Knowledgebank: INDIVIDUAL REWARDS IN ORGANIZATIONS

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1 Knowledgebank: INDIVIDUAL REWARDS IN ORGANIZATIONS As noted earlier, one of the primary purposes of performance management is to provide a basis for rewarding employees. We now turn our attention to rewards and their impact on employee motivation and performance. The reward system consists of all organizational components-including people, processes, rules and procedures, and decision-making activities-involved in allocating compensation and benefits to employees in exchange for 25. Peter Senge, The Fifth Discipline. (New York: The Free Press, 1993). 28

2 their contributions to the organization. As we examine organizational reward systems, it is important to keep in mind their role in psychological contracts and employee motivation. Rewards constitute many of the inducements that organizations provide to employees as their part of the psychological contract, for example. Rewards also satisfy some of the needs employees attempt to meet through their choice of work-related behaviors. Roles, Purposes, and Meanings of Rewards The purpose of the reward system in most organizations is to attract, retain, and motivate qualified employees. The organization s compensation structure must be equitable and consistent to ensure equality of treatment and compliance with the law. Compensation should also be a fair reward for the individual s contributions to the organization, although in most cases these contributions are difficult, if not impossible, to measure objectively. Given this limitation, managers should be as fair and as equitable as possible. Finally, the system must be competitive in the external labor market for the organization to attract and retain competent workers in appropriate fields. Beyond these broad considerations, an organization must develop its philosophy of compensation based on its own conditions and needs, and this philosophy must be defined and built into the actual reward system. For example, Wal-Mart has a policy that that none of its employees will be paid the minimum wage. Even though it may pay some people only slightly more than this minimum, the firm nevertheless wants to communicate to everyone that it places a higher value on their contributions than just having to pay them the lowest wage possible. The organization needs to decide what types of behaviors or performance it wants to encourage with a reward system, because what is rewarded tends to recur. Possible behaviors include performance, longevity, attendance, loyalty, contributions to the bottom line, responsibility, and conformity. Performance measurement, as described earlier, assesses these behaviors, but the choice of which behaviors to reward is a function of the compensation system. A reward system must also take into account volatile economic issues such as inflation, market conditions, technology, labor union activities, and so forth. It is also important for the organization to recognize that organizational rewards have many meanings for employees. Intrinsic and extrinsic rewards carry both surface and symbolic value. The surface value of a reward to an employee is its objective meaning or worth. A salary increase of five percent, for example, means that an individual has five percent more spending power than before, whereas a promotion, on the surface, means new duties and responsibilities. But managers must recognize that rewards also carry symbolic value. Consider what frequently happens when a professional sports team signs a top college prospect for a huge bonus and salary. The new player often feels enormous pressure to live up to the salary, whereas veteran players may grumble that their pay should be increased to keep the salary structure in balance. 29

3 Thus, rewards convey to people not only how much they are valued by the organization but their importance relative to others. Consider again a five percent salary increase. If the recipient later finds out that everyone else got three percent or less, she will feel vitally important to the organization, someone whose contributions are recognized and valued. On the other hand, if everyone else got at least eight percent, the person will probably believe the organization places little value on her contributions. In short, then, managers need to tune in to the many meanings rewards can convey-not only the surface messages but the symbolic messages. Types of Rewards Most organizations use several different types of rewards. The most common are base pay (wages or salary), incentive systems, benefits, perquisites, and awards. These rewards are combined to create an individual s compensation package. Base Pay For most people, the most important reward for work is the pay they receive. Obviously, money is important because of the things it can buy, but as we just noted, it can also symbolize an employee s worth. Pay is very important to an organization for a variety of reasons. For one thing, an effectively planned and managed pay system can improve motivation and performance. For another, employee compensation is a major cost of doing business as much as 50 to 60 percent in many organizations so a poorly designed system can be an expensive proposition. Finally, since pay is considered a major source of employee dissatisfaction, a poorly designed system can result in problems in other areas, such as turnover and low morale. Incentive Systems Incentive systems are plans in which employees can earn additional compensation in return for certain types of performance. Examples of incentive programs include: 1. Piecework programs, which tie a worker s earnings to the number of units produced. 2. Gain-sharing programs, which grant additional earnings to employees or work groups for cost-reduction ideas. 3. Bonus systems, which provide managers with lump-sum payments from a special pool based on the financial performance of the organization or a unit. 4. Long-term compensation, which gives managers additional income based on stock price performance, earnings per share, or return on equity. 5. Merit pay plans, which base pay raises on the employee s performance. 6. Profit-sharing plans, which distribute a portion of the firm s profits to all employees at a predetermined rate. 7. Employee stock option plans, which set aside stock in the company for employees to purchase at a reduced rate. Plans oriented mainly toward individual employees may cause increased competition for the rewards and some possibly disruptive behaviors, such as sabotaging a coworker s performance, sacrificing quality for quantity, or fighting over customers. A group 30

4 incentive plan, on the other hand, requires that employees trust one another and work together. Of course, incentive systems have advantages and disadvantages. Long-term compensation for executives is particularly controversial because of the large sums of money involved and the basis for the payments. Executive compensation is one of the more controversial subjects that US businesses have had to face in recent years. News reports and the popular press seem to take great joy in telling stories about how this or that executive has just received a huge windfall from his or her organization. Clearly, successful top managers deserve significant rewards. The job of a senior executive, especially a CEO, is grueling, stressful, and takes talent and decades of hard work to reach. Only a small handful of managers ever attain a top position in a major corporation. The question is whether some companies are overrewarding such managers for their contributions to the organization. 26 To understand the ethical context of this decision, consider the following statistics. From 1990 to 1995, the pay for the average worker in the United States increased by 16 percent from $22,976 in 1990 to $26,652 in During the same period, worker layoffs increased by 39 percent from 316,047 to 439,882. Corporate profits, meanwhile, increased at a rate of 75 percent from 1990 to 1995, with the 1990 level being $176 billion and the 1995 level $308 billion. But CEO pay increased an amazing 92 percent during the same period, the average growing from $1.95 million in 1990 to $3.75 million in Keep in mind, of course, that these numbers are only averages. The high-end salaries of some executives are truly staggering. For example, in 1998 Jack Welch, the CEO of General Electric, received $8 million in salary and bonus plus another $12.5 million in long-term compensation, giving him total pay for the year in excess of $20.5 million. When a firm is growing rapidly and its profits are also growing rapidly, relatively few objections can be raised to paying the CEO well. However, objections arise when an organization is laying off workers, its financial performance is perhaps less than might be expected, and the CEO is still earning a huge amount of money. It is these situations that dictate that a board of directors take a close look at the appropriateness of its actions. Benefits Another major component of the compensation package is the employee benefits plan. Benefits are often called indirect compensation. Typical benefits provided by businesses include the following: 1. Payment for time not worked, both on and off the job. On-the-job free time includes lunch, rest, coffee breaks, and wash-up or get-ready time. Off-the-job time not worked includes vacation, sick leave, holidays, and personal days. 2. Social Security contributions. The employer contributes half the money paid into the system established under the Federal Insurance Contributions Act (FICA). The employee pays the other half. 26. Alfred Rappaport, New Thinking on How to Link Executive Pay With Performance, Harvard Business Review, March-April 1999, p

5 3. Unemployment compensation. People who have lost their jobs or are temporarily laid off get a percentage of their wages from the state. 4. Disability and workers compensation benefits. Employers contribute funds to help workers who cannot work due to occupational injury or ailment. 5. Life and health insurance programs. Most organizations offer insurance at a cost far below what individuals would pay to buy insurance by themselves. 6. Pension plans. Most organizations offer plans to provide supplementary income to employees after they retire. A company s Social Security, unemployment, and workers compensation contributions are set by law. But how much to contribute for other kinds of benefits is up to each company. Some organizations contribute more to the cost of these benefits than others. Some companies pay the entire cost; others pay a percentage of the cost of certain benefits, such as health insurance, and bear the entire cost of others. Offering benefits beyond wages became a standard component of compensation during World War II as a way to increase employee compensation when wage controls were in effect. Since then, competition for employees and employee demands (expressed, for instance, in union bargaining) has caused companies to increase these benefits. In many organizations today, benefits now account for 30 to 40 percent of payroll. Mastering Change also illustrates how many companies today are offering workers more flexibility in terms of the benefits that they can choose to take. The burden of providing employee benefits is growing heavier for firms in the United States than it is for organizations in other countries, especially among unionized firms. For example, consider the problem that General Motors faces. Workers at GM s brake factory in Dayton, Ohio, earn an average of $27 an hour in wages. They also earn another $16 an hour in benefits, including full health-care coverage with no deductibles, full pension benefits after 30 years of service, life and disability insurance, and legal services. Thus, GM s total labor costs at the factory average $43 an hour. A German rival, Robert Bosch GmbH, meanwhile, has a non-unionized brake plant in South Carolina. It pays its workers an average of $18 an hour in wages, and its hourly benefit cost is around $5. Bosch s benefits include medical coverage with a $2,000 deductible, 401-K retirement plans with employee participation, and life and disability coverage. Bosch s total hourly labor costs, therefore, are only $23. Toyota, Nissan, and Honda buy most of their brakes for their US factories from Bosch, whereas General Motors must use its own factory to supply brakes. Thus, foreign competitors realize considerable cost advantages over GM in the brakes they use, and this pattern runs across a variety of other component parts as well. Perquisites Perquisites are special privileges awarded to selected members of an organization, usually top managers. For years, the top executives of many businesses were allowed privileges such as unlimited use of the company airplane, motor home, vacation home, and executive dining room. In Japan, a popular perquisite is a paid membership in an exclusive golf club; a common perquisite in England is first-class travel. In the United States, the Internal Revenue Service has recently ruled that some perks constitute a form of income and thus can be taxed. The IRS decision has 32

6 substantially changed the nature of these benefits, but they have not entirely disappeared, nor are they likely to. Today, however, many perks tend to be more job-related. For example, popular perks today include a car and driver (so the executive can work while being transported to and from work) and cellular telephones (so the executive can conduct business anywhere). More than anything else, perquisites seem to add to the status of their recipients and thus may increase job satisfaction and reduce turnover. 27 Awards In many companies, employees receive awards for everything from seniority to perfect attendance, from zero defects (quality work) to cost reduction suggestions. Award programs can be costly in the time required to run them and in money if cash awards are given. But award systems can improve performance under the right conditions. In one medium-size manufacturing company, careless work habits were pushing up the costs of scrap and rework (the cost of scrapping defective parts or reworking them to meet standards). Management instituted a zero-defects program to recognize employees who did perfect or near-perfect work. The first month, two workers in shipping caused only one defect in over two thousand parts handled. Division management called a meeting in the lunchroom and recognized each worker with a plaque and a ribbon. The next month, the same two workers had two defects and there was no award. The following month, the two workers had zero defects, and once again top management called a meeting to give out plaques and ribbons. Elsewhere in the plant, defects, scrap, and rework decreased dramatically as workers evidently sought recognition for quality work. What worked in this particular plant may or may not work in others. And of course, managers and workers can sometimes have very different perceptions as to the value of different awards! 27. Painless Perks, Forbes, September 6, 1999, p