Fundamentals Of Employee Reward Systems Management Essay

Reward systems are one of the most prominent and most important features of any organization. Because of the wide ranging impact a reward system has on individual behavior and behavior of organizations, it is very important designing such reward systems that will motivate the right performance, attract the right people and create a supportive and good working climate within organization.

However it is important to discuss what behavior does a reward system influence. A research on reward system suggests there are six factors which are influenced by reward systems, which in turn influence the organizational effectiveness:

1) Attraction and Retention

According to Lawler (1993) organizations that give the most reward tend to attract and retain most people. This happens because high rewards lead to higher job satisfaction and therefore less turnovers.

However what organizations are interested in is how to attract and retain the best performers. Retaining them requires organizations to design such rewards for them that will make them feel justly treated when comparing their rewards with those of other people performing the same job but in other organizations. According to Lawler and Jenkins (1992) this strategy can be very costly and lead to an intra-organizational inequity if the good performers feel to be rewarded same as the bad performers inside the organization, although they might be fairly treated when compared externally. As result of this situation the better performers may feel dissatisfied, complain and mistrust the organization.

As respond to above mentioned situation what a company should do is designing competitive reward systems and basing rewards on performance. This will encourage the better performers to stay with the organization.

2) Motivation of Performance

When managed and designed successfully a reward system can motivate performance. However we have to keep in mind that not all reward packages can motivate a person to perform effectively, because it also depends on the needs of people. According to Lawler (1993) people have their own needs and mental maps of how the world is like.

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The approach that best explains how people act on their mental maps is called the expectancy theory (Lawler et al, 1973). This theory suggests that human behavior will be motivated by the conscious expectation more than response to stimuli. The expectation will be that the action in prospect will lead to desired goal or outcome. Therefore, in motivating staff, we must take certain conditions into consideration. These include the fact that we can not develop a general reward package, but we need to learn and understand the individuals and their needs in order to motivate them accordingly.

3) Skills and Knowledge

Pay systems can motivate not only performance but as well learning and development. According to Lawler (1993) individuals are motivated to learn those changes that are rewarded. Thus reward systems that offer promotion tend to encourage individuals to learn those skills that lead to promotion.

4) Culture

One important factor that influences the overall culture of the organization is reward system. Depending on how the reward systems are developed they contribute in creating a wide variety of organizational cultures. For example, Foulke (1991) stated that when people receive relatively high pay they feel as important employees working for a successful company and moreover having a system that allows employees to involve in pay decision produces a participative culture in which employees are more committed to the success of the organization.

5) Reinforce and Define Structure

Reward systems have also an important impact on the structure of an organization. Reward systems also help in defining the organizational structure of an employee, because the level at which performance is measured and rewarded (individual, team, plant, division, business or corporation) draw employee attention to those levels (Heneman, 2002).

6) Cost

Reward systems are expensive. For employers, compensation decisions influence their cost of doing business and thus, their ability to sell at competitive price in the product market (Gerhart et al, 1995). Since employee compensation packages represent a large percentage of an organization’s operating costs, when designing them, employers should focus on how high they should be.

To summarize, a reward system can be viewed as a powerful strategic tool for improving the organizational effectiveness, having into consideration the wide range of factors it influences.

2.2 The elements of reward system

A reward system consists of several elements which are base pay, contingent pay, employee benefits and allowances.

Base pay

Base pay may be expressed as annual, weekly or hourly rate. It is amount of pay that constitutes the rate for the job and it might vary accordingly to the grade of job or level of skills required.

Base pay is influenced by internal and external relativities. The internal relativities may be measured by some forms of job evaluations. External relativities are assessed by tracking market rates (Armstrong, 2007). Most organizations use one or more market pay surveys to help determine what other organizations pay specific jobs in making their own pay level decisions (Gerhart et al, 1995).

Contingent pay

The term “contingent pay” it is used to describe formal pay schemes that provide payments on the top of base rate due to performance, contribution or skills of an employee. According to Armstrong (2009) contingent pay is either consolidated in the base rate so the pay progresses within a pay range or it is paid as a non-consolidated cash bonus.

Employee benefits

Employee benefits consists of elements of remuneration additional to the cash pay, like pensions, sick pay, company’s cars and they also include provisions that are not strictly remuneration such as annual holidays.

Allowances

Allowances are paid in addition to basic pay for special circumstances and are often subject of negotiation between the employer and employee. Some of the main forms of allowances are location allowances for example for living in the US, overtime payments, working condition allowances, etc.

Although the above mentioned elements constitute the main elements of a reward package, we must mention that different organizations use different combinations of these elements when compensating their employees. These combinations may vary not only across organizations but also across employing units within the organizations. For example in the US 70 percent of payments to employees are in the form of cash, leaving 30 percent in the form of noncash and deferred cash benefits (Noe et al, 1994).

Also the nature of pay may vary across employing units. A very often asked question is: Are employees of the same hierarchical level within different parts of the organization paid the same? Sometimes organizations decide to pay relatively high rates for the employees of entry level, but giving them a very slow opportunity for pay growth, while other organizations may start with a lower pay rate, but with greater opportunities for promotion and pay growths.

Pay decisions are usually part of organization’s policies but are often made based on the results of market trends and pay surveys. However we should never forget about the powerful influence of these decisions on the company’s effectiveness.

2.3 The aim of reward system from the company and employee perspective

The purpose of employee reward is to ensure the achievement of the organization’s strategic objective by retaining the skilled, competent and committed employees. These employees will be attracted and retained in the organization as long as they are fairly rewarded for the value they create and as long as the organization continues motivating them to create value.

The success of an organization depends on the quality of its employees. Therefore one a well-managed and attractive reward system is one important factor that can contribute to improvement of that quality.

According to Armstrong (2002) there are several aims of reward systems from organization’s point of view. Among them we can mention the following:

help attract, retain and motivate high-quality people

play a significant part in the communication of the organization’s values, performance, standards and expectations

encourage behavior that will contribute to the achievement of the organization’s objectives

underpin organizational change programmes concerned with culture, process and structure

support the realization of the key values of the organization in such areas as quality, customer care, teamwork, innovation, flexibility and speed of response

provide value for money.

Except from the organization’s point of view, there are also several aims of employee reward from employees’ perspective. Those include:

treat them as stakeholders who have the right to be involved in the development of the reward policies that affect them

meet their expectations that they will be treated equitably, fairly and consistently

be transparent – they should know what the reward policies of the organization are and how are they affected by them (Armstrong, 2002).

Having into consideration the aims of employee reward according to both the employee and the organization’s perspective, we can conclude that a successful reward system is the one that aligns the incentive of both parties. This can be achieved if designing such a reward system that will result in added value for the organization, however in turn will remain transparent toward employees and employees will be involved in the development of reward systems.

3. Motivation and reward

In the chapter above we mentioned that reward systems are powerful tools to attract employees to organizations and channel their motivation in desired ways. In other words reward systems should keep employees coming to work and motivate them to perform at high levels.

Organizations expect that their employees will fulfill the tasks assigned to them according to rules established from the organization itself. While, employees expect that the organization will provide them a fair pay for their performance and safe working conditions. However it could be the case that the management of the organization as well as the employees could expect more. How far their expectations could go depends on how ambitious both parties are. These ambitious vary across organizations. For organization to address these expectations an understanding of employee motivation is required (Beer et al, 1984). A motivated employee will be more committed to his work and increase its own performance and in turn the organization’s productivity.

Snell (1999) says motivation is everything. Without motivation even the most talented people will not deliver to their potential. With motivation, others will perform way above the level expected of their intelligence and academic ability. Furthermore, according to Bateman and Snell (1999) a highly motivated person will work hard toward achieving performance goals. With adequate ability and understanding of the job such a person will be highly productive.

There are several theories that try to explain motivation and job satisfaction in the workplace.

On this chapter we will focus on three very popular theories used in research on pay such as:

Reinforcement theory

Expectancy theory

Equity theory

3.1 Reinforcement theory

The reinforcement theory of motivation was developed from B.F. Skinner a psychologist from Harvard. According to Lussier and Achua (2010) the reinforcement theory of B. F. Skinner suggests that managers should not try to understand employees’ needs or behaviors they choose to fulfill those needs, but they should try to understand the relationship between behaviors and their consequences. In this way they could reinforce the desirable behaviors.

If we intend to use the reinforcement theory as a motivating tool in the workplace, the supporters of this theory offer some important guidelines which include the following:

Positively reinforce desired behavior

Ignore undesired behavior so far as possible

Avoid using punishment as principal means of achieving desired performance

Provide reinforcement as soon as possible after the response

Apply positive reinforcement regularly

Asses positive and negative factors in the individual’s environment

Specify desired behavior/ performance in quantifiable terms (Cole, 2004).

Rewards that positively reinforce desired behavior can range from praise from a supervisor to gifts, cash bonuses, recognition, and career opportunities. According to Goldstein and Ford (2002) trainers and supervisors can best enhance learning and transfer of knowledge and skills by identifying what rewards or outcomes the learner finds most positive.

3.2 Expectancy theory

Expectancy theory is one of the most prominent motivation and leadership theories developed by Victor Vroom. According to Vroom most behaviors are under voluntary control of the employee and are consequently motivated. Here motivation is seen as a function of two other factors: expectancy and valence.

Expectancy – refers to the individual’s belief concerning the likelihood or subjective probability that a particular behavior will be followed by a particular outcome such as level of performance (Gibson et al, 2000)

Valance – is an individual preference for an outcome. For example one might prefer a 5% increase in pay over a longer annual holiday. If an outcome is preferred it is positively valent and if it is not preferred it is negatively valent. A zero valence outcome is the one toward which people are indifferent.

According to expectancy theory all motivation is conscious. Individuals consciously make a choice following a calculation of pleasure they expect to attain out of it. However expectancy theory says nothing about subconscious motivation. This is one major critic of expectancy theory.

3.3 Equity theory

Equity theory was developed from Stacey Adams, a research psychologist at General Electrics in New York. Equity theory suggests that employee perceptions of what they contribute to the organization, what they get in turn, and how their return-contribution ratio compares to others inside and outside the organization, determine how far they perceive their employment relationship to be (Adams, 1963).

In essence, this theory proposes that individuals are motivated to maintain fair or “equitable” relationships between themselves and to change those relationships that are unfair, “inequitable” (Kini and Hobson, 2002)

In other words, what this theory suggests is that if employees judge that their effort in the organization are rewarded fairly in comparison to others in the organization doing the same job, than they will be motivated to perform better and if not fairly rewarded compared to others doing the same job, the employees will put less effort while performing their tasks at workplace.

4. Trends that shaped the future of Reward Systems

Before starting to scrutinize the different trends which were shaping the current and future reward systems, it is relevant to stop for a moment and shed lights on the topic itself. As Richard Thorpe (2000) expressed, to date there was a limited number of literature which investigated the issue of reward and pay. Since then, pay and reward became an essential part of human resource management and several scholarly works and books were published on this topic. Michael Armstrong is one of those scholars who extensively examined remuneration strategies and trends behind reward systems. His books, Employee Reward (2002) as well as Reward Management: A Handbook of Remuneration Strategy and Practice (2007) were in-depth analyzed the aforementioned topic as it was already mentioned before. The watershed between the traditional and new trends in the reward system was the 1980s. Until that the remuneration administration was a compulsory, however still secondary task in the organizational culture. John Child (1984) considered reward policy as a whole range of rewards as well as punishments. However, the specific objective of rewards and punishment are totally differing from each other.

4.1 Traditional reward system

The transformation of reward system, including the new trends, mainly derives from the United States. Thereby, most of the essential literatures also come from the pen of American scholars, such as Michael Armstrong, Schuster and Zingheim (1992). Armstrong (2002) comprehensively scrutinized the former reward system which was called the traditional approach, mainly reigning the 1960s and 1970s. In this period, the salary administrator was considered as a subordinate position in the organizational structure, also telling everything about the relevance of this part of the business. With the emergence of performance management during the 90s, the former appraisal schemes became obsolete. As Schuster and Zingheim (1992) also indicated in The New Pay, ‘traditional pay practice was not unplanned or poorly directed’ rather it showed the need of attracting, motivating and retaining employees, mainly because it has focused on competitive attribute instead of tactical or strategic matters. The former remuneration system perfectly reflected the organizational configurations featured mainly by bureaucracy, hierarchy and vertical communication system (Armstrong, 2002). As part of this inflexible, sometimes fragmented structure, job evaluation was frequently too complex and bureaucratic.

Duncan Brown (2001) indicated that during 1980s payment related matters had been strongly affected by government policy and tradition. In this period, significant scholars such as Barry Curnow, President of the Institute of Personnel Management (currently the Chartered Institute of Personnel and Development) claimed that reward strategy is “at the crossroads between a restricted past and a future of great opportunities (Brown, 2001)

As it was already mentioned in the beginning of this chapter, the earlier decades meant the end of this old system and with new more horizontal and flexible organizational structures, the reward system also fundamentally changed. The former incremental pay structures were mostly disappeared with the suddenly emerging concept, performance-related pay (Armstrong, 2002).

New trends encouraged this change in 1980s which according to Armstrong was the decade of greed, money becoming as the main motivating factor for employees. During this period, remuneration initiatives such as the share options and different bonuses became widely used in the private sector. Major changes have occurred in payment system due to changing priorities and nature of organizations, mainly effected by increasing competition. Recognizing the necessity of rewarding groups instead of individuals also altered the organizational configuration and these changes were defined by Grayson (1986). He also compared the ‘to date’ payment system with a predicted future payment system (see Table 1).

4.2 The transformation period

As Thorpe (2000) also emphasized, the new structural configuration extensively focusing on teamwork, re-emergence of economic value has significantly affected also the reward systems. On the other hand, scholars applying human resource management have also recognized the effects of strategic choice upon corporate performance, and compared to the past, individuals were rewarded, not only based on individual achievement, but also for the success of the organization and their role on that.

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Table 1: The characteristics of existing and future pay systems

Source: Thorpe, R. (2000). Reward strategy In Thorpe, R. and Homan, G. (Ed.) Strategic Reward Systems. Essex: Pearson Education Ltd., p. 31

From the aspect of strategic change and also theories related to trust were applied in a research written by Chenhall and Langfield-Smith (2003) who investigated a manufacturing firm’s 15 years of strategic change. As it was stressed by the authors (Chenhall and Langfield-Smith, 2003), compensation systems and performance measurement became a significant part of management control system and simultaneously, the formulating and implementing corporate strategies. Subsequently, performance measurement also cannot be separated from reward system, mainly because these two fields of areas encourages employees to achieve planned strategic goals (Chenhall and Langfield-Smith, 2003).

Armstrong (2002) attributed to the appearance of “reward management” the beginning of the transformation period in respect to reward systems. There was a tendency of oversimplifying this new phenomenon, mainly relating to money. On the contrary, reward management also paid attention to non-financial rewards which generated motivation in the work force. However, this was only the first challenge in the salary administration, following innovative competence and skill-based rewarding and recognition of partnership, employee, trust and transparency involvement (Armstrong, 2002). The New Pay written by Schuster and Zingheim was dedicated to investigate this new phenomenon and its effects. With regard to the pay in the United States, the authors (Schuster & Zingheim, 1996) collected five realities which contribute to the change of American organizations strictly during the 1980s and 1990s:

Emerging global competition among businesses within the United States as well as internationally created economic transformation and as a consequence, organizations had to be also more productive in order to avoid failure.

New technologies, as a major factor in global business, left a major impact on job requirement and eligibility for the tasks related to that. This will also raise the competition among people.

The significance of the service sector, especially due to the new technologies, will increase as a consequence of reallocation of the nature of work thanks to more relevant supplying and utilizing information. Demand regarding new positions will switch from the production to the service industry.

Becoming really difficult for workers to maintain their standard of living if they are not able to raise real income in the 1990s comparable to 1980s unless productivity improves. [1] 

Fewer new people enter to the labor force and decreasing or flat real income.

Besides these realities, they (Schuster & Zingheim, 1992) also prescribed the basic principles of new pay such as:

Companies are able to remain competitive due to their employees, thereby organizations have to focus on establishing partnership with them.

Management is about leadership, not hierarchy and bureaucracy.

Remuneration is above all employee relations issue, meaning that workers can determine if the values, reward systems and culture of organization fit to their own.

Relevance of employee communication for success. Payment may have a strategic role in delivering the appropriate message about the values, standards and expectations.

Indirect pay, variable and base are part of remuneration strategy.

New pay begins with external labor market without forming internal equity through the whole organization.

The main impetus in new pay is the utilization of variable pay to employee groups compared to the majority of organizations which tend to pay the basics.

Obviously, one of the main disadvantages of variable pay is that it is able to form alliance between the organization and the workers, this way encouraging for higher performance, teamwork and cooperation.

Compared to previous forms, the new pay is based on individual and simultaneously team rewards, furthermore focuses on partnership, meaning the worker benefits from corporate success. [2] 

Finally, organizations have to agree on a sustainable total compensation mix along with the level of benefit costs.

A really interesting point was mentioned by Schuster and Zingheim (1996) which became valid again after watching the economic debate of the last years: “to survive, American industry must have a new view of the future”.

4.3 Trends in reward

As Schuster and Zingheim (1993) claimed in their article Building pay environment to facilitate high-performance teams “dynamic change and increased competition, which characterize business in the 1990s, most likely will accelerate the trend toward high employee involvement. This was only one of the numerous trends which were extensively negotiated by others. Armstrong together with Murlis (2007) extensively scrutinized the different trends within reward system in their mutual work called Reward System: A Handbook of Remuneration Strategy and Practice. The authors (Armstrong and Murlis, 2007) collected ten major trends which according to their experience affected reward system: (1) the new realism; (2) total reward; (3) job evaluation; (4) equal pay for work of equal value; (5) contribution-related pay; (6) flexible benefits; (7) line manager capability; (8) career family structures; (9) broadbanding; (10) and engaged performance.

Stephen Pilbeam and Marjorie Corbridge (2006) have split into two main groups, internal and external shapers, the factors which affected trends in reward management. Internal shapers contain strategic and integrated reward approaches in connection to human resource management; the culture of the organization, such as managerial beliefs on factors which motivate employees; the expected reward by the employee; the nature of the task; and employee negotiation arrangements (Pilbeam and Corbridge, 2006). On the other hand, external shapers could include every economic and political factors which independently from the company affects its reward policy, such as labor market surpluses or shortages; economic climate; public policy on employment; altering configuration of work and industrial changes in types of work; public policy on labor for instance the influence of EU Directives; technological developments; and pay legislation such as the statutory minimum wage or tax breaks. Considering these shapers, they are significant as the authors (Pilbeam and Corbridge, 2006) also stressed; however, they have to be treated as general rather than general factors. Stredwick (2000) recognized the continuous alter of pay with the help of identifying the characteristics of treating pay from the aspect of expense and means to competitive advantage.

The Price Waterhouse/ Cranfield Survey (Fillela and Hegewish, 1994) has also differentiated several trends in reward strategies internationally and gave examples for them. First of all, they identified the relationship between approaches to collective bargaining and pay determination. Secondly, the recognized that there is a trend towards flexibility, avoiding the collective and centralized determination of pay. As a third, the implementation of the flexible reward system was more and more determined lower levels of the management within organizations. Furthermore, the general trend of increasing variability of pay is having a bigger role, such as merit- and performance-related pay or profit sharing (Fillela and Hegewish, 1994). As Eugene Mckenna and Nic Beech (2008) stressed beside these factors, the size of the company could play a relevant role in shaping the new forms of reward systems. In addition, some general trends such as local culture and the implementation of the reward strategy can also influence the styles of reward which would be chosen based on them.

Total reward stresses the relevance of taking into consideration every single detail of reward as a coherent overall idea (Armstrong and Murlis, 2007). This concept became essential during the 1990s with the perception of trying to maximize the impact on reward initiatives upon commitment, job engagement and motivation. It also contains other aspect of managerial activities such as recruitment, talent management and retention. This perception also contributed to the organizations in involving the role of non-financial rewards, such as recognition schemes. Total reward also supports the organizations to think about their employee proposition, considering also the different aspects why people would join and stay with the company. Indeed, conventional parts of reward management, like pay or bonus, play a significant role. This also requires employees with all-around experience inside the organization thus understanding all aspects of the organization and creating a closer, more flexible working environment among the colleagues. Consequently, the reward system has to be adjusted to this and be flexible in order to successfully motivate all workers (Armstrong and Murlis, 2007). On the other hand, according to Armstrong and Murlis (2007) the latest and most relevant development was the use of career and job families. “A career family structure is one in which separate job families are identified and defined but a common grade and pay structure applies to all the families”. Indeed, it is not a new innovation and career and job families concept were utilized way before.

In broad banding, companies basically pay more attention to compatible needs of a flexible working environment. Indeed, most of the organizations tried to achieve greater job, career and market (Brown, 2001). Some companies tried to stress the personal development and contribution, rather than accepting points-scorer who would like to achieve promotion.

Nowadays, there is a totally different structure, explicitly a more diverse and complex pattern, requiring a much more complex and diverse pattern, including the necessity of a more strategic approach, basically copying new practices from other multinational companies (Armstrong and Brown, 2006). Axiomatically, since the 1990s, some of these trends amplified, on the other hand changed and additional factors also started to affect the reward systems. Currently, the authors (Armstrong and Brown, 2006) recognized four major trends in the current labor markets. First of all, due to the emergence of more mixed foreign populations, governments started to use more local managers at senior levels, and quicker localization of expatriate staff. Furthermore, many companies use short-term and distance assignments via Internet, subsequently, establishing longer business travels and international commutes, and localized transfers too. Cost pressures became a leading challenge to the balance sheet reward approach, which is not always applicable to the expatriates in every location. Finally, companies started to pay attention not only to their worker, but also the family, especially to the partner and family.

As it was also discussed earlier, contribution-related pay was introduced by Duncan Brown and Michael Armstrong in their book, Paying for Contribution: Real Performance-Related Pay Strategies (1999), fundamentally changing the former competence related or performance related pay. Table 2 compares the two concepts from the aspects.

As the authors emphasized performance-based pay is something which just simply does not work for several reasons. Armstrong and Duncan (1999) were affected a western prospective, compa