Effective Reward Strategy - Case Study Example

Managing the Performance of Individuals REWARD SYSTEMS: BONUS AND PERFORMANCE-RELATED PAY INTRODUCTION Reward systems that are generally established by organisations consist of bonuses and performance related pay, besides other incentives. In the Case Study Culture of Greed (Toynbee 2009) in “The Guardian”, London, which relates particularly to the banking and financial sector, it is indicated that a gradual decline in the culture of exorbitant bonuses and payoffs to the upper echelons of organisational hierarchy is likely to take place in the future. However, market competition is attributed as the reason for continued support by organisations to high pay structures, for the purpose of motivating the “best people” and keeping them in their jobs. According to the Case Study, the negative effects of bonuses is that they create perverse incentives, including “insane risks with bonuses pegged to share price” (Toynbee 2009), and “encourage auditors to turn a blind eye”. There is a decision to withhold bonuses to bailed-out bank chiefs until state cash is paid back. This is apparently causing banks to further wrongful actions, such as to stop disbursing bank loans in order to save capital for the pay back of state cash. The author of the Case Study supports the abolishment of bonuses altogether since evidence indicates that either they do not work or have perverse effects. “Performance-related pay demotivates losers without motivating winners” (Toynbee 2009). Thesis Statement: The purpose of this paper is to determine whether one agrees with the author of the Case Study who claims that Bonuses and Performance-related Pay do not work or have detrimental effects; both supporting and opposing arguments will be investigated. Further, the goals of an effective Reward Strategy will be discussed. DISCUSSION When the performance of an employee is above or beyond expectations, a bonus or additional compensation is paid in addition to the base salary or hourly rate. Most bonuses are considered as discretionary, and are different from incentive plans which are related to the successful completion of assignment. Bonuses are of various types, can be optional such as the ‘holiday bonus plan’ or may be associated with established objectives like the ‘spot bonus plan’ which rewards outstanding performance; or the ‘sales performance bonus’ for exceeding a particular quota of sales. Essentially, it is the employer’s prerogative regarding matters pertaining to the (Bogardus 2009). A form of bonus is the performance-related pay, or financial rewards for individual employees based on profitable outcomes achieved by them. It is based on assessment of performance, summed up in an appraisal rating with specific objectives. Evaluation is carried out against firm bench-marks concerning a range of criteria from the achievement of specific objectives to the effective development of required competencies. Performance-related pay (PRP) can be an individual cash bonus, “a percentage increase or additional increase on a pay scale” (Thompson & Milsome 2001: p.25). Performance-related pay is based on motivational theory and its inter-related goal theory; since objective-setting is a key element of PRP systems, and is a powerful motivator on its own. On the other hand, expectancy theory suggests that performance-related pay can be an effective motivator only when the employee feels that he has the abilities and skills to fulfill the specified goals which is essential to receive the reward of the performance-related pay (Brown & Armstrong 1999). The Advantages of Performance-Related Pay Systems The above schemes such as bonus and performance-related pay have the advantage of flexibility, and can reward several dimensions of work performance; for example stress tolerance, delegation, initiative, oral expression and other aspects. Some of the other benefits of using performance-related pay systems are increased productivity, cost-effectiveness, and greater profits. This is achieved through minimising negative side effects, encouraging cooperation and gaining acceptance (Furnham 2005). Need Theories pertaining to behaviour at work are “based on the simple idea that work-related behaviours are directed to satisfying certain needs” (Furnham 2005: p.286). Both for survival and progress people try to satisfy their needs, whether at the workplace or outside. According to Murray (1938), motivation is key to personality theory, and people’s motivation to satisfy needs or drives produces tension. Need is a force in the brain region, directing an unsatisfying situation towards a particular goal. Maslow’s (1954) well-known theory of the hierarchy of needs states that when the lowest physiological needs are met, the next higher level need for safety is triggered, and when that need is satisfied, the need at the next higher level requires to be met, thereby progressing in the same way. The topmost desire for self actualisation or self fulfilment relates to developing one’s potential and realising one’s abilities to the fullest. Employees who feel self-fulfilled “can be extremely valuable assets to their organisations” (Furnham 2005: p.288). There are numerous types of performance-related pay (PRP) systems based on the section of people included, the extent of inclusion, whether performance is measured by objective counts, subjective ratings or a combination, and the form of incentives used: whether money, shares, or others. The purpose of PRP systems is to motivate good performers to continue to work hard towards merit-pay based on performance; and to motivate poor performers to persevere more to achieve a reward (Furnham 2005). The Weaknesses and Adverse Outcomes of Performance-Related Pay Systems Despite the beneficial purpose of the performance-related pay system, it often has adverse impacts in some organisations, resulting in dissatisfaction, embitterment and alienation among staff. The root cause of this is difficulty in ensuring fair and differentiating systems of rating. Hence, many organisations severely cut the amount of merit pay. Further, there is resistance from managers and unions to PRP systems. The system depends on managers, requiring them to be clear and explicit with regard to perceptions of poor performance and rewarding successful performance. On the other hand, unions oppose equality-based systems because collective bargaining for securing special benefits for their cadres becomes redundant (Furnham 2005: p.283) Significantly, it is difficult to design an effective pay for performance programme because performance assessment is frequently subjective in nature, the resulting inconsistencies are difficult to eliminate “and create the risk of pay differences that cannot be justified” (Swanepoel et al 2003: p.519). For the above reason, another serious limitation to performance-related pay systems is that “ratings of performance tend to drift to the centre” (Furnham 2005: p.282), which refers to ratings both good and bad being closer to the average. The fundamental principles of the system are undermined because managers are confronted with conflict or anxiety between people in a team; hence managers tend to overrate poor performers and at the same time underrate better performers with merit increases which are too small to be effective. This is explained by Equity Theory which states that people tend to compare themselves with others in a social context, in terms of outcomes consisting of benefits and rewards such as pay, fringe benefits and prestige, and inputs composed of effort and ability which includes contribution of time, effort, number of units produced and personal qualifications for the job. Performance-related pay systems may fail also because of the reliance on subjective performance ratings due to the absence of objective, quantitative performance measures for many jobs; and unclear association between performance and pay commonly due to systems ignoring immediate reinforcement, and linking performance to reward only at the end of the year. Further, the overall strategic performance objectives may not be adhered to, and some other, unrelated aspects of performance may be rewarded. Moreover, performance-based rewards such as production bonus scheme may encourage wrong kinds of behaviour such as bypassing quality assurance procedures in order to meet the required levels of output. Additionally, there may be inadequate communication about the “objectives, procedures and benefits of the scheme” (Swanepoel et al 2003: p.519). During the times of economic downturn, when higher motivation and effort are required, there is a tendency to slash the size of merit pay rewards. In an equitably administered and effective open system, the amount of performance-related pay should be depicted clearly, separate from other increases such as cost of living. Frequently many managers underestimate the pay of their superiors and overestimate the pay of their peer and subordinates, thereby creating dissatisfaction among employees (Furnham 2005). Baker (2002) states that a crucial part of any incentive system is performance measurement. Since distortion and risk are two parameters of performance measurement affecting the strength and value of incentives such as performance-related pay, fairness of the system cannot be completely validated. Greiling (2006: p.48) found from her research study that “the majority of theories applied are sceptical about the assumption that performance measurement will act as an efficiency driver”. Hence, an ambivalent situation regarding effective outcomes continues to persist. The Required Outcomes of an Effective Reward Strategy An effective reward strategy would focus on the fact that besides higher pay other satisfactions at work such as personal respect also contribute to self-fulfilment, the highest human need according to Maslow’s theory. This is reiterated by Locke’s (1976) value theory which argues that job satisfaction is more dependent on whether or not work provides people with what they value, want or desire such as adequate pay, optimal working conditions and promotion opportunities. Hence, an effective reward strategy would ensure that those employees who have performed well should be validated and singled out through a sufficiently high percentage of performance-related pay, as compared to basic pay, or other highly valued incentives. This would help to motivate both good and poor performers to increase their profitable outcomes. Despite the various limitations to using the performance-related pay system, it can be used beneficially through implementing particular steps. First, the bonus system should be such that performance-related or merit-pay should be allocated from the corporate treasury, and should not be associated to a percentage of the basic salary. Second, the range should be wide, while the amount involved should be maintained the same. For example, 0 to 20 % for lower paid employees, and 0 to 40 % for higher paid employees. Thirdly, management raters are required to be trained to assess and rate behaviour accurately and fairly, and should be accountable for their appraisals (Furnham 2005). The most important element for making performance-related pay work successfully is to ensure that appraisals are conducted in a just and comprehensive manner. The evidence from a study conducted by Marsden & French (1998) indicated that the individual motivational effects of performance-related incentives was to increase employees’ work beyond the requirements of the job, increase their sensitivity towards colleagues, more effective dealings with the public, promote motivation to get work priorities right and raise employees’ initiative in carrying out one’s job. However, Marsden (2004) warns that individual incentives that discourage cooperation among colleagues leads to dysfunction in carrying out work, resulting in adverse outcomes. Courty & Marschke (2002) divided a large government organisation into independent pools of agencies, with each pool distributing performance awards to the respective agency subject to two constraints: the award could not be negative and the total amount of the awards could not exceed a fixed budget. These constraints on the award distribution produced inefficiencies in the work performance. This is explained by the fact that the award designers may have had additional objectives besides effort maximisation. Thus, other than greater efficiency and output, other required outcomes of an effective reward strategy include increased cooperation among colleagues, improved employee loyalty to the company due to greater feeling of self-actualisation. CONCLUSION This paper has investigated Toynbee’s (2009) claim that “performance-related pay demotivates losers without motivating winners”. Despite the advantages of the PRP system, one agrees with the author of the case study Culture of Greed that the weaknesses and detrimental effects of the bonus sytem are much weightier, as discussed above. This is mainly due to the difficulty in formulating a completely just and valid system of performance appraisal, which consequently impacts the compensation sytem. Further, the goals of an effective reward strategy have also been determined. REFERENCES Baker, G. (Autumn 2002). 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Dunnette (Ed.). Handbook of industrial and organisational psychology. Chicago: Rand-McNally. pp.1297-1349. Marsden, D. (April 2004). The role of performance-related pay in renegotiating the “effort bargain”: the case of the British Public Service. Industrial and Labour Relations Review. 57 (3): 350-370. Marsden, D. & French, S. (1998). What a performance: Performance-related pay in the public services. Centre for Economic Performance. London: Centre for Economic Performance Publications. Maslow, A. (1954). Motivation personality. New York: Harper & Row. Murray, H. (1938). Exploration in personality. New York: Oxford University Press. Thompson, P. & Milsome, S. (2001). Reward determination in the U.K. London: CIPD (Chartered Institute of Personnel and Development) Publishing. Toynbee, P. (Saturday 7 February 2009). End this culture of greed. If Obama can, labour must. “The Guardian”. Retrieved on 3rd August, 2009 from: http://www.guardian.co.uk/commentisfree/2009/feb/07/bonus-culture-city-excesses Swanepoel, B., Erasmus, B., Van Wyk, M., & Schenk, H. (2003). South African human resource management: theory and practice. Edition 3. Cape Town: Juta & Company. Read More