The Relationship between Business Strategy and Business Performance - Research Paper Example

ANALYSIS OF PRIVATE SECTOR COMPENSATION STRATEGIES AND THE RELATIONSHIP WITH BUSINESS STRATEGY AND BUSINESS PERFORMANCE TABLE OF CONTENT .................................................3 INTRODUCTION.........................................4 LITERATURE REVIEW..............................5 METHODOLOGY........................................13 RESULTS......................................................14 DISCUSSIONS..............................................16 CONCLUSION..............................................17 RECOMMENDATIONS...............................18 REFERENCES...............................................19 ABSTRACT The research analyzes the fundamental relationship between performance targets, business strategy and compensation strategies. The study involves a critical review of literature and an analysis of the responses put in place by five different firms during the credit crunch. To this end, the research analyzes the processes and procedures that was used by the firms to motivate management and achieve results that removed them from the credit crunch and convert most of them from loss-making entities to profitable firms. The research identifies that there is a strong relationship between firm strategy and performance needs. And this provides the basis for the design and implementation of performance-based remuneration packages. It is therefore recommended from the five firms that in any situation where a firm needs to institute a performance-based compensation strategy, it must be in relation to the external environment this is because the intrinsic motivation can be flexed to meet performance targets. INTRODUCTION The Enron saga brought to bear a number of risks and issues that came with poor accounting and reporting targets. One of the biggest issues that came with the scandal was the fact that the directors offered compensation based on accounting results (Niskanen, 2007). In the case of Enron, there were numerous accounting and financial reporting malpractices that were against the standard rules. However, after the scandal, there was a question about the importance and the impact of various compensation packages that goes to employees and management. In a standard company, there is direct and indirect compensation that employees receive. The main end this seeks to attain is to provide an avenue through which a firm’s employees will be motivated and work hard enough to meet organizational objectives and standards (Jackson et al, 2011). Compensation and the use of a blend of different remuneration portfolios enables a firm to motivate its employees intrinsically and extrinsically (Neely, 2007). Compensation leads to employee satisfaction and this has an impact on employee turnover and productivity (Deb, 2009:Deng and Gao, 2013; Hui et al, 2014 & Skarbek et al, 2012)). However, it is difficult to state how firm compensation strategy actually affects and influences the work environment of a firm. Deloitte states on their official website that during the global financial crises, most firms abandoned their performance-based compensation strategies due to the lack of money and the need to cut costs as well as the fact that the markets were choked and there were limited opportunities to motivate their staff and workers for (2014). There is therefore a question of how compensation strategies have been varied in the past five years after the recession and how that has influenced firm strategy. To this end, the paper will undertake a critical review of compensation systems and strategies in private entities in the United States and how they have affected and been affected by the external environment. The aim of the research is to: Analyze the relationship between Compensation Strategies and its relationship to business strategy and its impact on business performance. In order to attain this end, the following objectives will be explored: 1. A critical review of firm compensation systems and strategies. 2. The analysis of the conventional relationship between compensation strategy and corporate or business strategy. 3. An empirical analysis of the compensation strategy and its relationship with business strategy and business performance LITERATURE REVIEW This section of the paper will analyze important ideas and concepts that will be applied in the field work. This will be done in two parts. In the first part, the research will evaluate the core concepts, ideas and definitions that will form the framework for the entire research and the study. The second part will focus on important linkages that emphasize on the relationship between business strategy, compensation strategy and performance or firm results. Compensation Strategy There are are various facades of remuneration and this include direct, indirect, overt or covet benefits given to employees in return for labor and it could be in cash or in kind (Rozovsky, 2008: p364). This implies that remuneration could be in many forms and different approaches can be used to pay a person for his work or labor to an organization. This is mainly because in every organization, there is the need for the firm to have important players and important stakeholders who will work to raise money and attain results. This involve the carrying out of various activities and processes that will bring results to the firm. These workers need to be given money and resources as compensation for their effort and contribution. The most popular method of compensating labor by individuals include wages and salaries (Eyraud, 2013). Wages are paid on a daily or weekly basis whilst salaries are calculated on a monthly basis. This could include job rate, average salary rates and/or average earning measures (ILO, 2008). Thus, the different components and elements of the wages and salary structure is one that helps the firm to attain results and desired end. However, there are different compensation types that a firm can utilize and all of them come together to define the total compensation system in the entity. The idea of remuneration management is to create an optimal blend of fixed and variable remuneration to make the system work for the best results for the firm (Westacott, 2013). This is because remuneration is not just paid to employees without consideration. Now that there is competition in everything a firm does, there is the need for firms to find ways and means of tying their corporate strategy with their remuneration systems and procedures. Remuneration is therefore used as system for attaining competitive advantage by recruiting and retaining the best pool of sufficiently skilled personnel to carry out their activities (Wolper, 2011: p142). In most firms, the compensation strategy is issued by the remuneration or compensation committee (Chingos, 2012). This is the main way through which the firms remuneration systems can be linked and connected to the top level of the firm. This is because most firms have their affairs coordinated at the top of the firm and matters are resolved at the top tier of the firm and its operations. And the boards supervision is carried out by numerous committees. The committee that deals with a firms payment systems is the remuneration committee. They fix the directors earnings and approve overall remuneration plan or strategy (Chingos, 2012). In cases where there are stock participation options, the remuneration committee is in charge of defining the long-term plan including the main values and worth (Chingos, 2012). “A compensation strategy is referred to as the aspect of the human resource management that influences the cost of paying workers” (Heckman, 2012: p103). This involves building effective compensation to ensure that the right staff are retained whilst the firm pays as little as possible for remuneration and employee salaries (Gomez-Meija, 2013: p33). Therefore compensation strategy focuses on getting members of staff to get the best results. This is also done to streamline the affairs and processes of the firm through the means of tuning the earnings of workers and managers of the firm in order to get them to achieve certain ends that the organization seeks to attain. The compensation strategy is designed in such a way and manner that external competition is eliminated and there is an attraction of the best and most talented persons in the industry (Henemann, 2012). Thus, the compensation strategy plays a role in designing and carrying out processes that will enable a firm to come up with important methods of dealing with labor and retaining only the best in order to meet a firms obligations and objectives. Performance Based Compensation “Economists have long believed that efficient compensation contracts should link pay with performance to provide executives with desirable incentives” (Bebchuk and Fried, 2010: p19). This belief is steeped in the idea that if an executive or top staff member knows that his performance will be rewarded, that individual will work hard to ensure that performance targets are met in the organization. Bogardus (2012) identifies that performance based compensation is mainly a preserve of people charged with governance and it focuses on adding a performance based pay to the base pay. This will mean that the base pay is constant whilst the performance based element is variable and is based on the achievement of certain objectives. There are also other forms of compensation that enables the firm to achieve its results and expectations. This is usually stock-based compensation plans that gives the management and workers the opportunity to own shares or stocks based on the attainment of certain ends or objectives (Deb, 2010). This payment system is very strong and effective in the short-run and long-run (Deb, 2010). This is because the firm is able to motivate workers and managers to meet immediate goals of putting the firm in a given position or a given level. This is hinged on the fact that a manager given targets will want to meet them in order to achieve these targets and attain results. At the same time, when the targets are met, the managers are rewarded with the choice of being shareholders. And this will enable them to become tied to the firms fortunes and they will be able to work hard and attain results in order to generally grow their shares value and the worth of the entity. However, some writers disagree with the position that performance-based strategies always grow firms. First of all, performance based strategies do not always invoke intrinsic motivation this is because some workers and managers are not on the same level as others and hence, their needs for motivation are very different (Frey and Osterloh, 2012). This is because performance based strategies may not provide the same kinds of motivation and the same kind of results for all parties and all persons. This implies that there will be an uneven spread of resources and results will also be uneven. Additionally, performance-based compensation systems are criticized for being complicated and extremely difficult to deduce throughout the organization (Jackson et al, 2011). This is because there is the need for careful evaluation and analysis in order to come up with performance-based indicators and performance standards. This may often go above the allocated funds for paying workers and could affect profitability and other indicators in the financial statements. In demonstrating the possible issues with performance-based payments, Solomon identifies that major entities like Enron had major problems and issues with their performance systems and procedures because they used various performance-based payment systems which triggered subjective appraisals (2011). This indicates that performance-based payment systems can cause firms to come up with subjective analysis and evaluation by managers. However, with the tightening of corporate governance standards and systems, most companies have remuneration committees that evaluate and fix performance-based remuneration (Borgadus, 2012). Corporate Strategy Corporate strategy typically refers to the overall strategy with which a firm operates and carries out their activities. Strategy is defined as “the pattern or plan that integrates an organizations major goals, policies and action sequence into a cohesive whole” (Letto-Gilles, 2009: p176). This means that corporate strategy is the collection of strategies that come together to determine the way through which a company operates or carries out its activities and processes. “Corporate strategy is the definition of mission and objectives and conducts external and internal analysis and makes strategic choices and implements them” (Hulsmann and Jefferson, 2009: p272). This means that corporate strategy sets the tone for an organization. It forms the overall firm objectives and processes that enables the firm to carry out its activities. Corporate strategy creates the framework within which all the departments and units of a firm will work together to achieve specific results. Ansoff gives a technical definition of strategy and states that it is a rule for making decisions and it is determined by the product or market scope, growth vector, competitive advantage and synergy (2002). This implies that strategy is a system through which a firm positions itself in relation to the markets. Thus for the purpose of this discussion, strategy will set the overall scope based on the elements of the markets and this will in turn, influence the human resource policy and the compensation strategy of the firm. Strategy is formulated by identifying opportunities and threats in the environment and defining the means through which a firm can best attain their ends over a long-term horizon (Rasche, 2009). This involves defining the markets a firm will compete in and how the firm will undertake its activities in order to attain its ends. “Corporate strategy defines the businesses in which a company will compete and how resources will be converted by the distinctive competency of the firm into competitive advantage” (Wit and Meyer, 2012: p74). This implies that corporate strategy sets the framework and the system through which a firm will carry out its affairs and how it will compete in the market in order to attain survival and achieve its set objectives. Compensation Strategy and Corporate Performance Targets Most firms actively operate through the use of a performance-based strategy in which new measures are defined and new metrics are set (Jevsevar et al, 2014). This is because firms will need to define new methods and new means of seeking efficiency and meeting their targets and expectations as defined in the corporate strategic targets for given periods. Thus, to reach that end, there is the need to motivate workers and managers by promising them a direct share in the increases that will occur from a particular strategy. This will inadvertently motivate them to look at working to meet company strategic targets. Research and studies show that performance-based payments encourage personnel to decrease their participation in unpaid activities and focus on activities that reward them (Jones, 2013). In other words, a performance-based system provides a framework within which a firm will have to work and achieve results by means of working to achieve certain specified results and expectations. On the downside, where there is more discretion and power given to the remuneration committee to pay more in a performance-based system, the firm pays more for this package (Werner and Tosi, 2009). However, in firms in which there are high monitoring and controls, there is little that is paid to managers as performance-based compensation (Yoshikawa et al, 2010). This is because the persons charged with making performance-based decisions might not get enough resources to do so. Hence, the firm will use various forms of supervision and target setting to ensure that rigid controls are in place to ensure that workers and managers work hard to achieve specific targets and results. Firms that seek cost leadership sell at lower prices and therefore seek to sell higher volumes to recover the profits targets they have and such strategies often integrate performance-based remuneration systems (Balsam et al, 2011). In other firms like research entities, empirical studies show that there are performance-based pay packages that are given to people as a means of promoting innovation and this is often positively related to the firms employee-pay levels and has a place in the short-term and long-term performance (Yanadori et al, 2003). Thus it can be stated that performance-based strategies are often designed on the basis of the strategic vision and strategic targets that a firm sets for itself. This involves the identification of the best way and means through which the firms targets can be met and this will enable them to achieve their results and expectations. This explains the finding of Chen et al (2014) who state that moderately differentiated firms and cost leadership firms use high proportions of performance based compensation packages. In practice though, most firms have mixed compensation systems which comes together to define the total compensation strategy (Gomez-Mejia and Balkin, 2012). This is because profit sharing remuneration packages are often linked and connected with high returns on assets and efficiency (Le et al, 2013). Gaps in Literature Review The literature review identifies that there are numerous compensation packages and systems that a firm may typically employ. This varies according to the circumstances and situations in the organization. The main idea around which the issue of compensation strategy is built is the strategy of the firm. This is because the strategic vision of the firm forms the basis of the firms desire and expectation for the payment packages that it institutes. This influences the positioning of the firm and provides the way through which the firm carries out its affairs. Thus, from the circumstances at hand, the following hypotheses can be deduced: 1. A firms strategy forms the basis for the formulation of the performance-based compensation system within the firms strategy; 2. The compensation system are aimed the firm to meet its performance targets 3. Performance targets are met by the proper implementation of the firms strategy and expectations METHODOLOGY The research will be primarily concerned with testing the hypotheses presented above. This will give information about the compensation regimes and systems in private sector entity. To this end, a set of companies and organizations will be studied and analyzed with the view of proving the following: The relationship between their corporate strategy and the compensation system with an emphasis on performance-based compensation; An analysis of the actual compensation system and their corresponding performance targets An evaluation of the results achieved by the firm in the period under review. Data Collection In order to define the impact of compensation strategies and the utilization of performance-based compensation regimes in the private sector, the research will focus on a set of five private sector entity. These entitiess annual reports will be subjected to a critical and analytical review which will involve the assessment of their existing strategy according to conditions on the market. This will culminate in the identification of strategic preferences, strategic choices and their remuneration packages. This will form the basis of the data collection. Data Analysis and Interpretation Strategy and processes will be deduced from the directors reports of the financial statements to be reviewed. This will be summarized for each of the firms. The next item will involve the identification of the compensation strategy which will be done by analyzing the remuneration committees reports. Finally, the performance targets will be evaluated from the actual financial statement and this will show the worth of the firms remuneration and performance-based package. From there theorization will proceed after generalizations are made for the five private firms under review. RESULTS There was a total of five companies that were analyzed in relation to their compensation strategy. To this end, each of the firms that were studied were analyzed in relation to their makeup and their composition. This include the analysis of their compensation systems and components of their remuneration system. After that, their strategy and growth plan was evaluated and critiqued. The stock options and their details were expressed in basic terms that were understandable. However, due to the fact that different companies had different policies and systems of setting up their stock systems and structures, there were a few modifications and an attempt to narrate the different approaches used by the companies that were studied. All in all, the findings indicated that there were different processes. The impact of these new profit systems and structures were interpreted and reviewed in terms of their impact on turnover and processes. Company Compensation System Strategy Stock Options after Credit Crunch Turnover/Profitability Alliance Oil (Petrochemical Industry) Base salary, Annual bonus 50% - 100% of salary. -Vertically integrated oil company -Control of refineries -Gas and oil involved oil Options worth 100% - 200% of annual compensation based on performance -Turnover 2010 - $2,195756, 2011: $3,082,660, 2012: $3,495,239 -Profits 2010: $226,332, 2011:$328,298,, 2012: $420,770 Bombardier (Aerospace and transport industry) -Base salary -Class B shares options for employees and top managers; increases with seniority -Continuous research -Commercialization of new research -Class B shares worth $133,782,688: 1% dilution to management: 2.2% as of year under review -Turnover 2010 - $19,366m. 2011: $17,892m; 2012: $16,768m -Profits 2010 - $2010: $0; 2011: $785m; 2012: $865m MCB Finance - Base Salary - Share Options for Employees and Managers -Credit solutions to people in Eastern Europe -Aggressive growth after 2006. -1.5million employee share stock outstanding -Approximately 8.02% of share capital -Turnover 2010 - $2.76m; 2011: $6.2m; 2012: $7,252m Profit 2010 - $577,000; 2011: $3.670m; 2012: $2,52m AVIVA Insurance -Base Salary -Management remuneration on performance -Insurance services -Survival strategy -Up to 75% - 150% extra of of directors base salary on attainment of results Turnover 2010: £1,546m; 2011: £1,246m; 2012: £1,203 Profit 2010: £571m; 2011: £500; 2012: £251 Air Liquide -Base Salary -Employee and manager stock options -Gases, technology and service industry -Innovation and research -Annual honor of 100 talented researchers -2.9% of workforce have shares -Promote innovation Turnover 2011: $14,457m; 2012: $15,326m Profit: 2011: $1,595; 2012: 1,675 DISCUSSIONS The findings indicate that there is a general trend amongst organizations to use a remuneration strategy that blends a range of remuneration systems and processes. To this end, the general trend involved the use of base salary and a remuneration package and process that that were meant to encourage management. From the trends and processes, it appears that most of the firms used the blend of base salary and performance based remuneration as a tool to ensure that firms work in a way and manner that they get results in order to survive the elements of the credit crunch which was at its height in the year 2010. Most firms made losses or marginal gains in the 2010 financial year. However, the use of performance based remuneration caused the firms to increase their productivity in the form of better turnover and better profits. This means that performance based remuneration is a good and a productive method and system that gets managers and executives to improve their contributions to the firm. There are three different types of remuneration systems that involved stock options and performance based systems. One includes increasing salaries in proportion to meeting performance targets and process. This involves defining a percentage of profit that a firm will give to management. The second system of compensation strategies involve providing a percentage of shares to a selected group of managers and executives upon meeting certain targets. This involve the identification of what the managers have done and providing some kind of compensation that is related to the results they attained. The third method and process is to provide a high volume of share exercise options to a small number of executives who will be given high targets. This is meant to provide a systematic and progressive system of getting a small group of people become motivated enough to provide results in specific aspects of their areas and processes. CONCLUSION Performance based strategies are important and vital in putting a firm on track. It motivates managers and gives them targets that they are able to achieve through hard work, effort and dedication. Although it sometimes works to a limited degree due to externalities, performance based remuneration is important and vital in helping a firm to achieve targets and it involves giving the workers and managers of a firm extra reward for their effort. This boosts intrinsic motivation and enables a firm to meet its survival and growth targets. It is established in the research that performance based strategies are dependent on the strategy that a firm puts across in a given period of time. This gets the firm to modify its systems of doing things and this is based on the performance targets and expectations. RECOMMENDATIONS It is recommended that firms must identify the circumstances in the external environment and formulate a compensation strategy. Compensation strategies are parts of the strategic process and the strategic systems of corporate entities. Therefore, firms are able to analyse their circumstances and conditions and come up with the best way to motivate them. Pay strategies and processes are sources of motivation and it has been shown from empirical analysis that they help firms in the private sector to move from one point to another. However, every firm has its own tailor-made approach and system that can be used to enable the firm to come up with the best solution to the firms needs. REFERENCES Ansoff, I. (2002) Corporate Strategy: An Analytical Approach London: Heinemann Balsam, S., Fernando, G. D. and Tripathy, A. (2011) “The Impact of Firm Strategy on Performance Measures used in Executive Compensation” Journal of Business Research 64 (2) pp187 – 193 Bebchuk, L. A. and Fried, J. M. 92010) Pay without Performance: The Unfilfilled Promise of Executive Compensation Cambridge, MA: Harvard University Press Bogardus, A. M. 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