Issue Of Executive Compensation Commerce Essay

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Lately, the issue of executive compensation and incentive systems has been much in the business world. This is because organizations do not always recognize the importance of compensation in motivating employee. We take Herzberg's (1966) and McGregor's (1966) which defined the theories of motivation held that individuals were motivated by true factor to their jobs. For example the sense of title, position and of accomplishment their jobs provided, and the internal factors to their jobs such as a fair compensation, could give individual a satisfaction. Basically, the compensation is represented a situation of no-win issues for employers, because ignoring these issues brought with it the risk of individual dissatisfaction and tending to them brought with it no promise of improved individual performance. Not surprisingly, the years following the introduction of the two factor theories of motivation also saw the introduction of programs like job rotation, quality circles, flexible scheduling, and so forth that focused heavily on job content and ignored compensation.

Currently the Financial Accounting Standards Board (FASB) is debating the question of whether companies should be required to accrue an expense in the income statement for all stock compensation plans - many of which currently do not result in an income consequence [ 1]. Additionally, beginning in 1993, the Securities and Exchange Commission (SEC) implemented new disclosure requirements in registrants' proxy filings requiring more disclosure about executive compensation packages.

These changing accounting and reporting requirements have potentially very significant implications on the reported earnings of companies which use stock compensation as a significant component of executives' incentive compensation system. Additionally, it has been argued that the accounting (as well as the tax) treatment of executive compensation plans has a significant influence on the design of the incentive compensation system[2,3].

Another line of thinking is posited by agency theorists who argue that executive incentive contracts may be designed in response to potential agency problems within the organization[4]. Agency problems and costs may arise for several reasons; however, a special concern involves the separation of ownership from decision making which provides managers with the opportunities to pursue personal goals which may be accomplished at the expense of the organization's objectives[5]. The role for incentive systems (in conjunction with other internal control policies and procedures) is to motivate managers so that their personal interests are congruent with those of the organization. Still, the effectiveness of the incentive system in producing this desired behaviour is likely to be dependent on the organization's operating and control environment. In particular, environmental uncertainty and the ability to monitor behaviour have been identified by both analytical and empirical researchers as critical factors associated with incentive system design[6,7]. This article provides empirical evidence of the implications of the design of incentive systems. The primary research question investigated was why do some firms use outcome-contingent compensation schemes to a greater extent than do other firms? In investigating this question the effect of uncertainty in the environment as well as monitoring of management by the board of directors was studied to determine the effect on the use of outcome-contingent compensation plans.

The next section provides a discussion of incentive system design using an agency theory framework including the effects of uncertainty and monitoring by the board of directors. Subsequent sections provide a description of the research method, analysis of the results and a conclusion.

The problem

-Executive management may elect to pursue self rewarding objective

-Temporary Compliance

Do rewards work? The answer depends on what we mean by "work." Research suggests that, by and large, rewards succeed at securing one thing only: temporary compliance. When it comes to producing lasting change in attitudes and behavior, however, rewards, like punishment, are strikingly ineffective. Once the rewards run out, people revert to their old behaviors. 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. 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. These studies examined rewards for children and adults, males and females, and included tasks ranging from memorizing facts to creative problem-solving to designing collages. In general, the more cognitive sophistication and open-ended thinking that was required, the worse people performed when working for a reward. Interestingly enough, the researchers themselves were often taken by surprise. They assumed that rewards would produce better work but discovered otherwise.

-Why reward failed

Why do most executives continue to rely on incentive programs? Perhaps it's because few people take the time to examine the connection between incentive programs and problems with workplace productivity and morale. Rewards buy temporary compliance, so it looks like the problems are solved. It's harder to spot the harm they cause over the long term. Moreover, it does not occur to most of us to suspect rewards, given that our own teachers, parents, and managers probably used them. "Do this and you'll get that" is part of the fabric of American life. Finally, by clinging to the belief that motivational problems are due to the particular incentive system in effect at the moment, rather than to the psychological theory behind all incentives, we can remain optimistic that a relatively minor adjustment will repair the damage. Over the long haul, however, the potential cost to any organization of trying to fine-tune reward driven compensation systems may be considerable. The fundamental flaws of behaviorism itself doom the prospects of affecting long-term behavior change or performance improvement through the use of rewards. Consider the following six-point framework that examines the true costs of an incentive program.

1. "Pay is not a motivator." W. Edward Deming's declaration may seem surprising, even absurd. Of course, money buys the things people want and need. Moreover, the less people are paid, the more concerned they are likely to be about financial matters. Indeed, several studies over the last few decades have found that when people are asked to guess what matters to their co-workers or, in the case of managers, to their subordinates--they assume money heads the list. But put the question directly--"What do you care about?"--and pay typically ranks only fifth or sixth. Even if people were principally concerned with their salaries, this does not prove that money is motivating. There is no firm basis for the assumption that paying people more will encourage them to do better work or even, in the long run, more work. As Frederick Herzberg, Distinguished Professor of Management at the University of Utah's Graduate School of Management, has argued, just because too little money can irritate and demotivate does not mean that more and more money will bring about increased satisfaction, much less increased motivation. It is plausible to assume that if someone's take-home pay was cut in half, his or her morale would suffer enough to undermine performance. But it doesn't necessarily follow that doubling that person's pay would result in better work. 2. Rewards punish. Many managers understand that coercion and fear destroy motivation and create defiance, defensiveness, and rage. They realize that punitive management is a contradiction in terms. As Herzberg wrote in HBR some 25 years ago ("One More Time: How Do You Motivate Employees?" January-February 1968), a "KITA"-which, he coyly explains, stands for "kick in the pants"--may produce movement but never motivation.

What most executives fail to recognize is that Herzberg's observation is equally true of rewards. Punishment and rewards are two sides of the same coin. Rewards have a punitive effect because they, like outright punishment, are manipulative. "Do this and you'll get that" is not really very different from "Do this or here's what will happen to you." In the case of incentives, the reward itself may be highly desired; but by making that bonus contingent on certain behaviors, managers manipulate their subordinates, and that experience of being controlled is likely to assume a punitive quality over time. Further, not receiving a reward one had expected to receive is also indistinguishable from being punished. Whether the incentive is witheld or withdrawn deliberately, or simply not received by someone who had hoped to get it, the effect is identical. And the more desirable the reward, the more demoralizing it is to miss out. The new school, which exhorts us to catch people doing something right and reward them for it, is not very different from the old school, which advised us to catch people doing something wrong and threaten to punish them if they ever do it again. What is essentially taking place in both approaches is that a lot of people are getting caught. Managers are creating a workplace in which people feel controlled, not an environment conducive to exploration, learning, and progress.

3. Rewards rupture 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 employees compete for a limited number of incentives, they will most likely begin to see each other as obstacles to their own success. But the same result can occur with any use of rewards; introducing competition just makes a bad thing worse. Relationships between supervisors and subordinates can also collapse under the weight of incentives. Of course, the supervisor who punishes is about as welcome to employees as a glimpse of a police car in their rearview mirrors. But even the supervisor who rewards can produce some damaging reactions. For instance, employees may be tempted to conceal any problems they might be having and present themselves as infinitely competent to the manager in control of the money. Rather than ask for help--a prerequisite for optimal performance-they might opt instead for flattery, attempting to convince the manager that they have everything under control. Very few things threaten an organization as much as a hoard of incentive-driven individuals trying to curry favour with the incentive dispenser.

4. Rewards ignore reasons. In order to solve problems in the workplace, managers must understand what caused them. Are employees inadequately prepared for the demands of their jobs? Is long-term growth being sacrificed to maximize short-term return? Are workers unable to collaborate effectively? Is the organization so rigidly hierarchical that employees are intimidated about making recommendations and feel powerless and burned out? Each of these situations calls for a different response. But relying on incentives to boost productivity does nothing to address possible underlying problems and bring about meaningful change. Moreover, managers often use incentive systems as a substitute for giving workers what they need to do a good job. Treating workers well-providing useful feedback, social support, and the room for self-determination--is the essence of good management. On the other hand, dangling a bonus in front of employees and waiting for the results requires much less effort. Indeed, some evidence suggests that productive managerial strategies are less likely to be used in organizations that lean on pay-for-performance plans. In his study of welders' performance, Rothe noted that supervisors tended to "demonstrate relatively less leadership" when incentives were in place. Likewise, author Carla O'Dell reports in People, Performance, and Pay that a survey of 1,600 organizations by the American Productivity Center discovered little in the way of active employee involvement in organizations that used small-group incentive plans. As Jone L. Pearce, associate professor at the Graduate School of Management, University of California at Irvine, wrote in "Why Merit Pay Doesn't Work: Implications from Organization Theory," pay for performance actually "impedes the ability of managers to manage."

5. Rewards discourage risk-taking.

"People will do precisely what they are asked to do if the reward is significant," enthused Monroe J. Haegele, a proponent of pay-for-performance programs, in "The New Performance Measures." And here is the root of the problem. Whenever people are encouraged to think about what they will get for engaging in a task, they become less inclined to take risks or explore possibilities, to play hunches or to consider incidental stimuli. 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. As Thane S. Pittman, professor and chair of the psychology

department at Gettysburg College, and his colleagues point out, when we are motivated by

incentives, "features such as predictability and simplicity are desirable, since the primary focus associated with this orientation is to get through the task expediently in order to reach the desired goal." The late Cornell University professor, John Condry, was more succinct: rewards, he said, are the "enemies of exploration." Consider the findings of organizational psychologist Edwin A. Locke. When Locke paid subjects on a piece-rate basis for their work, he noticed that they tended to choose easier tasks as the payment for success increased. A number of other studies have also found that people working for a reward generally try to minimize challenge. It isn't that human beings are naturally lazy or that it is unwise to give employees a voice in determining the standards to be used. Rather, people tend to lower their sights when they are encouraged to think about what they are going to get for their efforts. "Do this and you'll get that," in other words, focuses attention on the "that" instead of the "this." Emphasizing large bonuses is the last strategy we should use if we care about innovation. Do rewards motivate people? Absolutely. They motivate people to get rewards.

6. Rewards undermine interest. If our goal is excellence, no artificial incentive can ever match the power of intrinsic motivation. People who do exceptional work may be glad to be paid and

even more glad to be well paid, but they do not work to collect a paycheck. They work because they love what they do. Few will be shocked by the news that extrinsic motivators are a poor substitute for genuine interest in one's job. What is far more surprising is that rewards, like punishment, may actually undermine the intrinsic motivation that results in optimal performance. The more a manager stresses what an employee can earn for good work, the less interested that employee will be in the work itself. The first studies to establish the effect of rewards on intrinsic motivation were conducted in the early 1970s by Edward Deci, professor and chairman of the psychology department at the University of Rochester. By now, scores of experiments across the country have replicated the finding. As Deci and his colleague Richard Ryan, senior vice president of investment and training manager at Robert W. Baird and Co., Inc., wrote in their 1985 book, Intrinsic Motivation and Self-Determination in Human Behavior, "the research has consistently shown that any contingent payment system tends to undermine intrinsic motivation." The basic effect is the same for a variety of rewards and tasks, although extrinsic motivators are particularly destructive when tied to interesting or complicated tasks. Deci and Ryan argue that receiving a reward for a particular behavior sends a certain message about what we have done and controls, or attempts to control, our future behavior. The more we experience being controlled, the more we will tend to lose interest in what we are doing. If we go to work thinking about the possibility of getting a bonus, we come to feel that our work is not self-directed. Rather, it is the reward that drives our behavior.