan AIT
The example in figure 3 is a simple one: it varies only the amount of the pay increase with
performance and the place in the rate range. Rather than having a set percentage increase, as
illustrated here, each of the boxes could have a range, say 11 to 14 percent, so that finer
adjustments could be made for those close to the boundaries of the boxes. Even more movement
for good performers and less for poor performers can be allowed by altering the time period
between adjustments, such as giving increases to good performers every six months while
granting lower performers increases every eighteen months. Such alterations allow the top
percentages to not appear so large and the percentages at the bottom to appear larger than they
are in reality.
Comparative Study of 2 MNCs: Organization A following Pay for performance and
Organization B, pay based on experience
The pay-for-performance of Organization A is very well designed pay structure which takes into
consideration the quality of work done, the quantity of work done, independence, punctuality,
and personal development. All these factors are measured in an unbiased manner and most of
measurement is system generated. Although this organization was part of the BPO industry
which faces high attrition rates, it was found that the attrition rate in this organization was below
4%. The organization also sets industry’s best standards when it comes to quality.
On the other hand Organization B, paid its employees more on the basis of experience and the
employees of this company were highly dissatisfied, and the attrition rate in this organization
was more than 20%, and most of employees were not motivated enough nor were the employees
happy with salary structure of this organization.
Conclusion:
Pay for performance compensation structures not only account for individual, but also account
for the working environment and performance of the team as well. This can be a valuable
benefit, as knowing that compensation increases will be based on the performance of the team
will coerce employees to operate as a cohesive unit in order to reach a common goal.
Biju Chandramohan AIT
Pay for performance, or P4P is a system in which employees attain increased levels of
compensation if their team, department, or company reaches specified targets. P4P has been
implemented as a motivational tactic and with an eye to persuade employees to work harder and
benefit the company while at the same time providing an added benefit for themselves.
BIBLIOGRAPHY
1 . Heneman, R.L. & Gresham, M.T., "Performance-Based Pay Plans" in Smither, J.W.,
Performance Appraisal: State-of-the Art Methods for Performance Management, San Francisco,
Jossey-Bass, 1998.
2 . Lawler, E., Mohrman, S. & Ledford, G. Creating High Performance Organizations: Practices
and Results of Employee Involvement and TQM in Fortune 1000 Companies, San Francisco,
Jossey-Bass, 1995.
3. Lawler, Et al. Ibid.
4. Kelley, C., "Making Merit Pay Work" American School Board Journal, National School
Boards Association, 2000.
5. Fox, J., Scott, K., & Donahue, J., "An Investigation into Pay Valence and Performance in a
Pay-for-Performance Field Setting", Journal of Organizational Behavior, Vol.14, 1993. pp. 622-
636.
6. D. C. Feldman and H. J. Arnold, Managing Individual and Group Behavior in Organizations
(New York, McGraw-Hill, 1983, pp. 296-301.
7. E. E. Lawler, Pay and Organizational Effectiveness (New York: McGraw-Hill, 1971).
8. Lawler, E., & Jenkins, G. "Strategic Reward Systems" in Dunnette, M. Handbook of
Industrial and Organizational Psychology 2nd Ed. Vol. 3, Palo alto, Consulting Psychologists
Press, 1992. pp. 1009-1055.
9. H. H. Meyer, "Pay for Performance Dilemma," Organizational Dynamics, Winter 1975, pp.
71-78.
10. D. McGregor, "An Uneasy Look at Performance Appraisal," Harvard Business Review,
May-June 1957, pp. 89-94.
11. Seltz, S., & Heneman, R., Linking Pay to Performance, Scottsdale, AZ. World at Work,
2004.
12. Byars, L. & Rue, L., Human Resource Management; 8th Ed. Boston, McGraw-Hill, 2006.
Biju Chandramohan AIT
13. Landy, F., & Farr, J. The Measurement of Work Performance: Methods, Theory and
Applications, New York, Academic Press. 1983.
14. Heizer, J., & Render, B., Operations Management, 6th Ed. Chicago, Pearson Education,
2005.
15. Gregory, R. Psychological Testing, Chicago, Pearson Educational, 2006.
16. Grote, D. The Complete Guide to Performance Appraisal, New York, AMACOM, 1996.
17. Bureau of National Affairs, Performance Appraisal Programs, Personnel Policies Forum
Survey No. 135 (Washington D.C., 1983).
18. Gregory. Op Cit.
19. Grote. Op Cit.
20. Schriesheim, C., & Gattiker, U. "A study of the Abstract Desirability of Behavior-Based v.
Trait-Oriented Performance Ratings" Proceedings of the Academy of management 43 1982. pp.
307-311.
21. Goffin, R., Gellatly, I., Paunonen, S., Jackson, D., and Meyer, J. "Criterion Validation of
Two Approaches to Performance Appraisal: The Behavioral Observation Scale and the Relative
Percentile Method" Journal of Business and Psychology, vol. 11 #1, September 1996, pp. 23-33.
22. Murphy, K. & Cleveland, J. Understanding Performance Appraisal: Social, Organizational
and Goal-based Perspectives, Thousand Oaks, Sage Publications, 1995.
23. Grote, op Cit
24. G. P. Latham and E. A. Locke, "Goal Setting: A Motivational Technique That Works,"
Organizational Dynamics, 1979, pp. 68-80.
25. P. H. Thompson and G. W. Dalton, "Performance Appraisal: Managers Beware," Harvard
Business Review, January-February 1970, pp. 149-57.
26. Milkovich, G. & Newman, J. Compensation, 8th Ed., Boston, McGraw-Hill, 2005.
27. Edwards, M. & Ewen, A. 360-Degree Feedback: The Powerful New Model for Employee
Assessment and Performance Improvement, Toronto, American Management Association, 1996.
28. London, M, Mone, E., & Scott, J., "Performance Management and Assessment: Methods for
Improved Rater Accuracy and Employee Goal Setting", Human Resource Management., Winter,
2004. Vol. 43, # 4; p. 319-336.
Biju Chandramohan AIT