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The purpose of the paper is the study about one of the compensation issues which is to determine the effect of base salary and incentive pay toward employee performance. It is also to identify, analyze and explain the specific problem occur in implementing both approach of base pay and incentive pay that usually used in compensation and how do they link with employee performance. This paper will use resources from broad to specific perspective from various researchers in and outside of Malaysia. Several business theories will be included in the discussion to shows the relationship of base salary and incentive pay effect toward employee performance. In this report also have some proposition that may related in solving the problem from this issue.
Before we look further into the topic discussed, it might as well we defined the term used in for the discussion. "Base salary is a fixed amount of money paid to an employee by an employer in a return for work and task performed. Base salary does not include benefits, bonuses or any other potential compensation from an employer" (base salary definition, 2012). Base salary is paid, most frequently in a monthly paycheck to an exempt or professional employee. An employee who is paid with a base salary is forecasted to complete a whole job in return for the base wage. "Basically, base salary is determined by market pay rates for people doing similar work in similar industries in the same region. Base salary is also determined by the pay rates and base salary ranges that established for an individual employer" (base salary, 2012). Base salary is also be controlled by government by act, term and regulation that organization must compliance with it. From my main reference textbook, it is mention that "salary referring to pay for employees who are exempt from regulations of Fair Labor Standards Act 1938 (FLSA) and hence do not receive overtime pay" (Newman, 2011). "FLSA is a federal law governing minimum wage, overtime pay, and equal pay for men and women in the same type of jobs, child labor and record keeping requirements". But this act and regulation did not practice at Malaysia because we have our government regulation and control such as Employment Act 1955 and Workmen Compensation Act 1952. When we talk about government and regulation control, I interested with the issue of minimum wage at Malaysia. "KUALA LUMPUR May 3 - Putrajaya's minimum wage policy will lead to surging unemployment "black market" labour and inflationary pressure employers and economists have warned Datuk Seri Najib Razak announced on Monday a base wage of RM900 for the peninsular and RM800 in Sabah and Sarawak with a grace period of six months or double that for micro-enterprises File photo of workers taking part in a Labour Day rally in Kuala Lumpur on May 1 2012 - Picture by Choo Choy May But employers and economists told The Malaysian Insider of the pitfalls of introducing minimum wage "When employers refuse to hire at the minimum wage desperate workers will look to the black market and agree to take less than that " said Wan Saiful Wan Jan chief executive of libertarian think-tank Institute for Democracy and Economic Affairs "The irony is that the government introduced this to provide a social safety net but these workers will not have EPF or Socso " he told The Malaysian Insider referring to the state pension fund and social security organisation." (Malaysia, 2012). This article is written by Shannon Teoh on May 03, 2012 at the web site www.themalaysianinsider.com. For me, this article did not influence me to think the right or wrong of action that take by government. But every action from government will give big consequences for organization, employer and employees generally whether in short or long term and the relation with employee's performance.
Besides that, another important term in this discussion is word incentive. Incentive is one of the forms of pay of cash compensation from organization towards their employee. The other way to pay compensation beside than give cash compensation is by giving them a benefit such as medical, accommodation, allowance, KWSP and SOCSO and many more. In compensation perspective, we must understand what incentives means are. "Incentive is binding on the pay increases directly to performance of the employee" (Newman, 2011). But we must know that the incentives did not make the base wage increase so it must be re-earned for each pay period to get more amount of monetary compensation. Then, the kind of amount of the incentive payment will generally be known in advance. This is because employee usually will understand with organization policy or they must know the target and what kind of achievement that she or he must get in term to get the amount of incentive payment. Sometimes it is measures by how much we can sale or produces the extra product. These make incentives different with merit pay. "The merit pay program is carried out by evaluate the past performance of and individual and then decide on the size of the increase" (Newman, 2011). For example most of the car sale person knowing that the more incentive will be given if they can sale imported mobile car better than sale a local car. This is because the different profit that company will earned by sells this two type of car. Even both merit pay and incentives try to influence employee performance, the incentive payment try to influence a future behavior while merits give a reward base on past performance.
Individual incentive plans (Relationship between Production Level and Pay)
Pay constant function of production level
Pay varies as function of production level
Method of Rate Determination
Unit of production per time period
Time period per unit of producttion
Straight piecework plan
Standard hour plan
Taylor differential piece- rate system Merrick multiple piece rate system
Halsey 50-50 method Rowand plan Gant plan
The table above explains about the relationship between the production level and pay for individual incentives. Generally all incentives plan have one common characteristic which is the standard in determined the level of incentive with the quantity of production.
3.0 The problem
Lately, the issue of executive compensation and incentive systems has been much in the business world. This problem is occurring because organizations do not totally recognize the importance of compensation in motivating employee. The most popular theory Herzberg's (1966) and McGregor's (1966) have defined the theories of motivation held that "individuals were motivated by true factor to their jobs" (Herzberg 1966, 2012). As we can see, the desired of title, position and of accomplishment of the jobs provided, and the internal factors to their jobs such as a fair compensation, could give individual high job satisfaction. Basically, the compensation is representing by a situation of no-win issues for employers and employees. By ignoring the issues it will contribute to the employee's dissatisfaction and lead to the problem of individual performance level. This is because from the previous years, the organization intention is more to the issue like job rotation, flexible scheduling, and quality circle that focused more on the job content. So it is obvious that much organization ignored the compensation issue.
3.1 Executive incentives compensation system
The changing in reporting and measuring requirements will give significant impact on the financial earning of organization that compulsory used stock compensation as a component of executive's incentives compensation system. Moreover, sometimes people doubt about the treatment in accounting the incentive compensation system for executive compensation plan. This is because they concern if there is some error or biases while designing the compensation plan because usually people only thinking about benefit that they should get first before others. This will make some argument that executive incentive may contrast in the designing the plan and it will lead towards organization problem. But for salary base pay, it maybe not contribute for contrasting problem as the base salary was standardize by company policy and must compliance with act and government rule.
3.2 Organizational operating and control environment
The agency cost and problem may happen because of the several reasons such as the effectiveness of the incentives system in encouraging the desired behavior. Although the incentives compensation in organization is high, the good employees behavior is still depend from organizational operating and control environment. This is because the worst work environment and the lack of management in monitoring employee behavior will lead to the inefficiency in using an incentives system. This factor is same with the base salary initiative. Mostly people will attract with organization that can pay more in hiring them. But another important condition is the environment and administration of the organization. The comfortable working condition usually will make employee feel great and build their loyalty for the company. So it is normally if we can see the big company that can give high value of compensation also faced the problem of high employee turnover. Maybe the employee did not satisfy with the working condition or their relationship with the employer is not so good and they used to exit from the company to find another better job.
3.3 Temporary Compliance
Some of the big problem in implementing the incentives plan is the consistency of employee in maintainig their performance. Usually once the reward is already run out employee is start to continue with the old behaviour. So the reward or incentives paying must be consistent or increased from time to time. But not every organization can survive in gaining the profit because of the external factor such as economic condition, competitors for same business field and another problem. Because of this problem, company may be forced to reduced the incentive and at the same time reduce the cost in stable the organization financial. The incentive plan have the strong relationship with employee performance but it only for a temporary because "studies show that offering incentives for losing weight, quitting smoking, using seat belts, or (in the case of children) acting generously is not only less effective than other strategies but often proves worse than doing nothing at all" (Why Incentive Plans Cannot Work, 2012). From that statement, we can defined that employees behavior is mostly attracted with monetary or other benefit that can be a an incentive as a stimulant. Furthermore, it is defined that "incentives, a version of what psychologists call extrinsic motivators, do not alter the attitudes that underlie our behaviors. They do not create an enduring commitment to any value or action. Rather, incentives merely and temporarily change what we do. As for productivity, at least two dozen studies over the last three decades have conclusively shown that people who expect to receive a reward for completing a task or for doing that task successfully simply do not perform as well as those who expect no reward at all" (Why Incentive Plans Cannot Work, 2012). This relationship contributes the same problem among organization and they should take an effective way to solve this problem. For salary base pay, the level of salary also can affect the behavior of employee but usually people will choose the organization with high or better base salary compare with other company because of the monetary effect. Besides that, people want to get the high based salary as a guarantee because the increased of cost of living and the geographical factor. For example, the cost of living at Kuala Lumpur is high so people desperate to find a job with high return to survive in the urban area.
From the earlier discussion, we can define that's a positive relationship between based salary and incentive with employer performance. This type of compensation also always faced some problem even it implementing to influence employee behavior from bad to good behavior. The goal for organization in invest the financial cost is for increase the satisfaction in doing job with hope they will increase their effort followed by the increasing of improvement in performance. In elaborate the relationship; we must have the model or theory as a guideline in defining the performance and it factor. This is because the reward such as based pay and incentive will contribute to the employee motivation in doing their job. MARS model from (McShane & Glinow, 2010) conclude that there are four important key in performance which is motivation, ability, role perceptions and situational factors. This MARS model can be related with the base pay and incentive and how does it effect on employees performance. The MARS model is describe in the explanation below:
"It is represents the forces within a person that affect someone direction, intensity, and persistence of voluntary behavior. Firstly direction refers to the journey along which people get from their effort. Employees have choice about how they show their effort and they have knowledge of what they are trying to achieve. Then, intensity is the amount of effort allocated to the goal. Intensity is elaborate how much people push their selves to complete a task. For example, two employees might be motivated to finish their project a few hours early (direction), but only one of them puts forth enough effort (intensity) to achieve this goal. Persistence is the continuing the effort for a certain amount of time" (Pathiratne, March 2012).
In this contact, base salary and incentive can be the motivator for employees to put full effort for their job and increase their performance. So employee have their direction, generate the intensity and persistence in what they are doing.
"Ability includes both the natural aptitudes and the leaned capabilities required to successfully complete a task. Aptitudes are the natural talent that helps employees learn specific tasks more quickly and perform them better. The capabilities include the physical and mental skills and knowledge you have acquired. Learned capabilities tend to reduce over time when it is not in use" (MARS model of individual behavior and performance , 2012).
So how compensation effecting the employee ability and generate toward their performance? As mention above the one of the key in ability is learned capabilities which is knowledge that already posses, if the compensation are satisfied by the employee, they will increase they ability to learn new skills, knowledge and try to fully utilize what they have learn so far. For example, if the employees have degree in human resource, he or she will fully utilize it in their work. This are closely related to motivation to learn.
"Role and perception is the extent to which people understand the job duties (roles) assigned to them or expected of them. These perceptions are critical because they guide the employee's direction of effort and improve coordination with co-workers, suppliers and other stakeholders. The role perception has three components. First, employee have accurate role perceptions when they understand the specific tasks assigned to them that is when they know the specific duties or consequences for which they are accountable. Second, people have accurate role perceptions when they understand the priority of their various tasks and performance expectations. The third component of role perceptions understands the preferred behaviours or procedures for accomplishing the assigned tasks" (Pathiratne, March 2012).
In general role perception is to understand the job duties (roles) assigned to or expected of the employee. employee who understand the job duties are to be expected to get a good compensation reward such as base increment and incentive or given a more challenging task. Different employee perceived different toward their favourite type of compensation, for such some are favor to challenging work environment and some are not.
"It is a condition beyond the employee's immediate control that constrains or facilitates behaviour and performance. Employee's behaviour and performance also depend on how much the situation supports or interferes with their task goals. Some situational characteristic is consumer preferences and economic conditions originate from the external environment and consequently are beyond the employee's and organizations control. However, other situational factors such as time, people, budget, and physical work facilities are controlled by people within the organization" (MARS model of individual behavior and performance , 2012).
Compensation also influenced by situational factor whether financial or nonfinancial compensation toward the employee. For example, during economics regression, firm might reduce the benefit given or reduce the pay of the employee. If any employee performance well during the regression, the firm might not even give the raise in monetary and nonmonetary reward such as increment of base salary, and relational returns such as employment security.
From the five factor of the MARS model, we can see the strong relationship on how base pay and incentive can affect the employee's performance. From another sources, it also determine why the reward and compensation sometimes can be failed in influencing employee behavior.
4.1 Why reward failed
4.1.1"Pay is not a motivator"
Based on the words from W. Edward Deming, he declares that pay (salary) is not a motivator. Al of us knows that money is very importance in our life. The less people get their salary or money, the more their concerned about financial matters. Furthermore, some research defined when employees are asked to making something, they assume something they will get as a reward especially in monetary form. But even employee concerned with their salaries, it stills not a good evidence to prove money is motivating. There is no strong review to assume by paying people, they will more motivate in doing their work. Frederick Herzberg has argued if because of the small amount of payment people can be irritate and demotivate, it does not mean that by increased the payment will increased employees satisfaction and motivation also.
But for Herzberg's philosophy, he only defined reward as in monetary value. Actually another motivator for employee to increase their employee performance is through punishment. Punishment and reward is the two methods that have the same purposed and same consequences towards employee's behavior. Sometimes, reward also makes people feel enforced to do the work but at least they will get something that is beneficial for certain people.
In the case of incentives, this type of reward is valuable for employee. But by making the high bonus on certain behaviors, managers or supervisor manipulate their subordinates, and the experience to being manipulate will reduce the quality overtime. Furthermore, not receiving a reward that employee is expected to receive is also make the situation same with get a punishment. Whether the incentive is delayed or it takes back with some kind of purpose, or simply not received by someone who had hoped to get it, the effect is very deep. As the sequences, the more desirable the reward, the more demotivate happen to the employees.
4.1.4"Rewards disturb the relationships"
Relationships among employees are often casualties of the scramble for rewards. As leaders of the Total Quality Management movement have emphasized, incentive programs, and the performance appraisal systems that accompany them, reduce the possibilities for cooperation. Peter R. Scholtes, senior management consultant at Joiner Associates Inc., put it starkly, "Everyone is pressuring the system for individual gain. No one is improving the system for collective gain. The system will inevitably crash." Without teamwork, in other words, there can be no quality. The surest way to destroy cooperation and, therefore, organizational excellence, is to force people to compete for rewards or recognition or to rank them against each other. For each person who wins, there are many others who carry with them the feeling of having lost. And the more these awards are publicized through the use of memos, newsletters, and awards banquets, the more detrimental their impact can be. Furthermore,
When among employees is compete for a limited amount of incentives, they will more tend to see each other as a competitors or obstacles to their own success. But the same situation can be happen with any kind of rewards. Let's say the competition just makes a negative thing occur. The relationships between manager and subordinates can also distantly because of the different value of incentives. And the supervisor who rewards can produce some damaging reactions. For example, employees may be desired to conceal any problems they might be having and present themselves as totally competent to the manager in control of the money. They might attempt to convince the manager that they have everything under control.
4.1.5 "Rewards ignore reasons"
In effort to solve problems in the workplace, managers must investigate what is the point or sources of the problem. Are employees not totally prepared for the demands of their jobs? These situations will contribute for a different response. But relying on incentives to increase productivity also will lead for some problem with unsure result at the future. Even though, managers always use incentive systems as a method for giving workers what they need to do in creating a good job. Treating workers well will lead to useful feedback, social support, and the room for self determination is the essence of a good management. On the other hand, hanging a bonus in front of employees and waiting for the results requires much less effort.
4.1.6 "Rewards discourage risk-taking"
When people are encouraged to think about what they will get for participating in a task, they become less courage to take risks or explore the probabilities, to try nicely or to consider the futher action. In a word, the number one casualty of rewards is creativity. Excellence pulls in one direction; rewards pull in another. Tell people that their income will depend on their productivity or performance rating, and they will focus on the numbers. Sometimes they will manipulate the schedule for completing tasks or even engage in patently
unethical and illegal behavior. Mostly people always want to gain a safety area.
Base payment and incentive pay is a part of compensation, and compensation is not entirely affecting the employee performance. To improve employee performance, one need to refer to performance management which include most of important component to improve employee performance includes using compensation rewards and pay. Performance management is a continuous process of identifying, measuring, and developing the performance of individuals and teams and aligning performance with the strategic goals of organization.
5.1 Top Management Support
Firstly, supervisors must understand the incentive pay process to support and manage all the fund with effective and efficiently. Normally, a lack of understanding affects the managers to ignore or adapt the process as they see ideal. In addition, if supervisors or manager are not trained on how to measuring performance, the process will not be standardized across the company. "For example, if top management does not support such a program, lower level managers will place little importance on effectively administering the program. Hence, a lack of top management support often leads to a lack of accountability" (Gordon, 2010).
Consistent and formal communication is very important when implementing an incentive pay plan. It will make sure employees understand what is expected from them while decreasing the probability of attitude problems that result from miscomplication of how incentives are awarded. Furthermore, "one survey found that just 25 percent of respondents communicate to specific employee groups, but of those that did, 74 percent said it was either an effective or very effective strategy". "American Airlines used effective communication to successfully utilize its compensation plans for an example".
5.3 Performance Management
"It's been identified a defective performance management system is the strong reason an incentive pay system is not effectively. When formulating a performance management process, it should be related with pay. It is important for both employees and managers to know what the individual goals are and how it will be measured, and what they will be compensated when achieved the goal". Managers and supervisor also must be carefully in ensuring that there is have differentiation between maximum and low performers. If medium employees are given an average of the increment of merit, they will realize that their performance is satisfied or at maximum level. Vice versa, if good performers only receive a small amount in incentive pay than average performers, they will realize that the company does not appreciate their performance.
5.3 Appropriate Rewards
The total of incentive a company should offer to an individual is depends on current income, amount of effort needed to invest, equity of reward and his or her contribution, and industry standards. A minimum paying for incentive is considered to be 5 to 15 % from individual's base pay
6.0 Conclusion and Implication
As mention before, compensation is not the only major component that effecting the employees performance. From this paper discussion, compensation pay can be in many form such as base pay, incentives, long term incentives, work security, relational return and such. Every company has different type of pay and reward as the compensation. It is the strategy of the company to attract and retain the employee other than to increase employee performance.
Employee performance is important to generate profit to company, because the company main objective is profit maximization.
Base pay and incentive which is part of compensation is being use to improve employee performance, there's a lot of perspective and view in term of on how the base pay and incentive effecting the employee performance.
From all of the theory discuss, the overall shows that the base pay and incentive pay is indeed affecting the employee performance. To summarize all the theory that has been stated, there are similar traits that come from all the theory which is higher pay and reward can increase employee motivation and create sense of fairness. However, not all employee are preferring monetarily pay, non monetary such as recognition, challenging work environment and such also play an important role to employee performance. Employees perceive the relational returns as a appreciation or recognition of their work and feel being appreciated.
To cover of what financial and nonfinancial is lack, the use of other method is important to improve employee performance, as mention in proposition section, performance management can be use as one of the additional component to improve employee performance.