Introduction
In modern business environment, employees’ compensation stands out as an important component of every organization. The rationale is that it shapes other aspects of an organization including productivity and strategy. Compensation has the main aim of attracting and enhancing company’s ability to retain employees.
A firm that retains employees through competitive compensation benefits from high productivity and increased job satisfaction among employees. Ioana & Raluca (2011) explicate that competitive compensation is important for organizations and subsequently, it constitutes the largest single cost for many companies in the world. Pamela (2012) articulates that 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.
This research paper discusses the advantages of pay for performance as a way of motivating and retaining employees. In addition, it will explore theories that surround pay for performance as the best system of retaining and motivating employees.
Pay for Performance and Theories discussed
According to Edralin (2010), numerous theorists have proposed many arguments relating to pay for performance employees’ compensation method. Although there is no consensus on the theories, pay for performance has various organizational benefits. Ioana & Raluca (2011) say 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 an extra income tend to search for other employment opportunities that have higher fixed 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 (Edralin, 2010). 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 improved achievement of a specific goal if they stand to gain. Besides, Gruman & Saks (2011) 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 (Pamela, 2012). This way, managers are able to understand the progress of a specific project, which in turn leads to improved teamwork. Gruman & Saks (2011) 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 to have asked for help and advice from their colleagues in order to improve on performance. In an environment marked with companies seeking to have a competitive edge over others, pay for performance is a strategic tool that facilitates organizations to achieve its set objectives and goals.
Pay for performance provides a company with the ability to predict its financial performance in the short run (Ghazi et al., 2010). Companies that use the policy attract qualified employees who are able to surpass expectations. In case of increased projects and scheduled goals, an organization is able to place increased motivation on bonuses to lure employees to accomplish the tasks (Galanou et al., 2011).
Organizations are therefore able to forecast their sales and productivity. According to Chen (2011), predictability of an organization increases investors’ confidence due to the stability of the organization. As such, it is only obvious to conclude that pay for performance leads to organizational stability and value.
Many social scientists have proposed theories that attempt to explain the psychological, behavioral and economic perspectives of pay for performance. Outstandingly, cognitive theories articulate that human beings are solely driven by the urge to get rewards. They say that human beings tend to repeat actions that yield them highest level of happiness. This crosscuts across all societies, organizations and countries.
In organizations particularly, pay for performance tends to reward hard work. Cognitive theorists argue that employees interpret hard work as an action that when repeated, will increase their rewards and happiness (Ioana & Raluca, 2011; Erdogan, 2002). The reward theory postulates that individuals’ ability to be consistent is a motivational factor.
In the business contexts, a motivated team of staff is an asset for the company. It gives the organization a competitive edge over the rivals and competitors. When the employees are motivated to work due to pay for performance, 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 organization’s strategy (Gruman & Saks, 2011). A firm uses a compensation method stands to gain optimized profits due to its costs and perceived benefits. Agency theorists argue that organizational costs come about due to the apparent differences of employees and the firms.
One source of costs for organization is when employees fail to put maximum effort in their productivity leading to reduced efficiency. The rationale is that an organization pays more number of hours than when the employees put their maximum effort on the work (Edralin, 2010).
Further, the theory says that firms seek to optimize their revenues and profit margins by motivating, recruiting, and acquiring high skilled and qualified employees. Nonetheless, the employees are consumers. They therefore seek to maximize utility (Chiang & Birtch, 2008; Galanou et al., 2011). 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 to strike a balance between disutility and utility. Employees are likely to assume that the increased effort that is synonymous to pay for performance is costless. To the contrary, the increased effort only seems to benefit both the firm and the employee marginally.
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 his or her abilities and motivation in the long term.
Due to the risks that are apparent for the employees, agency theory articulates that firms have an obligation to pay the employees a premium (Gruman & Saks, 2011). This creates even 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 well aware of their full potential, skills and abilities. On the other hand, the firm knows little if anything about the ability and full productivity of the employees.
This information asymmetry between employees and organizations leads to erection of measures by the organization to unleash employees’ full productivity. For example, if a firm decides to offer low and guaranteed pay to all workers upon large organizational performance, it is likely that the organization will record improved performance across all the departments.
Psychologists have also come up with a theory that seeks to explain pay for performance for individuals in organization (Chen, 2011). Social comparison theory posits that employees and all other members of the society evaluate their productivity and abilities through comparison. Employees tend to compare their productivity depending on the opinions of referent groups.
Danish & Usman (2010) assert that the theory is anchored in the belief that human beings have the desire to evaluate themselves using the opinions held by others. The rationale is that there is no standard assessment of abilities and as such, people tend to look to others (Ioana & Raluca, 2011 Danish & Usman, 2010).
To this end, the theory argues that individuals engage in social comparisons with people who are close and have similarities with them. This is the most common way of gaining information on individual performance in many contexts.
Further, the theory proposes that employees exude effort comparable to their peers. This is despite the notion that an increase in individual earnings may result to increase in productivity. Social comparison theorists say that employees do not work in a vacuum (Erdogan, 2002). This implies that they will be influenced by the amount of effort that other employees put in their work and tasks.
Chen (2011) argues that many employees who work under the context of pay for performance policies do not consider the differences in their incomes but instead, they emphasize on comparison of effort at work place. This is in line with equity theory that says that workers’ perspective on the inequality in pay is justifiable (Chiang & Birtch, 2008; Chen, 2011).
This is because they perceive the pay as objective due to the clear and observable differences in their productivity and effort. These minute details according to the proponents do not necessarily result to psychological costs for the other employees. This theory seeks to appraise the conventional pay for performance method of compensating employees.
Other theories that attempt to explain motovation and pay for performance include Abraham Maslow theory of motivation. The theory asserts that the employees will attempt to increase their productivity depending on the position they occupy in Maslow’s hierarchy of needs (Erdogan, 2002). Chen (2011) says that an increase in income due to hard work may lead to satisfaction leading to motivation.
Contingency fit theory is also applicable to pay for performance. It states that human resource practices must be in line with internal and external contingencies for the performance to affect the company or organization.
Application of the Theories to the Business World
The aforementioned theories are instrumental in informing many organizations and businesses about the most appropriate method of compensating employees. Social comparison theory is applicable in organizations that desire to harness increased productivity from performance-based compensation. Danish & Usman (2010) say that organizations use unconventional and other forms of compensation.
Indeed, they combine it with fixed salaries. As such, the employees become 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 (Ghazi et al., 2010). 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 to an increase in the output of the company. On the other hand, employees expect a reward for increased productivity.
Danish & Usman (2010) elucidate that this 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, increase in 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.
According to Chiang & Birtch (2008), agency theory 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 on profits therefore, managers adopt a compensation scheme that leads to maximization of profits.
Given the advantages of pay for performance, the agents (managers) are able to entice the employees to increase their productivity and ultimately, increase the profit margins of the company (Danish & Usman, 2010). In addition, it is important to note that agency theory projects a direct relationship between individual pay for performance and productivity (Erdogan, 2002).
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 financials.
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 (Danish & Usman, 2010). 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. To that end, employers use equity theory to appraise the performance of the employees when they introduce such a compensation policy or method. It serves to explain why many companies may have failed to get the benefits that are associated with pay for performance.
Conclusion
In essence, there are various ways of compensating employees for their work. While we recognize that employers and their objectives are different, compensation methods differ across the wide spectrum of business. One of the most renowned methods of compensation is pay for performance. It refers to a bonus wage increase that a company gives to an employee due to his or her exceptional performance or ability to meet the objectives of the company.
Pay for performance increases motivation among the employees leading to high level of retention (Danish & Usman, 2010). This allows an organization to exploit the skills and talents that the employees possess. To explain the impact of pay for performance among employees, various theories are imperative. First, cognitive and behavior theorists argue that reward theory is central in pay for performance scheme of compensation.
Employees are likely to repeat an action that yields them high benefits. Agency theory argue that firms and employees are distinct in the sense that the former aim at maximizing profits while the latter aim at maximizing utility.
Other theories include social comparison that projects that employees’ performance is relational to the opinions and information that they have about their abilities especially from their peers (Erdogan, 2002; Danish & Usman, 2010). Contingency and equity theories also provide insights in the way pay for performance method of compensation affects the employees.
The theories that relate to pay for performance are applicable to the contemporary business contexts. Reward theory serves to inform the managers on the choices they make on the appropriate way to compensate the employees. Social comparison theory assists them to anticipate the effect of pay for performance on the increase in productivity.
Agency theory on the other hand allows organizations to strike a balance between maximization of profits and utility for the employees and the firm (Danish & Usman, 2010). It is worth mentioning that pay for performance has immense benefits for an organization if well implemented.
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