Rewarding Performance 1. Psychological Theories Related to Rewards. 2. Challenges to Pay-for-Performance. 3. Meeting the Challenges to Pay-for-Performance. 4. Difference in Merit Pay and Incentive Pay. 5. Four Types of Incentive Systems and the Conditions Favoring Each Type.

Rewarding Performance

Pay-for-Performance (Incentive) Systems Assume That… Individuals and teams differ in level and quality of contribution Firm’s overall performance depends on performance of individuals and groups in the firm Firm should reward employees based on their relative performance to attract, retain and motivate high performers

Primary reasons for adopting performance based pay arrangements Motivate employees to give their very best effort. Clearly communicate the relationship between employee/team performance and organizational success. Attract and retain a high performing workforce.

Challenges to Performance Based Pay The assumptions of a pay-for-performance system seem straightforward and acceptable. However, it is widely recognized that incentive systems can create negative consequences for firms.

Challenges to Performance Based Pay Focus only on behaviors leading to rewards. Negative effects on cooperation. Lack of control over factors necessary for success. Difficulty in measuring performance. Psychological contract. Credibility gap. Job dissatisfaction and stress. Reduction in intrinsic motivation.

Challenge 1: Focus only on behaviors leading to rewards. . The closer pay is tied to particular performance indicators, the more employees tend to focus on those indicators and neglect other important job components

Challenge 2: Negative effects on cooperation. For most jobs and operations, cooperation is needed for success. Negative Effects on the Spirit of Cooperation Employees may withhold information from a colleague if they believe that it will help the other person get ahead

Challenge 3: Lack of control over factors affecting job performance. Employees often cannot control all of the factors affecting their performance .

Challenge 4: Difficulty in measuring performance. Assessing employee performance is one of the thorniest tasks a manager faces, particularly when the assessments are used to dispense rewards Organizations must ensure that performance measures are relevant and devoid of bias and favoritism.

Challenge 5: Perceived Psychological Contract. Expectations about continuing rewards Once implemented, a pay-for-performance system creates a psychological contract between the employee and firm, and it is very resistant to change

Challenge 6: The credibility gap. Employees often do not believe that pay-for-performance programs are fair or that they truly reward performance For performance based pay to motivate, employees must trust management to set realistic targets and to provide equitable rewards when those targets are met.

Challenge 7: Job dissatisfaction and stress. Pay-for-performance systems may lead to greater productivity but lower job satisfaction. Reasons might be: Perceived lack of control over work related factors. Poor training for the job. Break-downs in communication and coordination among individuals and departments. Pressure to attain inflexible performance goals. Dissatisfaction with the size of the rewards.

Challenge 8: Reduction in Intrinsic Motivation. Research in psychology and management science have documented the importance of Intrinsic motivation. Employees seek (a) variety, (b) challenge, (c) interest, (d) autonomy, and (e) a sense of personal achievement from their work. Short term pay-for-performance programs, which emphasize Extrinsic motivation, may dilute the sense of employee “ownership” and empowerment, and undermine intrinsic motivational effects.

Meeting the Challenges 1. Linking pay to performance. 2. Use as part of broader HR system. 3. Build employee trust. 4. Allow employee involvement. 5. Communicate company goals. 6. Use multiple layers of rewards. 7. Build on intrinsic motivation.

1. Link between performance and rewards Use performance based pay (Rewards) where : 1. There is a range of performance possible in the job. (Flexibility). 2. Employees have reasonable control over factors that affect their performance. 3. Performance goals can be clearly identified. 4. Performance standards and rewards can be clearly specified. So that employees know what rewards will be forthcoming for meeting specified goals.

2. Use as part of a broader HR system Performance based pay plans are more likely to succeed when complimentary HR programs are effective. Employees are more likely to perform well and receive rewards when: Selection assures needed skills. Employees are trained effectively. Career planning puts people in right jobs.

3. Build employee trust through communication, employee involvement, and consistent administration of the system. 4. Provide employee involvement/Participation Appoint an oversight committee, use worker councils, productivity committees (quality circles), and allow appeals. 5. Communicate company goals and how employee performance makes a difference and success Share industry data, company performance, and relevant financial information, operating plans, goals

6. Use multiple levels of rewards Because all pay-for-performance systems have positive and negative features, providing different types of pay incentives for different work situations is likely to produce better results than relying on a single type of pay incentive Multiple levels of rewards – i.e. individual, group, and company-wide. Helps: ensure cooperation reduces employee risk, such as fair wages and benefits, ensure team bonuses, facility or division-wide bonuses (i.e., gain sharing), and profit sharing or employee stock ownership (ESOPs).

7. Provide an opportunity for intrinsic rewards Some people are more interested in the nonfinancial aspects of their work Intrinsic motivation emanates from a sense of personal achievement and growth. It is experienced through the variable reinforcement schedule, which gives strong and consistent performance. Organizations can capitalize on this kind of human motivation through: Empowerment (more authorities) Job enrichment (improvement on work conditions) Participative management (participating in the decision making process)

Types of Incentive Plans I. Individual II. Group/Team III. Facility/Division IV. Corporate

I. Individual Plans Rewards are based on individual performance (e.g. piece rate, commissions, or bonuses). Also, stock awards are used in many companies.

Conditions under which individual-based plans are most likely to succeed: When jobs have autonomy (i.e., performed independently). When individual contributions can be isolated (i.e., measured). When coordination and cooperation between employees is not critical for success. (i.e., jobs are independent).

II. Group/Team Plans Rewards are based upon group or team performance and/or outcomes. These plans normally reward all team members equally based on group outcomes.

Conditions under which team-based plans are most likely to succeed: Less supervision is needed (e.g. self-directed teams). When the firm’s organization facilitates the implementation of team-based incentives When work tasks are so intertwined it is difficult to single out who did what Emphasis is on common goals. Employees tend to have high job commitment. When the objective is to foster entrepreneurship in self-managed work groups

III. Facility/Division Plans Generally referred to as gainsharing programs because they return a portion of the company's cost savings to the workers, usually in the form of a lump-sum bonus. Emphasis is on inter-group cooperation. Pulling together toward shared goals.

Corporate culture of trust and participation. Conditions under which Facility/Division Plans are most likely to succeed: Small to medium sized firms. Technology allows improvements in performance. Stable product market. Where company historical records related to performance are available Corporate culture of trust and participation.

IV. Corporate-Wide Plans Macro type of incentive program and is based on the entire corporation's performance Corporate-wide plans are typically designed as Profit Sharing arrangements. These plans attempt to reduce the complexity of other incentive plans, but hope to secure long term employee commitment.

Conditions Favoring Corporate-Wide Plans: Medium to large firms. Interdependence of many divisions, and it would be difficult to set separate performance goals for each. Competitive markets may be complex and/or unstable, which would make it difficult to determine a meaningful incentive formula. The presence of other incentives