Individual Pay and Incentive Pay

Transcription

1 Last updated: May 4, 2017 Individual Pay and Incentive Pay COMM 203 Flex at the Sauder School of Business, University of British Columbia W:\Learning Services\Courses\COMM 203\Siobhan Flex Work with Brian

2 Individual Pay and Incentive Pay Once an organization has a pay structure established for the jobs, as shown in this diagram, it is usually represented by pay grades for groups of jobs having similar evaluations and pay ranges to allow for individual pay differences for employees in the same job. The entire pay structure will be adjusted upward periodically for cost of living increases. Organizations may make these inflation adjustments annually, or every few years. The next policy question is to determine how individual pay within the ranges will be determined. There are 4 common methods for doing this. 1. First, one option is flat rates. That is, all employees in a job, or all jobs in the same pay grade are paid the same rate. There is no variation in pay among the employees and there are, in fact, no pay ranges. This is common in many collective agreements for unionized workers, but other non-union employers may use this method for lower level, or unskilled jobs. This may be appropriate for job clusters where there is either very little potential for variation in employee performance or if it is difficult to get valid measures of individual performance differences. UBC SAUDER SCHOOL OF BUSINESS PAGE 2

3 2. A second option is to base individual pay differences within a job on seniority. This is a very common method for many organizations, including unionized employees. One example is school teachers. A new education graduate starting a job as an elementary teacher will start at the bottom of the pay range, and their pay will received pay increases in steps with years of experience. Within the pay range for one pay grade there is another step function for pay increases based on years of service. This method is favored by many unions, but also by many employers as it fosters a commitment to the organization among long tenure employees. Once they have worked their way up the seniority based pay steps, employees may lose this seniority pay premium if they leave for another organization. 3. The final two options are basing individual pay differences on performance. Merit pay raises are permanent increases in employees pay based on past performance. Once they have earned a merit pay raise, this increase will carry on to future periods or years. 4. The fourth method is performance based incentive pay. Incentive pay is temporary. That is, employees earn the extra incentive pay as a reward for good performance in one time period, but this does not carry forward to future pay periods. The incentive has to be earned through good performance in each period. This is very common in sales jobs, but many others as well. None of these 4 methods is ideal. They all have some advantages and some disadvantages. You should think about each of these in terms of what incentives, or disincentives, they create for employees, and also which employees may like the method, and which employees may not like the method. I will provide some examples. Flat rates are easy to understand and easy for payroll administration. They also appeal to some UBC SAUDER SCHOOL OF BUSINESS PAGE 3

4 employees. If they all do the same job why should they all not be paid the same? But consider a very ambitious employee who works very hard and outperforms the coworkers, or at least the ambitious employee perceives that they are outperforming the others. Equity theory suggest they will see this system as very unfair. With flat rates the only financial performance incentive is to do the minimum necessary for satisfactory performance. Think about which employees are likely to stay in an organization with flat rates, and which are more likely to leave? Seniority systems reward loyalty to the organization. This can be very valuable to the organization if long tenure employees develop a great deal of knowledge and expertise unique to the organization, and it would be difficult for the organization to replace this if they left. Also, senior works may become better performers, more efficient, and they often need to help the newcomers learn the job. It is easy to administer as seniority is objective and easily determined with great accuracy. But seniority systems create the same performance incentives, and disincentives, as flat rates. As long as performance is satisfactory, an employee will move up the seniority pay steps over time. A hard working junior employee who may outperform the senior workers, but be paid much less, will see this system as unfair. Performance based pay has great appeal to many people. Intuitively, it just seems fair. Employees who work hard and do a great job should be rewarded for this. Equity theory suggests this should help keep the ratios in employee comparisons to others in balance. Organizations can use it to direct employees to the desired work behaviors and outcomes that they want employees to achieve. In principle, it sounds great. But in practice, it can be very difficult to do. Most of the issues with pay for performance are related to the difficulties in measuring performance. Systems of performance pay raises, or merit raises are generally based on subjective performance evaluations, often completed by the supervisors. We have already discussed the numerous sources of error and bias in subjective performance evaluations. Consider the very common problem of central tendency, which leads evaluators to rate all employees as close to average. If annual merit raises are based on these annual subjective performance evaluations by supervisors, and most employees are rated the same, then merit raises become automatic, or at least the same, for all employees. This is really no different than a seniority based system. Merit pay raises will only work as intended if the organization carefully develops valid performance evaluations (such as Behaviorally Anchored Rating Scales, or BARS) for each job focusing on the desired behaviors and outcomes that the organization wants to reward. And the supervisors must be careful to differentiate in performance among their employees. This can be done, but the systems are expensive to develop and time-consuming to use, so many organizations simply don t have these good performance evaluation systems. If not, and the organization uses merit based raises, the desired behaviors and outcomes may not be rewarded. Bonuses or other forms of one-time incentive pay for good performance are even more complicated and difficult. If they are well designed and implemented they can be very effective at motivating the desired behaviors and outcomes, but doing so is not easy and many well intentioned incentive pay plans have failed due to poor design. To design an effective incentive pay system, the organization must first be clear on what UBC SAUDER SCHOOL OF BUSINESS PAGE 4

5 behaviors and outcomes it wants the employees to achieve. Consider the example of sales jobs that I used earlier. The organization wants it sales employees to focus on 1) sales volume; 2) customer service; 3) timely follow-up; and 4) good customer relations. Objective data on sales volume is readily available, but for the other 3 aspects of performance it is very difficult to get reliable and valid measures of performance. Unfortunately, many organizations just focus on what is easily measured. Sales data is a very deficient measure of performance in this case. Using only sales date in this case would incentivize the sales employees to focus on only sales volume, but to ignore customer service and follow-up, and in the long run this would lead to poor customer relations. There is a saying that what gets measured gets done since the focus tends to be on what data is readily available. Incentive pay based on what is measured makes this even more so. The organization must be careful to define and measure all the aspects of performance that are important, or the incentive pay system will fail, and the employees will not be contributing toward the success of the organization. In addition to 1) sales commissions, individual incentive pay systems include 2) piecework which is pay for units produced in a given time period, 3) the standard hour plan, which focuses on how quickly work is performed, or 4) performance bonuses which may be based on objective measures or subjective evaluations of performance. In addition to individual incentive pay, pay may be linked to performance of teams or larger groups of employees. Team incentives may include bonuses for all team members if the team achieves previously set, specific, and most importantly measurable performance goals. Gainsharing plans focus on teams achieving productivity improvements or cost reductions, and a portion of the gain (perhaps half of it) is distributed back to the team members. As with individual incentives, these require comprehensive performance measures including all aspects of desired team performance to be effective at motivating the desired behaviors and outcomes. Incentive pay systems can focus on larger groups of employees including the entire organization. These include profit sharing where a portion of profits are distributed to the employees, stock options or employee stock ownership plans. Earlier we discussed that three key goals of compensation management are to attract, retain, and motive employees. So how do incentive plans do in terms of meeting these 3 critical goals? In terms of attracting more and better qualified applicants, the results are disappointing. There is no clear and consistent evidence that they do. However there is evidence that they attract different types of applicants than organizations that do not use incentive pay systems. They attract applicants who are: 1. More materialistic, and focused on monetary rewards 2. Have higher self-esteem, and are more confident in themselves 3. Risk takers 4. More individualistic, preferring to work independently So over time, the culture of the organization may change with the introduction of incentive pay. UBC SAUDER SCHOOL OF BUSINESS PAGE 5

6 For example, attracting more employees with these characteristics would not be supportive of a collaborative culture in a team based work environment. Do incentive pay systems help retain employees? The evidence supports that individual incentive pay does reduce turnover. As mentioned above, Equity Theory would suggest this should happen as self-other comparison ratios of outputs over inputs are more likely to be perceived as balanced with individual incentive pay. However, group incentive pay tends to increase turnover. This higher turnover is generally attributed to free-rider problems in group incentive systems, where some employees do not do their fair share of the work, but still reap the group incentive pay. Furthermore, I would encourage you to think about which employees would leave the organization and which ones would stay with free-rider problems in teams or work groups with group incentive pay. Do incentive pay systems motivate employees? The results vary widely. Some are highly successful and some are dismal failures. The difference, as I already noted, is mostly due to the quality of the performance measures used. Well-designed systems with highly valid performance measures that do not suffer from deficiency can be very effective. But poorly designed systems, with poor performance measures will likely fail. Deficiency is a major problem with performance measures and a key reason why many incentive plans fail. Group based incentive systems are generally effective at increasing performance, despite the evidence that they increase turnover. Organization-wide systems can be effective but the performance increases are very small, most estimates show only a few percentage points improvement. So, done properly, incentive pay can be very effective. But, it is not easy to do. If you cannot measure performance, then you should not use performance based incentive pay systems. To be effective you need carefully developed, valid performance measures that are free from contamination and deficiency, and furthermore, they must be accepted by the employees as accurate and true measures of their performance. UBC SAUDER SCHOOL OF BUSINESS PAGE 6