Motivation: Reward system and the role of compensation

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The design and management of reward systems present the general manager
with one of the most difficult HRM tasks. This HRM policy area contains
the greatest contradictions between the promise of theory and the
reality of implementation. Consequently, organizations sometimes go
through cycles of innovation and hope as reward systems are developed,
followed by disillusionment as these reward systems fail to deliver.

Rewards and employee satisfaction

Gaining an employee’s satisfaction with the rewards given is not a
simple matter. Rather, it is a function of several factors that
organizations must learn to manage:

1. The individual’s satisfaction with rewards is, in part, related to
what is expected and how much is received. Feelings of satisfaction or
dissatisfaction arise when individuals compare their input – job skills,
education, effort, and performance – to output – the mix of extrinsic
and intrinsic rewards they receive.

2. Employee satisfaction is also affected by comparisons with other
people in similar jobs and organizations. In effect, employees compare
their own input/output ratio with that of others. People vary
considerably in how they weigh various inputs in that comparison. They
tend to weigh their strong points more heavily, such as certain skills
or a recent incident of effective performance. Individuals also tend to
overrate their own performance compared with the rating they receive
from their supervisors. The problem of unrealistic self-rating exists
partly because supervisors in most organizations do not communicate a
candid evaluation of their subordinates’ performance to them. Such
candid communication to subordinates, unless done skillfully, seriously
risks damaging their self-esteem. The bigger dilemma, however, is that
failure by managers to communicate a candid appraisal of performance
makes it difficult for employees to develop a realistic view of their
own performance, thus increasing the possibility of dissatisfaction with
the pay they are receiving.

3. Employees often misperceive the rewards of others; their
misperception can cause the employees to become dissatisfied. Evidence
shows that individuals tend to overestimate the pay of fellow workers
doing similar jobs and to underestimate their performance (a defense of
self-esteem-building mechanism). Misperceptions of the performance and
rewards of others also occur because organizations do not generally make
available accurate information about the salary or performance of

4. Finally, overall satisfaction results from a mix of rewards rather
than from any single reward. The evidence suggests that intrinsic
rewards and extrinsic rewards are both important and that they cannot be
directly substituted for each other. Employees who are paid well for
repetitious, boring work will be dissatisfied with the lack of intrinsic
rewards, just as employees paid poorly for interesting, challenging work
may be dissatisfied with extrinsic rewards.

Rewards and motivation

From the organization’s point of view, rewards are intended to motivate
certain behaviors. But under what conditions will rewards actually
motivate employees? To be useful, rewards must be seen as timely and
tied to effective performance.

One theory suggests that the following conditions are necessary for
employee motivation.

1. Employees must believe effective performance (or certain specified
behavior) will lead to certain rewards. For example, attaining certain
results will lead to a bonus or approval from others.

2. Employees must feel that the rewards offered are attractive. Some
employees may desire promotions because they seek power, but others may
want a fringe benefit, such as a pension, because they are older and
want retirement security.

3. Employees must believe a certain level of individual effort will lead
to achieving the corporation’s standards of performance.

As indicated, motivation to exert effort is triggered by the prospect of
desired rewards: money, recognition, promotion, and so forth. If effort
leads to performance and performance leads to desired rewards, the
employee is satisfied and motivated to perform again.

As mentioned above, rewards fall into two categories: extrinsic and
intrinsic. Extrinsic rewards come from the organization as money,
perquisites, or promotions or from supervisors and coworkers as
recognition. Intrinsic rewards accrue from performing the task itself,
and may include the satisfaction of accomplishment or a sense of
influence. The process of work and the individual’s response to it
provide the intrinsic rewards. But the organization seeking to increase
intrinsic rewards must provide a work environment that allows these
satisfactions to occur; therefore, more organizations are redesigning
work and delegating responsibility to enhance employee involvement.

Equity and participation

The ability of a reward system both to motivate and to satisfy depends
on who influences and/or controls the system’s design and
implementation. Even though considerable evidence suggests that
participation in decision making can lead to greater acceptance of
decisions, participation in the design and administration of reward
systems is rare. Such participation is time-consuming.

Perhaps, a greater roadblock is that pay has been of the last
strongholds of managerial prerogatives. Concerned about employee
self-interest and compensation costs, corporations do not typically
allow employees to participate in pay-system design or decisions. Thus,
it is not possible to test thoroughly the effects of widespread
participation on acceptance of and trust in reward system.

Compensation systems: the dilemmas of practice

A body of experience, research and theory has been developed about how
money satisfies and motivates employees. Virtually every study on the
importance of pay compared with other potential rewards has shown that
pay is important. It consistently ranks among the top five rewards. The
importance of pay and other rewards, however, is affected by many
factors. Money, for example, is likely to be viewed differently at
various points in one’s career, because the need for money versus other
rewards (status, growth, security, and so forth) changes at each stage.
National culture is another important factor. American managers and
employees apparently emphasize pay for individual performance more than
do their European or Japanese counterparts. European and Japanese
companies, however, rely more on slow promotions and seniority as well
as some degree of employment security. Even within a single culture,
shifting national forces may alter people’s needs for money versus other

Companies have developed various compensation systems and practices to
achieve pay satisfaction and motivation. In manufacturing firms, payroll
costs can run as high as 40% of sales revenues, whereas in service
organizations payroll costs can top 70%. General managers, therefore,
take an understandable interest in payroll costs and how this money is

The traditional view of managers and compensation specialists is that if
the right system can be developed, it will solve most problems. This is
not a plausible assumption, because, there is no one right answer or
objective solution to what or how someone should be paid. What people
will accept, be motivated by, or perceive as fair is highly subjective.
Pay is a matter of perceptions and values that often generate conflict.

Management’s influence on attitudes toward money

Many organizations are caught up in a vicious cycle that they partly
create. Firms often emphasize compensation levels and a belief in
individual pay for performance in their recruitment and internal
communications. This is likely to attract people with high needs for
money as well as to heighten that need in those already employed. Thus,
the meaning employees attach to money is partly shaped by management’s
views. If merit increases, bonuses, stock options, and perquisites are
held out as valued symbols of recognition and success, employees will
come to see them in this light even more than they might have perceived
them at first. Having heightened money’s importance as a reward,
management must then respond to employees who may demand more money or
better pay-for-performance systems.

Firms must establish a philosophy about rewards and the role of pay in
the mix of rewards. Without such a philosophy, the compensation
practices that happen to be in place, for the reasons already stated,
will continue to shape employees’ satisfactions, and those expectations
will sustain the existing practices. If money has been emphasized as an
important symbol of success, that emphasis will continue even though a
compensation system with a slightly different emphasis might have equal
motivational value with fewer administrative problems and perhaps even
lower cost. Money is important, but its degree of importance is
influenced by the type of compensation system and philosophy that
management adopts.

Pay for performance

Some reasons why organizations pay their employees for performance are
as follows:

under the right conditions, a pay-for-performance system can motivate
desired behavior.

a pay-for-performance system can help attract and keep
achievement-oriented individuals.

a pay-for-performance system can help to retain good performers while
discouraging the poor performers.

In the US, at least, many employees, both managers and workers, prefer a
pay-for-performance system, although white-collar workers are
significantly more supportive of the notion than blue-collar workers.

But there is a gap, and the evidence indicates a wide gap, between the
desire to devise a pay-for-performance system and the ability to make
such a system work.

The most important distinction among various pay-for-performance systems
is the level of aggregation at which performance is defined –
individual, group, and organizationwide. Several pay-for-performance
systems are summarized in the exhibit that follows.

Individual performance Group

performance Organizationwide performance

Merit system

Piece rate

Executive bonus

Productivity incentive

Cost effectiveness

Profit sharing


Historically, pay for performance has meant pay for individual
performance. Piece-rate incentive systems for production employees and
merit salary increases or bonus plans for salaried employees have been
the dominant means of paying for performance. In the last decade,
piece-rate incentive systems have dramatically declined because managers
have discovered that such systems result in dysfunctional behavior, such
as low cooperation, artificial limits on production and resistance to
changing standards. Similarly, more questions are being asked about
individual bonus plans for executives as top managers discovered their
negative effects.

Meanwhile, organizationwide incentive systems are becoming more popular,
particularly because managers are finding that they foster cooperation,
which leads to productivity and innovation. To succeed, however, these
plans require certain conditions. A review of the key considerations for
designing a pay-for-performance plan and a discussion of the problems
that arise when these considerations are not observed follow.

Individual pay for performance. The design of an individual pay-for
performance system requires an analysis of the task. Does the individual
have control over the performance (result) that is to be measured? Is
there a significant effort-to-performance relationship? For motivational
reasons already discussed such a relationship must exist. Unfortunately,
many individual bonus, commission, or piece-rate incentive plans fall
short in meeting this requirement. An individual may not have control
over a performance result, such as sales or profit, because that result
is affected by economic cycles or competitive forces beyond his or her
control. Indeed, there are few outcomes in complex organizations that
are not dependent on other functions or individuals, fewer still that
are not subject to external factors.

Choosing an appropriate measure of performance on which to base pay is a
related problem incurred by individual bonus plans. For reasons
discussed earlier, effectiveness on a job can include many facets not
captured by cost, units produced, or sales revenues. Failure to include
all activities that are important for effectiveness can lead to negative
consequences. For example, sales personnel who receive a bonus for sales
volume may push unneeded products, thus damaging long-term customer
relations, or they may push an unprofitable mix of products just to
increase volume. These same salespeople may also take orders and make
commitments that cannot be met by manufacturing. Instead, why not hold
salespeople responsible for profits, a more inclusive measure of
performance? The obvious problem with this measure is that sales
personnel do not have control over profits.

These dilemmas constantly encountered and have led to the use of more
subjective but inclusive behavioral measures of performance. Why not
observe if the salesperson or executive is performing all aspects of the
job well? More merit salary increases are based on subjective judgments
and so are some individual bonus plans. Subjective evaluation systems
though they can be all-inclusive if based on a thorough analysis of the
job, require deep trust in management, good manager-subordinate
relations, and effective interpersonal skills. Unfortunately, these
conditions are not fully met in many situations, though they can be
developed if judged to be sufficiently important.

Group and organizationwide pay plans. Organizational effectiveness
depends on employee cooperation in most instances. An organization may
elect to tie pay, or at least some portion of pay, indirectly to
individual performance. Seeking to foster team-work, a company may tie
an incentive to some measure of group performance, or it may offer some
type of profits or productivity-sharing plan for the whole plant or

Gains-sharing plans have been used for years in many varieties. The real
power of a gains-sharing plan comes when it is supported by a climate of
participation. Various structures, systems, and processes involve
employees in decisions that improve the organization’s performance and
result in a bonus throughout the organization.

Russian management’s approach to motivation.

IBS-Plekhanov Human Resource Management

Motivation: Reward system and the role of compensation



Anton Skobelev

TIME \@ “ae III aa” 14 Mar 97 Page PAGE 7

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