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Currently, many companies and organizations fail to compensate their employees competitively as a way of enhancing job satisfaction. In fact, employees’ compensation stands out as an important component of every organization.
The reason is that it shapes other aspects of an organization including efficiency and strategy. Compensation’s main objective is to attract and enhance the company’s ability to retain employees.
A firm that retains employees through competitive compensation benefits from high productivity and increased job satisfaction. Salgado (1997) argues that competitive compensation is important for organizations and subsequently, it constitutes the largest cost for many companies in the world.
There are many ways of compensating employees in both the private and public organizations although there is none that is generally practiced across the business environment. How does pay for performance lead to job and employees satisfaction?
Theories of Compensation
Many social scientists have proposed theories that attempt to explain the psychological, behavioral and economic perspectives of compensation. Outstandingly, cognitive theories articulate that human beings are driven by the urge to get rewards.
Human beings tend to repeat actions that yield them the highest level of happiness. This crosscuts across all societies, organizations, and countries. In organizations, competitive compensation tends to reward hard work (Salgado, 1997).
Cognitive theorists argue that employees interpret hard work as an action. Repeating this action will increase their rewards and happiness.
Consistency in actions and rewards leads to job satisfaction. This is according to the reward theory. In business contexts, a motivated team of staff is an asset for the company. It gives the organization a competitive edge over rivals and competitors.
When the employees are motivated to work owing to competitive compensation, the organization retains them with ease. Agency theory is central to any compensation method applicable to the modern business environment.
It proposes that compensation of employees is an organizational strategy (Chen, 2011). A firm uses a compensation method due to its costs and perceived benefits. Agency theorists argue that organizational costs come about due to the apparent differences in employees and firms.
One source of costs for an organization is when employees fail to put maximum effort in their productivity leading to reduced efficiency. The rationale is that an organization pays number of hours than when the employees put their maximum effort into the work.
Further, the theory says that firms seek to maximize their revenues and profit margins by motivating, recruiting, and acquiring high skilled and qualified employees. Nonetheless, employees are consumers. They, therefore, seek to maximize utility.
This is through increased income that affects the utility in a positive way. The theory, however, cautions that employees who seek to maximize their utility must strike a balance between disutility and utility (Riordan, Vandenberg & Richardson, 2005).
Employees are likely to assume that the increased effort typical of pay for performance is costless. To the contrary, the increased effort only seems to benefit both the firm and the employee in a marginal way.
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Chen (2011) says that the employees under pay for performance are likely to put effort into fulfilling small tasks.
In fact, the study showed that many employees are unlikely to take up huge and difficult tasks. The theory also posits that extra work for the employees may affect their ability and motivation in the long term.
Due to the risks that are apparent for the employees, agency theory articulates that firms have the obligation to pay the employees a premium (Chen, 2011). This creates more costs for the organization, which aims at retaining such employees.
The theory has empirical foundations owing to the amount of literature in the world of business. It is apparent that agency theory’s core is in the differences between the employees and the firms. For instance, Chen (2011) pinpoints that employees are aware of their full potential, skills, and abilities.
On the other hand, the firm knows little about the ability and full productivity of the employees.
This information asymmetry between employees and organizations leads to the erection of measures by the organization to unleash employees’ full productivity (Ivancevich & McMahon, 1982).
For example, if a firm decides to offer low and guaranteed pay to all workers, it is likely that the organization will record improved performance across all the departments.
Application of the Theory: Pay for Performance
The above theories present many arguments relating to employees’ compensation methods. They advocate paying for performance model as a way of compensating employees and enhancing job satisfaction.
Although there is no consensus on the theories, pay for performance has various organizational benefits.
Riordan et al. (2005) point out that pay for performance assists many organizations to achieve the goal of recruiting qualified employees who are interested in earning increased wages and salaries out of their hard work.
The compensation policy allows employees who do not meet the set objectives to quit the organization voluntarily. The reason is that employees who fail to earn extra income tend to search for other employment opportunities that have higher salaries and wages.
To that end, pay for performance helps organizations to retain and recruit highly qualified employees who are able to offer their skills for improved performance of the company (Salgado, 1997).
Highly qualified and skilled employees are directly related to positive performance of an organization. They translate to increased productivity and revenues.
In his study, Chen (2011) found that pay for performance method of compensating employees encourages group and team work in all organizations. Employees tend to cooperate with others for the improved achievement of a specific goal if they stand to gain.
Ivancevich & McMahon (1982) assert that the method of compensation allows members of the staff to interact closely with their supervisors and managers. This allows employees to avoid mistakes and risks since they seek for advice from the entire team (Judge, Bono, Ilies & Gerhardt, 2002).
This way, managers are able to understand the progress of a specific project, which in turn leads to improved teamwork and job satisfaction. Judge et al. (2002) articulate that over half of the employees who took part in the study earned increased bonuses and extra pay through teamwork.
Most of them agreed that they had asked for help and advice from their colleagues in order to improve their performance.
In an environment typical of companies that seek to have a competitive edge over others, pay for performance is a strategic tool that facilitates organizations to achieve its set objectives and goals.
Employees are motivated by the fact that they all have a fixed salary despite differences in their intermediate incomes from pay for performance. Organizations use the pay for performance as a way of rewarding employees who surpass expectations (Chen, 2011).
The reward theory discussed earlier is important in the pay scheme in all organizations. The firms expect that an increase in incentives will consequently result in an increase in the output of the company. On the other hand, employees expect a reward for increased productivity.
Salgado (1997) says that the interplay between input and output among the employees leads to a reinforced behavior of hard work and competency.
Reward theory also applies to firms that use pay for performance to assist the employees to increase their disposable income and as such, maximize their utility. However, improvement in the effort that each employee put into a task is marginal.
Chen (2011) asserts that disutility might increase among the employees in case the bonuses they receive for their exemplar performance is high. As such, firms tend to balance the extra income with the base salary rates to avert such risks. This way, employees remain committed to the organization.
Salgado (1997) posits that every member of the organization is placed in the organization for the sake of increasing the value of the shareholders. As such, the managers and employees represent the company in all decision and policymaking processes.
To maximize profits therefore, managers adopt a compensation scheme that leads to maximization of profits. Given the advantages of pay for performance, the managers can entice the employees to increase their productivity and profit margins of the company.
Additionally, it is important to note that agency theory projects a direct relationship between individual pay for performance and productivity.
Through the scheme, the employees are able to augment their efforts for the organization. Since the sole objective of a business is to increase profits, the extra effort that employees put into their work reflects in the company’s financial performance.
In sum, all the above theories work differently in various contexts. According to equity theory, employees may not increase their productivity merely because the pay for performance policy promises more income (Ivancevich & McMahon, 1982).
The rationale is that the employees seem to overlook the small differences in their pay. They believe that the pay is justifiable due to the increased individual effort and does not necessarily imply a source of discrimination. This leads to job satisfaction.
Chen, D. (2011). Research of Performance Management on Chinese SME. International Journal of Business and Management, 6(4), 263-265.
Ivancevich, M. & McMahon, T. (1982). The effects of Goal Setting, External Feedback, and Self-Generated Feedback on Outcome Variables: A Field Experiment. Academy of Management Journal, 25(2), 359-372.
Judge, T., Bono, J., Ilies, R & Gerhardt, M. (2002). Personality and Leadership: A Qualitative and Quantitative Review. Journal of Applied Psychology, 84(4), 765-780.
Riordan, C., Vandenberg, R. & Richardson, H. (2005). Employee Involvement, Climate and Organizational Effectiveness. Human Resource Management, 44(4), 471-488.
Salgado, J. (1997). The Five-Factor Model of Personality and Job Performance in the European Community. Journal of Applied Psychology, 82(1), 30-42.