Pay for Performance

1. © Nancy Brown Johnson, 2002 Pay for Performance

2. Seniority/Longevity Based Pay • Rewards employees for tenure • Way to keep investment in human capital • Advantages • Objective • Fair • Disadvantages • Fails to distinguish performance differences • Difficult to use strategically

3. Pay for Performance • Motivation to perform well • Motivation to acquire skills

4. Expectancy Theory Motivation = Expectancy X Instrumentality X Valence • Expectancy - can I do the work? • Instrumentality - if I do the work, will I be rewarded? • Valence - do I value the reward?

5. Implications for Compensation • Valence • Instrumentality Perceptions

6. Required Conditions for Performance Based Pay • Employees must be able to control performance • is performance dependent on others? • Better performance must help organization • Must be able to measure performance • cheaply and accurately • Organization must give meaningful increases • Pay increases must be tied to performance

7. Agency Theory • principals as owners • agents as managers • pay motivates performance • if performance can be monitored  pay based on work • if performance cannot be monitored  pay aligned with organizations goals

8. Agency Theory: Implications • Performance based pay can induce employee performance • Performance based pay linked to organization’s objectives • Employees will need premium for pay at risk

9. Can Compensation Motivate? • On average, organizations with pay for performance have better overall performance • Which way is causality??

10. Decision to Join Firm • People join because of pay • Depends on individual characteristics • Materialistic Pay level • Low self-esteem No pay for performance • Risk takers Pay for performance • Individualists Plans based on individual performance

11. Pay and Retention • Absenteeism reduced when tied with pay • Reduced turnover when skill based pay • Group incentives lead to turnover • Individual incentives lead to retention

12. Merit Pay Characteristics • Rewards past individual performance • Pay is linked to performance appraisal results • Feedback is infrequent

13. Merit Pay Implications • Doesn’t work when performance differences due to system • Discourages teamwork • Poor performance appraisal system will undermine • Pay increases not representative of performance • Contributes to entitlement mentality

14. Individual Incentives • Most jobs have no physical output • Individuals focus only on the incentive • Does not fit with team approach • Rewards output at the expense of quality or service

15. Group Incentives Advantages • Encourages employees to think like OWNERS • Payments are not part of base pay • Encourages teamwork Disadvantages • Does not make instrumentality connection • Many plans defer actual payments • Few plans pay out during business downturns • Often costs more

16. Summary • Pay can motivate • Remember the problem with incentives isn’t that they don’t work, they work too well • Incentives must be set in a context that encourages employees not to just pay attention to rewarded behaviors