The Use of Financial Incentives as Rewards to Improve Employee Performance in the Workplace - Assignment Example

Name) (Institution) (Course) (Module) (Instructor’s Name) 23rd September 2009 Letter of transmittal To: From: As requested, here is a report discussing the use of financial incentives as rewards to improve employee performance in the workplace. The report is based on McGregor's XY Theory and also borrows from Maslow’s Hierarchy of needs theory. I have used the report to make several conclusions and give a number of recommendations pertaining to the use of financial incentives. Please receive it in kind. Executive summary Rewards have for a long time been considered as a crucial part in management and HRM. Various ways have been invented to reward employees. Financial rewards have been the most controversial one. Theories and models have been developed to propose and oppose the efficacy of financial rewards on employees. Proponents of financial rewards argue from an economic point of view that every man loves money whereby money has no diminishing marginal returns. Opposers argue that money is not an efficient motivator and that intrinsic motivators are more effective. However, beyond finances, rewards can be offered in other forms such promotions, holidays and even plaques. Looking at the different methods of financial rewards, the contemporary understanding of rewards is bonuses. The basic argument lies on whether cash incentives are as good as intrinsic incentives. Content 1.0 Introduction ………………………………………….. 2.0 Types of financial incentives ………………………. 3.0 Determinants of pay incentive ……………………. 4.0 McGregor's XY Theory …………………………….. 5.0 Financial rewards vs costs …………………………… 6.0 Significance of pay incentives ……………………… 7.0 Conclusions …………………………………………. 8.0 Recommendations ………………………………….. References 1.0 Introduction Employees are an integral part of an organization without whom, an organization cannot exist. Therefore, it is important that beyond the brand name of an organization, the personnel running it are well managed and their efforts duly recognized. Armstrong (2002) says that employees are the major variable in an organization’s success. Mullich (2003) concurs with Armstrong and says that while most firms describe themselves by the products and services they offer, they are actually defined by the productivity, quality and service of their human resources, specifically the performance of their people. In order to improve the performance of the whole organization, Huselid (2006) says that employee performance management should precede organizational performance management. A number of authors (Huselid, 2006; Torrington, Taylor, & Hall, 2008; Mullins, 2007) agree that among the many ways of improving employee performance such as training, rewards, career support and performance appraisals, rewards have proved to be the most efficient. Most organizations offer rewards in form of cash incentives on top of basic salaries depending on their performance in attaining set organizational goals and targets. However, management literature suggests that pay is not the only factor that motivates people. Rather, people expect more out of a job than a pay check. Therefore, ‘reward systems that focus on pay and other monetary rewards exclusively at the expense of non-financial rewards are basically bribing their employees and eventually will pay a high price in a lack of employee loyalty and commitment’ (Aguinis 2009, p. 261). The McGregor's XY Theory also supports these findings by stating that “commitment to organizational objectives is a function of rewards associated with their achievement.” Employee’s commitment in this case is directed towards organizational goals and objectives leading to improved performance of the whole organization. This paper discusses how to effectively manage employee financial reward system in order to attain the commitment described by the McGregor's XY Theory that will eventually lead to improved organizational performance. 2.0 Types of financial incentives Piece-rate pay- employees are paid for time spent at work Commission- most effective in sales division as it increases both organizational performance and individual earnings Performance-related pay Bonuses- tied to profits or other measures of performance Shares and options- common reward for senior managers in large organizations as a form of equity Benefits in kind (“fringe benefits”)- e.g. holidays, shopping vouchers Pensions- payments after retirement 3.0 Determinants of pay incentive Job evaluation / content; used to set the basic pay and also rewards. It evaluates roles responsibilities and to a particular position in comparison with others. • Fairness – The work must match amount of work. • Negotiated pay rates – rate of pay is predetermined prior to employment either by government regulation (e.g. minimum wage law) or a contract where the employer has to comply • Market rates – pay rates viewed as fair and standard by the market • Individual performance – payment based on personal performance. 4.0 McGregor's XY Theory This theory was developed by one Douglas McGregor, an American social psychologist, who in his book ‘The Human Side Of Enterprise’ explained his famous X-Y theory (Millward, 2005). This theory is a combination of two theories, theory X and theory Y or rather two approaches in business management and HRM. The theory X approach is considered common in organizations with a vertical structure manipulated by one central source of authority. The authority carries on with management with an assumption that the average employee dislikes work and must be closely supervised as he tends to avoid work at every opportunity. Therefore, in order to make the employee deliver, he has to be threatened with severe consequences such as being fired upon failure to deliver. On the other hand, the theory Y approach takes makes entirely opposite assumptions. It assumes that the average employee loves work and is committed to attaining organizational goals and objectives. This theory also recognizes that employee’s potential intellect at work is not fully utilized and hence it seeks to employ ways through which to optimize employee intellect at work for better organizational performance. The theory thus recommends rewards but does not detail how rewards systems can be employed and utilized (Shields, 2007: Mullins, 2007; Basset-Jones, & Lloyd, 2005). The above theory is supported by Cole. E and Cole S. (2006) through an extensive review of literature material on employee performance and management. They conclude that employees’ level of satisfaction positively relates to organizational performance. Consequently some questions arise. Are organizations with happier employees more productive and successful? Is motivation at work the reason why these employees report more happiness? Do these organizations reward their employees” and are the rewards financial? The debate on rewards has been whether rewards, financial or not, really enhance employee performance (Millward, 2005). From a psychological point of view performance is tightly tied to psychological satisfaction which Millward (2005) connects to the Maslow’s hierarchy of needs theory. He says that since psychological needs are the most basic according to this model, they form the basis of satisfaction attained from other needs. Therefore, if an employee does not satisfy his psychological needs, satisfaction from higher level needs diminishes as well as his performance. Millward (2005) quotes Campbell (1991) who says that there are three determinants of performance variation among employees Declarative knowledge- knowledge on fact and requirements of a task Procedural knowledge and skill- combination of knowing what to do and how to do it Motivation-consists of choice to expend effort, increase effort and be consistence in expending that effort. However, Campbell (1991) (quoted in Millward, 2005) does not suggest the best way to address the variation in performance with pay as a reward. However, he is of the opinion that financial incentives, like all incentives, have a positive impact in driving an increase in the above elements that cause a variation in performance. Several theories have been developed to deny the significance of financial rewards or rewards in general in performance. Turner (2006) says that early thinkers in management believed rewards would affect the attitude of individuals toward their work and their understanding of why they are working that gave birth to the theory of cognitive dissonance. This theory suggests that intrinsic and extrinsic rewards cannot work hand in hand but work against each other. Simply put, the theory implores organizations to either employ extrinsic rewards or intrinsic rewards but not both simultaneously (Torrington et al 2008). 5.0 Financial rewards vs. costs Modern organizations have had some very emotional debates on how to reward and pay their employees due to continued growth in the cost of living that has seen employees more keen on better financial incentives and pay rises (Shileds, 2007). However, the increase in the use of financial rewards remains a high prerogative for senior managers who have relatively higher control on their remunerations than other employees. As a result, most employee rewards programs have to be performance based aligned to pre determined organizational policies. Early studies such as by Kohn (1993) link financial incentives to costs. He says that organizations keen on cutting costs tend to shy away from financial incentives for their employees not because they have proved to ineffective, but because they tend to contravene organizational polices and objectives. Kohn (1993) is overly against the use of incentives whether financial or not saying that “in numerous studies in laboratories, workplaces, classrooms, and other settings, rewards typically undermine the very processes they are intended to enhance.” (p. 54). He adds that incentives do not stimulate behavioral change through a change in attitude and perception to work as their impact is short term and lead to short term employee compliance aimed at clinching the reward but not actually committed to the organizational cause thereby increasing organizations costs both in the short term and log term while performance deteriorates in the long term. From another perspective, some organizations prefer to use financial incentives as a way of cutting their cost. This method was developed by motivation theorist Taylor who suggested piece rate form of payment for workers. Through this method, employees are motivated to work harder and be more efficient at work in order to increase their pay. Laezar and Shaw (2007) say that when firms apply piece rate pay, productivity increases. Unfortunately, this view only seeks to benefit the organizations but not the employees for their intrinsic value. Nielson and Stowe (2004) argue against piece rate pay as a financial incentive as it encourages inequality in wages. Consequently, inequality in wages leads to de-motivation for employees earning less. They say that employees tend to group themselves according to their level of pay and malice and backbiting becomes often. Nielson and Stowe (2004, p.4) say “in the Fehr-Schmidt model, an individual receives (self-oriented) utility from his own payoff but (social) disutility from any difference between his partner/opponent’s payoff and his own.” On the other hand, Shields (2007) says that measuring performance is a tricky task as some tasks might be hard to quantify. As such, any methods used to quantify work might be biased leading to discontent and de-motivation among employees. In the last 25 years, empirical evidence in this argument paints a different picture. Laezar and Shaw (2007, p. 92) say that “compensation now varies much more highly across individuals. In 1974, the 90th percentile of wage earners received about 1.9 times the hourly wage of the 50th percentile, but this multiple has risen steadily over the last three decades and has now reached about 2.3.” This simply implies that higher income earners have had increases in their earnings while the low income earners continue to witness a decrease in their earnings. Laezar and Shaw (2007) attribute this to a shift from pay for performance to pay through incentives and cash rewards. 6.0 Significance of pay incentives Financial incentives are also closely tied to Maslow’s Hierarchy of needs theory. Donaldson and Davis (2006) note that money facilitates employees to access some of the basic needs recognized by this theory such as food and shelter. They say that the need to meet the cost of these basic needs motivates employees to increase their performance if there is assurance that it will be rewarded financially. Turner (2006) puts it simply “gift for gift” saying that a gift to the employee attracts a gift to the other direction. He adds that the diverse usage of money as compared to other rewards systems is immense. Going by Maslow’s hierarchy of needs theory, extrinsic rewards that mostly entail non financial incentives come way much after the basic needs that financial incentives seek to address. However, he also takes note of what Kohn (1993) had warned about financial incentives being short term. He says, financial incentives given on the basis of attainment of set organizational goals and targets should be made at least on an annual basis in order to make motivation sustainable. Many organizations have used financial incentives to meet a number of legal requirements pertaining to pay such as minimum wage and equal pay across gender (Mullich, 2003). Gross pay is a very sensitive factor to new employees and job seekers. As such, promising financial incentives on top of basic pay has high potential in creating a wide and skilled pool of employees (Laezer and Shaw 2007). However, it should be noted that giving excessive weight in attracting potential employees through financial rewards may impact negatively on the company’s long term performance. Neely (2008) says that apart from increasing recurrent expenditure, employees peg their work on rewards rather than overall performance of the company. Neely (2008) says that piece rate payments and financial rewards are best suited for low level employments. He notes that senior managers who are rewarded with company shares instead of direct cash incentives have a tendency to make decisions that benefit shareholders and not the company itself. In actual fact, some management experts (Bergstressera & Philippon, 2004; Cole E & Cole S., 2005) have heavily criticized the inclusion of company CEO’s as shareholders or directors. This will be discussed in depth later in the paper. Employee retention is another reason that financial rewards are regarded highly by management (Neely, 2008). He confirms what had been mentioned earlier in this paper pertaining to employee satisfaction as per Maslow’s hierarchy of needs theory that shows that money forms the basis of realization of intrinsic motivation. Shields (2007) says that when financial rewards are offered in the long-term, employees have shown a tendency to remain in the same organization as they wait to reap their benefits. To make this strategy effective, the terms of an incentive must only be enjoyed after completion of a certain period of time with that organization. On the other hand, some authors have drawn similarly of these to social security fund. In a paper titled How Changes in Financial Incentives Affect the Duration of Unemployment, Lalive, Ours, and Zweimuller (2006) investigate how financial incentives to the unemployed in Austria impact on their search for work. They conclude that prolonging the period in which one becomes eligible for unemployment benefits after losing employment in the 1990’s encouraged more people to search for work thereby increasing the country’s output. In a reversed scenario, their model can be used to show that increasing the period in which an employee becomes eligible for financial incentives deters them from moving and maybe joining a competitor. Again, high rates of employee retention save employers a lot of money utilized through human capital investments. Laezer and Shaw (2007) argue that it is not by coincidence that some of the most highly paid CEO’s run the most successful companies. The argument here is that these companies do not necessarily pay these employees that much just because they can afford it, but because they seek the best talents and skills in the labor market. Such high salaries are also backed up by financial incentives that more than not are a function of the overall organization performance. Bergstressera and Philippon (2004) and Shields (2004) note that many companies have taken to rewarding employees with company shares instead of direct financial incentives. As earlier said, this has elicited much debate among management thinkers. Bergstressera and Philippon (2004) write that “the median exposure of CEO wealth to firm stock price tripled between 1980 and 1994, and doubled again between 1994 and 2001.” The main motive in this trend is to align senior management’s incentives to shareholders interests. The results have been mixed with CEO’s accused of making decisions that benefit shareholders but hurt the company in cases where such CEO’s have accumulated a huge stock share (Laezer & Shaw, 2007; Bergstressera & Philippon, 2004). Bergstressera and Philipponb (2004) remind us of the 1990’s Xerox scandal where the company’s CEO was accused of overstating the company’s income in order to personally gain from trading in the company’s shares in the stock market as a shareholder. To put this into perspective, revised financial statement reduced Xerox’s revenue between 1997 and 2001 by $2.1 billion and net income by $1.4 billion. Baker, Jensen and Murphy (1998) say that “explicit financial rewards in the form of transitory performance-based bonuses seldom account for an important part of a worker’s compensation.” They note that while senior management such as CEO’s and departmental heads are rewarded according to the overall performance of the organization or their respective departments, lower level employees are rewarded on non qualitative aspects such as hygiene in the workplace, teamwork participation and even neatness which have little correlation with organizational performance. However, in the service industry where the people element has more weight, such qualitative values take precedence and can be rewarded financially. Turner (2006) says that rewards such as recognition through praise, awards and plaques have little meaning for low level employees. Therefore, according to him, financial rewards should be highest for low level employees who usually earn less. Neely (2008) adds that since low level employees tend to be relatively low skilled, their chances of getting other forms of incentives such as promotions are low and hence the management has to reward these employees through the most convenient way to them. Again, some of rewards that Shields (2007) suggests such as membership to a club, gym or even holiday trips do not prioritize some of the employees needs. Therefore, financial rewards remains to be the most efficient and convenient form of incentives. Unfortunately, employees are prone to setting very high and unrealistic goals in order to cash up on financial incentives. The result is disorientation of an organization and eventual poor performance both at employee level and organizational level (Ordóñez, Schweitzer, Galinsky, & Bazerman, 2009) 7.0 Conclusions From the above discussion, it is obvious that employees of lower ranks value financial rewards more than any other form of incentives. Existing literature do to really connect indiscipline among low level employees, as a prerequisite of a successful reward program, hence appropriate for that. Nevertheless, indirect financial incentives in the form of shares for senior management have detrimental effect as shareholder interest and management interests may be in conflict. However, it has also been noted that the idea of having the senior management as shareholders works in the early stages of the system. But as shown, greed and over ambitions set and distract the normal business of a firm that eventually affects its performance. 8.0 Recommendations Financial incentives work best for low level employees earning less. Senior level employees give more weight to intrinsic rewards on the higher levels of Maslow’s hierarchy of needs theory. Organizations should not allow their top management to be shareholders as there might be a conflict of interest. Organizational culture should be evaluated first in order to decide on the best form incentives for their employees. Piece rate employment should not be considered as a form of financial incentive. Financial incentives are effective in improving organizational performance but should be applied with care Financial incentives should be aligned with company policy on costs. Financial incentives should be used to empower employees in the workplace and the feeling of security gained improves organization and individual performance Performance cannot be improved by incentives only but also by providing a convenient providing a conducive workplace through democracy. References Armstrong, M. (2002).Employee reward, Ed 3, New York: CIPD Publishing Baker, G., Jensen, M. & Murphy, K. (1998). Compensation and incentives: practice vs. theory, Harvard University Press, (Accessed on line on 23 Sept 2009 from), www-rcf.usc.edu/~kjmurphy/jmjpe.pdf Basset-Jones, N. & Lloyd, C. (2005) Does Herzberg's motivation theory have staying power? The Journal of Management Development; 2005; 24, 10; ABI/INFORM Global pg. 929 Bergstressera, D. & Philippon, T. (2004), CEO incentives and earnings management, Harvard Business School, (Accessed on line on 23 Sept 2009 from), http://archive.nyu.edu/bitstream/2451/26408/3/FIN-05-007.pdf.txt Cadsby, C., Song, F., Tapon, F. (2007). Sorting and Incentive Effects of Pay-for-Performance: An Experimental Investigation, The Academy of Management Journal Cole. E and Cole S. (2006) employee satisfaction and organizational performance: a summary of key findings from applied psychology, (Accessed on line on 23 Sept 2009 from), www.teammax.net/files/LiteratureReview.pdf Donaldson, L. Davis, J. (1991). Stewardship Theory or Agency Theory: CEO Governance and Shareholder Returns, Australian Journal of Management, 16, 1, p.128-146 Huselid (2006) The impact of human resource management practices on turnover and corporate financial performance, Academy of Management Journal, Vol. 38 (3) p. 635-872 Kohn, A. (1993) When reward systems fail don't blame the program -look at the premise behind it: Why Incentive Plans Cannot Work, Emerald Insight Database Laezar and Shaw (2007). Personnel Economics: The Economist's View of Human Resources Journal of economic perspectives, Vol. 21 (4), p. 91-114 Lalive, Ours and Zweimuller (2006) How Changes in Financial Incentives Affect the Duration of Unemployment Millward, L. (2005). Understanding occupational and organizational psychology, New York: Sage Mullich, J. (2003. ‘Get in line’, Workforce, 82(13):43-46. Mullins, L. (2007). Management and organisational behaviour, New York: Financial Times Prentice Hall Neely A. (2008). Business performance measurement: unifying theories and integrating practice, Ed 2, New York: Cambridge University Press Nielson and Stowe (2004) Piece-Rate Contracts for Other-Regarding Workers, Centre for Economic Research, Tilburg University, Wiley Database Ordóñez, L., Schweitzer, M., Galinsky, M. & Bazerman, M. (2009). Goals Gone Wild: The Systematic Side Effects of Over-Prescribing Goal Setting, (Accessed on line on 23 Sept 2009 from), hbswk.hbs.edu/item/6114.html Shileds, J. (2007). Managing employee performance and reward: concepts, practices, strategies, New York: Cambridge University Press Turner, L. (2006). Pay for performance: contrary evidence and a predictive model, Academy of Marketing Studies Journal, Vol. 10, (2), Torrington, D., Taylor, S & Hall, L. (2004). Human resource management, New York: Prentice Hall Read More