Managing Compensation

Total compensation consists of measurable rewards that employees receive for their work. There are three components included in total compensation:

  • Base compensation: Fixed pay workers get usually as salaries or hourly wages.
  • Pay incentives: Programs created to reward workers and good performance
  • Indirect compensation/benefits: Include programs such as health insurance, vacations and unemployment compensation.
    (Gómez-Mejía, Balkin & Cardy 2016, 315.)

There are many pay policies and procedures that managers have to consider when designing a compensation system that can help the firm achieve its strategic objectives, as well as positively impacting the company’s work environment. Here are some examples of the different criterias that companies can choose to implement in their compensation plan:

  • Internal versus external equity: Internal equity refers to the perceived fairness of the pay structure inside the company, while external equity is defined as the perceived fairness in pay compared to what other companies pay for the same type of work. Here firms can choose between two different types of pay equity, either the distributive justice model where workers give their contributions to the firm in exchange for monetary or nonmonetary rewards, or the labor market model where the wage rate for jobs are set at the point where the supply of labor equals the demand for labor in the marketplace. I think external equity is important for a company to remain competitive in there market. This way the employees will not be poached by competitors because of higher salaries or better benefits.
  • Fixed versus variable pay: Companies can decide to pay total compensation in the form of base pay, or in the form of variable pay that will fluctuate according to criterias set beforehand.
  • Performance versus membership: Performance-contingent compensation occurs when the bigger portion of the workers’ pay is bound to individual or group contributions e.g. sales commissions, while membership-contingent compensation takes place when the firm gives the same wages to all the workers in a given job, as long as they manage to reach satisfactory performance. I think that performance-contingent compensations can lead to a lot of stress and competition among employees. In some cases employees will not get a decent amount of base compensation, and therefore are forced to sell a certain amount in a specific period of time in order to receive bonuses. This can lead to bad customer service where the seller won’t stop pushing customers to purchase their product, something that is not beneficial for the company.
  • Job versus individual pay: Traditional compensation systems set the base compensation according to the value or contributions of each job, while knowledge-based pay or skill-based pay systems pay the workers based on the jobs they can do or the talents they can successfully apply to their work.
  • Egalitarianism versus elitism: Organizations choose to either place most of their workers within the same compensation plan in an egalitarian pay system, or to create various compensation plans according to the organizational level or employee group.
  • Below-market versus above-market compensation: Only few companies can afford the above market compensation that makes it possible to hire high quality workers, diminish voluntary turnover and create an exclusive work environment. It’s more usual for companies to see the importance of only certain groups by paying them above market and then cover these costs by paying other groups below market compensation
  • Monetary versus nonmonetary rewards: Monetary rewards consist of all the rewards that can be converted into cash in the future, including stocks and retirement plans. Nonmonetary rewards are intangible rewards such as interesting workplaces, challenging assignments, public recognition, flexible work hours and being able to work from home. Organizations wanting to reinforce individual achievement and responsibility within the workforce usually focus on monetary rewards. However, if they want to reinforce commitment to the company they normally take the approach of giving nonmonetary rewards. In CASE 5 (Pink 2009.) Dan Pink is talking about “The Candle Problem” where it’s shown that receiving monetary rewards don’t necessarily lead to more efficient solutions. In fact, other research over 40 years backs up the idea that for most tasks, people will not perform better if they receive monetary rewards. Extrinsic motivators only work well with manual work and simple solutions, narrowing people’s focus and pushing them to solve the problem quicker. But in businesses today workers usually have to solve more complicated tasks, as well as getting encouraged to become more innovative and original in their problem solving. This results in workers leaning more towards intrinsic motivators where they desire to direct their own lives through the development of mastery and purpose.
  • Open versus secret pay: Firms can either choose to make their worker’s compensation levels a secret, or to make it a matter of public record. Open pay can force employers to be more fair and effective in administering compensations, since all the decisions are open for everyone to see.
  • Centralization versus decentralization of pay decisions: In centralized systems the pay decisions are firmly controlled in a central location, usually in the HR department of the company’s headquarter, while in decentralized systems the pay decisions are appointed further down into the company, usually to the managers of each unit. Centralized pay is more suiting for companies that often face legal challenges, while decentralized pay fits better with large and diverse firms.
    (Gómez-Mejía et al., 2016, 316-328.)

Rewarding Performance

Pay-for-performance systems, also called incentive systems, reward employee performance on the assumptions that individual workers and work teams contribute differently to the company, that the organization’s overall performance depends on the performance of individuals and groups, and that firms need to reward workers according to their comparative performance in order to attract, retain and motivate performers. There are nine main challenges that companies have to face when using an incentive system:

  • The “Do only what you get paid for” syndrome: Pay-for-performance systems utilize objective indicators of performance, resulting in some managers using any objective data they can find to justify pay decisions.
  • Unethical behaviors: Incentives may cause workers to participate in undesirable behaviors like cutting corners, deceiving, misinforming, hiding negative information or taking more credit than deserved. In these cases managers might look the other way in order for their unit to exceed the set goals.
  • Negative effects on the spirit of cooperation: Pay-for-performance systems may lead to conflict and competition between employees and discourage cooperation. Workers who receive less than they feel they deserve might withhold information, sabotage projects or spread rumors about their colleagues who receive more.
  • Lack of control: There are some factors that are beyond the employees’ control, including the supervisors, performance of other group members, the quality of the materials, working conditions, the amount of support from management, and environmental factors.
  • Difficulties in measuring performance: Precise measures of performance are hard to accomplish, and problems might occur if pay is based on inaccurate measures. The appraiser has to prevent judgements of employees based on personality bias, likes and dislikes, as well as political agendas.
  • Psychological contracts: Pay-for-performance systems become psychological contracts between the company and its employees. Breaking this psychological contract can lead to employee dissatisfaction, employee turnover and lowering of employee morale.
  • The credibility gap: When employees don’t believe that pay-for-performance programs are fair or that they actually reward performance. Employees who don’t view the system as justifiable, will most likely respond with negative behaviors. Therefore it’s vital for incentive programs to have an effective performance appraisal and feedback system implemented in order to achieve the desired results.
  • Job dissatisfaction and stress: Incentive systems may lead to more productivity among the workforce, but also result in lower job satisfaction. The more pay is based on performance, the more the workforce begins to unravel and the more dissatisfied workers become.
  • Potential reduction of intrinsic drives: Pay-for-performance programs may drive the workers to the point that they’re willing to do anything in order to get the guaranteed reward, smothering their talents and creativity in the process. This leads to a reduction in their intrinsic drives and they end up becoming unwilling to take part in any activities that’s valuable for the firm unless they are rewarded.
    (Gómez-Mejía et al., 2016, 353-358.)

Well designed pay-for-performance systems helps managers coordinate the interest of both the employees and the company. Here are some ways to meet the challenges of pay-for-performance systems:

  • Develop a complementary relationship between extrinsic and intrinsic rewards: Rewards that are both intrinsic and extrinsic can be compelling motivators that perfectly complement each other. I think it’s important for management to truly understand the right balance between these two types of rewards, considering all the different factors that are important for their employees.
  • Link pay and performance appropriately: In piece rate systems, where workers are paid per unit produced, we can see the closest bond between pay and performance. Here it’s important that employees have complete control over the speed and quality of the work, something that has been made possible through the Internet where employees have the freedom to work from anywhere.
  • Use pay for performance as part of a broader HRM system: In order for incentive systems to achieve the desired results, they need to be complemented by suitable HRM programs. Performance appraisals, supervisory trainings and staffing practices are all important for pay-for-performance programs to succeed.
  • Build employee trust: To create successful incentive programs managers need to build employee trust, which can force them to make some changes. The management has to create a work environment that supports the incentive system and helps the employees know that they will get rewards for working harder, as well as being noticed for their extra efforts.
  • Promote the belief that performance makes a difference: The company has to create an atmosphere within the workforce that clearly shows that performance does make a big difference. 
  • Use multiple layers of rewards: Creating different types of pay incentives for various work situations will increase the chances of accomplishing better results. Basing the system on multiple layers of rewards, firms can gather the benefits of each incentive plan and at the same time diminish the negative side effects.
  • Increase employee involvement: The most beneficial method of developing acceptance within the workforce is to have employees take part in the creation of the pay plan. Employee involvement will lead to a better comprehension of the plan, a better commitment to the pay plan, and a better correspondence between employee needs and the pay-plan design.
  • Stress the importance of acting ethically: After implementing a pay-for-performance program it’s vital for the company to emphasize ethics as an important corporate value through training programs and other events. Here I think it’s important that managers show these ethical values through their own actions, not asking their employees to perform tasks that are within ethical gray areas.
  • Use motivation and nonfinancial incentives: Some employees are more interested in the nonfinancial aspects of their work, which can help the company understand the importance of creating a mix of monetary and nonmonetary rewards for their employees. These nonfinancial rewards include public praise, honorary titles, expanded job responsibilities, paid leaves and mentoring programs.
    (Gómez-Mejía et al., 2016, 358-362.)

Gomez-Mejia, L.R., Balkin, D.B. and Cardy, R.L. 2016. Managing Human Resources. Global Edition 8/E. Pearson. London.
Pink, D. 2009. The puzzle of motivation. URL: Accessed: 13 March 2017.
Ted Summaries 6 June 2014. Dan Pink: The Puzzle Of Motivation. URL: Accessed: 13 March 2017.
Teine, K. 2014. Internal and External Equity Comparison. URL: Accessed: 13 March 2017.



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