Strategic Employee Rewards and Compensation Management
Understanding Employee Reward Systems
Reward systems are a set of material and non-material counterparts that employees receive for the quality of their performance, their long-term contribution to business development, and their identification with the company’s values and operational principles:
- Non-monetary Rewards (Intrinsic)
- Monetary Rewards or Compensation (Extrinsic)
Compensation Management Principles
Compensation management involves determining appropriate compensation levels based on the complexity and requirements of the position, employee merit, the company’s financial situation, internal and external labor market conditions, and relevant legislation:
- Fixed Pay
- Variable Pay
- Benefits (Fringe Benefits)
Does Salary Truly Motivate Employees?
- Compensation is important for people on low income because it allows them to satisfy basic and safety needs.
- It is also important for those who are at the top of the hierarchy and responsibilities because it is a factor of prestige, status, and recognition.
- Without sufficient financial resources, living with family and friends is hampered, access to cultural goods and education is conditioned, the opportunity for fun, travel, and vacations is compromised – and work loses its meaning.
The reasons why it is sometimes argued that pay is not a source of motivation result from an equivocal interpretation of Herzberg’s two-factor model (motivation-hygiene theory).
Satisfying Higher-Order Needs
- Self-actualization needs: creative and challenging work; participation in decision-making; job flexibility and autonomy.
- Esteem needs: responsibility of an important job; promotion to higher status job; praise and recognition from boss.
Addressing Lower-Order Needs
- Social needs: friendly coworkers; interaction with customers; pleasant supervisor.
- Safety needs: safe working conditions; job security; base compensation and benefits.
- Physiological needs: rest and refreshment breaks; physical comfort on the job; reasonable work hours.
Herzberg’s Two-Factor Theory
- Motivating Factors (generate satisfaction): feeling of achievement; recognition; diverse and challenging work; personal development.
- Hygiene Factors (generate dissatisfaction): relationship with the superior; relationship with peers; technical supervision; work conditions.
- To truly motivate people, addressing only hygiene factors is insufficient; motivating factors must also be cultivated.
- The argument that wages are not motivating ignores the fact that a poor salary is a significant factor of dissatisfaction and demotivation.
The Powerful Role of Money in Motivation
Despite the importance of distinguishing between hygiene and motivating factors, money can be a powerful motivator:
- It allows access to valuable assets, from those that satisfy basic needs to those that fulfill status motivations.
- The pursuit of wealth and status may be hardwired in humans (it is almost “instinctive”).
- People want to make more money so they can buy a house “a little bigger” than that of their neighbor, or to be “a little richer” than a rival.
- Even the marvelously wealthy may seek to get richer to rise in wealth rankings.
- Money never seems to be excessive. Most people find it comforting to receive a salary that is higher than their colleagues’.
- Salary is really an important element for members of any organization.
- It should occupy an important place in the concerns of those in charge of managing people and talent.
- However, it is not the sole element that determines an individual’s decision to accept or decline a position, or to stay with versus leave the company.
Empirical Evidence for Financial Incentives
Financial incentives have a powerful motivating effect.
Supporting Research
Locke et al. (1980); Guzzo et al. (1985); Judiesch (1994); Stajkovic and Luthans (1997); Jenkins et al. (1998); Rynes et al. (2004).
Why is Money’s Motivational Value Understated?
So why do people decrease the value of money when they are asked about what motivates them?
- Social desirability – it is more acceptable, from the social point of view, to say that one works for “noble” reasons (e.g., social contribution, spirit of mission) than for money.
- Need to reduce cognitive dissonance: If someone walks daily to the workplace while receiving a low salary, how can they explain to themselves and others that the pay is motivating?!
Pay Transparency: To Disclose or Not?
A recent narrative review of literature (Colella, Paetzold, Zardkoohl & Wesson, 2007) shed light on the costs and benefits of withholding pay information from employees (i.e., pay secrecy).
Costs of Pay Secrecy
- Employees question the system’s fairness
- They overestimate pay levels received by colleagues
- Trust in the organization erodes
- Motivation decreases
- Lack of information creates inefficient labor markets
Benefits of Pay Secrecy
- Conflicts between employees or between employees and managers regarding pay occur less frequently
- Organizations can correct pay inequities without employees knowing
- Competition between employees decreases
- Employees have more privacy
- Lack of information about other employees’ pay reduces turnover
Finding a Middle Ground in Pay Transparency
Fortunately, there is a middle ground between complete secrecy and total openness regarding pay. Organizations can reveal some but not all pay information. For example, they can communicate minimums, midpoints, and maximums in pay grades while keeping individual salaries private. (Note that some states, such as Ohio, require state agencies to publish employees’ salaries). If your organization decides to tread this middle ground, make sure you have a well-developed compensation system. Otherwise, employees may not trust that the system is fair.
Types of Compensation and Rewards
Monetary Rewards (Extrinsic)
Include rewards of an extrinsic nature related to work, comprising salary and all assets susceptible to evaluation in monetary terms (e.g., incentives and benefits).
Non-Monetary Rewards (Intrinsic)
Include aspects such as challenging work, social recognition, role prestige, or corporate social responsibility actions not covered in the benefit categories. They are not easily assessed in monetary terms.
Both types of rewards are relevant in attracting candidates, motivating, and retaining them.
Key Components of Compensation
Fixed Pay
All amounts paid in cash linked to the function or to the competencies (monthly or not). Examples include: Monthly salary; Christmas allowance; Holiday allowance; Fixed allowances.
Variable Pay (Incentives)
Floats with the results or the achievement of goals. Examples include: Annual bonus; Medium and long-term bonus; Commissions; Distribution of profits; Attribution of company shares according to its performance; Stock options; Stock grant plans; Variable salary complement; Other incentives.
Benefits (Fringe Benefits)
Benefits attributed in non-remuneratory forms (e.g., automobile, credit cards, health insurance, supplementary pension plans, health clubs, cultural and sporting activities). Examples include: Company car; Petrol; Vehicle maintenance; Car insurance; Health care plan; Life insurance; Pension plan; Credit card; Payment of quotas in clubs and associations; Support for training/education; Other benefits (e.g., work-family balance).
Stock Options
A right of subscription or purchase of a certain number of shares that can be exercised, within a specified period, at a predetermined price.
Phantom Shares
Unlisted companies. The quotation of the units is defined by the company itself, according to accounting and equity criteria.
Stock Grant Plans
Possibility of acquisition of shares of the company at a reduced price, with the capitalization premium dependent on the valuation of stock prices in the stock market.
Objectives of Compensation Management
- Align individual behaviors with organizational goals, rewarding the achievement of desired goals.
- Achieve and/or maintain a state of internal, external, and individual equity.
- Positively reinforce good behaviors and negatively affect unwanted ones.
- Maintain optimal levels of motivation.
- Attract and retain the best employees.
- Keeping costs under control, avoiding excessive burden on the organization’s products/services, and ensuring the organization’s ability to adapt to environmental changes.
Equity in Compensation
- Internal Equity: The degree to which compensation within the organization is fair across different positions and jobs. Different jobs should generate different compensation levels.
- External Equity: The extent to which the compensation is fair compared to that paid in other organizations. There may be internal equity even if external equity is lacking.
- Individual Equity: The degree to which the compensation paid to individuals with the same job is fair. Two individuals with the same job but different performance should receive different compensation.
Impact of Equity on Rewards
- Large wage disparities can give rise to feelings of injustice, generate problems of cooperation within teams, and foster cynicism and mistrust, potentially leading to performance failures.
- Different people have varying sensitivities to fairness, from the compassionate to those who “feel entitled”.
- Different individuals have distinct reactions to the various components of rewards.
- Sensitivity to fairness varies across cultures.