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Chapter 12

McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc.

Chapter Overview
Defining the System
Selection of Rewards
Relating Rewards to Performance
Job Satisfaction and Rewards
Employee Compensation
The Role of the Human Resource Manager in
the Reward System
Summary of Learning Objectives

Defining the System
Organizational reward system
Concerned with selection of types of rewards to be used by
Organizational rewards
Rewards that result from employment the organization;
includes all types of rewards, both intrinsic and extrinsic
Intrinsic rewards Internal to individual and are normally derived
from involvement in certain activities or tasks
Examples Job satisfaction and feelings of accomplishment
Extrinsic rewards Directly controlled and distributed by
organization and more tangible than intrinsic rewards
Examples Pay and hospitalization benefits
Although differing, intrinsic and extrinsic rewards are closely
Often an extrinsic reward provides recipient with intrinsic

Intrinsic versus Extrinsic Rewards

Selection of Rewards
Management must recognize what employees perceive as
meaningful rewards
Pay is usually the first, and sometimes the only, reward
most people think about
However, rewards should be viewed in the larger
perspective as anything employees value
May include things such as
Office location
Allocation of certain pieces of equipment
Assignment of preferred work tasks
Informal recognition

Selection of Rewards

Returns benefiting organization through

distribution of awards can be realized only if
desires of employees are known
Organizations should learn what employees
perceive as meaningful rewards, which is not
necessarily what management perceives
Traditionally, managers have assumed they
are fully capable of deciding just what rewards
employees need and want
Unfortunately, this is often not true
Studies have shown that employees tend to
rank lack of recognition as the most probable
reason good employees quit their jobs
Selection of Rewards
Another false assumption is exemplified by fact that most
organizations offer same mix of rewards to all employees
Studies show that many variables can influence
employee preferences for certain rewards. They
Marital status
Number of dependents
Years of service
For example, older employees are usually much more
concerned with pension and retirement benefits than
are younger employees

Selection of Rewards
When selecting types of rewards to offer, intrinsic benefits
that might accrue as a result of the rewards need to be
Managers and employees alike consider only tangible
benefits associated with a reward
External factors that place limitations on an organizations
reward system also exist
These factors (usually beyond the control of the
organization) include such things as
Organizations size
Environmental conditions
Stage in product life cycle
Labor market

Relating Rewards to Performance
Free enterprise system is based on the premise that
rewards should depend on performance
Performancereward relationship is desirable at
Organizational or corporate level
Individual level
Employees will be motivated when they believe such
motivation will lead to desired rewards
Many formal rewards provided by organizations are not
related to performance
These rewards are almost always determined by
organizational membership and seniority; they include
Paid vacations
Insurance plans
Paid holidays
Relating Rewards to Performance
Other rewards, such as promotion, can and should be related to
Opportunities for promotion may occur only rarely
When available, higher positions may be filled
On basis of seniority
By someone outside the organization
Primary organizational variable used to reward employees and
reinforce performance is pay
Even though many U.S. companies have some type of pay-
for- performance program, most do a poor job of relating the
Surveys repeatedly show that employees do not have much
confidence about a positive relationship exists between the
Evidence shows that paying for performance is working at the
highest levels in many companies
Relating Rewards to Performance
Why is the practice not more widespread?
Not easy to do; much easier to give everybody the
same thing, as evidenced by the ever-popular across-
the-board pay increase
Relating rewards to performance requires that
performance be accurately measured, and this is
often not easily accomplished
Requires discipline to actually relate rewards to
Many union contracts require that certain rewards be
based on totally objective variables, such as seniority
No one successful formula for implementing a pay-for-
performance program has yet been developed

Preconditions for Implementing pay-
for-Performance Program
Trust in management
If employees are skeptical of management, it is difficult
to make a pay-for-performance program work
Absence of performance constraints
Jobs must be structured so that an employees
performance is not hampered by factors beyond his or
her control
Trained supervisors and managers
Supervisors and managers must be trained in setting
and measuring performance standards
Good measurement systems
Performance should be based on criteria that are job
specific and focus on results achieved

Preconditions for Implementing Pay-
for-Performance Program
Ability to pay
Merit portion of the salary increase budget must be
large enough to get the attention of employees
Clear distinction among cost of living, seniority, and merit
In absence of strong evidence to the contrary,
employees will naturally assume a pay increase is a
cost-of- living or seniority increase
Well-communicated total pay policy
Employees must have a clear understanding of how
merit pay fits into the total pay picture
Flexible reward schedule
It is easier to establish a credible pay-for-performance
plan if all employees do not receive pay adjustments
on the same date
Job Satisfaction and Rewards
An employees general attitude toward the job
Organizational reward system often has a significant impact on level
of employee job satisfaction
Manner in which extrinsic rewards are dispersed can affect intrinsic
rewards (and satisfaction) of recipients
There are five major components of job satisfaction:
Attitude toward the work group
General working conditions
Attitude toward the company
Monetary benefits
Attitude toward management
Other components include
Employees state of mind about the work itself
Life in general
Health, age
Level of aspiration, social status, and political and social activities
Job Satisfaction and Rewards

Organizational morale Employees feeling of

being accepted by and belonging to a group of
Through common goals
Confidence in desirability of those goals
Desire to progress toward the goals
Morale is the by-product of a group
Job satisfaction is more an individual state of
Two concepts are interrelated in that job
satisfaction can contribute to morale and
morale can contribute to job satisfaction
The SatisfactionPerformance
The path of least resistance Attempts to explain belief
that a satisfied employee is necessarily a good employee
If a performance problem exists, increasing an
employees happiness is far more pleasant than
discussing with the employee his or her failure to meet
Although happiness eventually results from satisfaction,
the latter goes much deeper and is far less tenuous than
Two propositions concerning the satisfaction-performance
theory exist
Traditional view is that satisfaction causes performance
Satisfaction is the effect rather than the cause of
The SatisfactionPerformance
Performance leads to rewards that result in a certain level
of satisfaction
Rewards constitute a necessary intervening variable in
the relationship
Another position considers both satisfaction and
performance to be functions of rewards
Satisfaction results from rewards, but current
performance also affects subsequent performance if
rewards are based on current performance
Research evidence generally rejects the more popular
view that satisfaction leads to performance
It does provide moderate support for the view that
performance leads to satisfaction

The SatisfactionPerformance
Evidence also strongly indicates that
Rewards constitute a more direct cause of
satisfaction than does performance
Rewards based on current performance
enhance subsequent performance
Reviews of studies in the area stating that job
satisfaction and job performance are related do
not support a strong relationship
Found that the best estimate of the true
population correlation between satisfaction
and performance is relatively low
Lay people often tend to believe strongly that
satisfied employees are more productive at work
The SatisfactionPerformance
It has been clearly established that job satisfaction does have a
positive impact on
Experience, gender, and performance can have a moderating
effect on these relationships
Organizations prefer satisfied employees simply because
they make the work environment more pleasant
Although a satisfied employee is not necessarily a high
performer, there are numerous reasons for cultivating employee
Other Factors Affecting Job Satisfaction
Wide range of both internal and external factors affect an
employees level of satisfaction
Surveys have found that the top drivers of employee job
satisfaction were
Pay, and benefits
Job security, and feeling safe in the work environment
Flexibility to balance work and life
Job satisfaction and motivation are not synonymous
Motivation is a drive to perform
Organizational reward systems can influence both job satisfaction
and employee motivation
It affects job satisfaction by making the employee more or
less comfortable as a result of the rewards received
It influences motivation primarily through the perceived value
of the rewards and their contingency on performance
Determinants of Employee Satisfaction
and Dissatisfaction

Employee Compensation
All extrinsic rewards that employees receive in exchange for
their work
Composed of base wage or salary, any incentives or
bonuses, and any benefits
Base wage or salary Hourly, weekly, or monthly pay
employees receive for their work
Incentives Rewards offered in addition to the base
wage or salary and are usually directly related to
Benefits Rewards employees receive as a result of their
employment and position with the organization
(Examples: Paid vacations, health insurance, and
retirement plans)
Refers only to actual dollars employees receive in exchange
for work
Components of Employee

Compensation Policies
Policies must deal with following issues:
Minimum and maximum levels of pay Taking into
Worth of job to organization
Organizations ability to pay
Government regulations
Union influences
Market pressures
General relationships among levels of pay (e.g.,
between senior management and operating
management, operative employees, and supervisors)
Division of total compensation dollar (i.e., what portion
goes into base pay, incentive programs, and benefits)

Compensation Policies

Organizations must also make decisions

How much money will go into pay increases
for the next year
Who will recommend them
How raises will generally be determined
Another important decision concerns whether
pay information will be kept secret or made

Pay Secrecy
Many organizations have a policy of not disclosing pay-related
Information about pay system as well as individual pay
Justification for pay secrecy
To avoid any discontent that might result from employees
knowing what everybody else is being paid
Many employees, especially high achievers, feel very strongly
that their pay is nobody elses business
Drawbacks of pay secrecy
Difficult for employees to determine whether pay is related to
performance and does not eliminate pay comparisons
May cause employees to overestimate pay of their peers and
underestimate pay of their supervisors
Can create feelings of dissatisfaction
Employees may become suspicious
Pay Secrecy
Some companies actually forbade employees to discuss
and/or disclose their pay
In 1992, the National Labor Relations Board (NLRB)
ruled that forbidding employees to discuss their pay
constitutes a violation of the National Labor Relations
Womens groups in U.S. and UK have begun to
challenge pay-secrecy rules stating that they
perpetuate income gap between men and women
A compromise on issue of pay secrecy is to disclose pay
ranges for various job levels within the organization
Clearly communicates general ranges of pay for
different jobs, but it does not disclose exactly what any
particular employee is making

Fair Labor Standards Act (FLSA)
Commonly called Wage and Hour Act
Primary requirements are that
Individuals employed in interstate commerce
or in organizations producing goods for
interstate commerce must be paid a certain
minimum wage
They be paid time-and-a-half for hours over 40
worked in one week
Section 218 of the FLSA permits states, localities,
and collective bargaining agreements to set a
higher standard than the federal minimum
FLSA places restrictions on the employment of
individuals between ages 14 and 18
Fair Labor Standards Act (FLSA)
Possible exemptions
Amendments to law have reduced number of
exemptions, but careful study is necessary to
determine an organizations obligations
Discussions of compensation systems often use
the terms exempt and nonexempt personnel
Nonexempt employees are covered by the
FLSA; they must be paid overtime and are
subject to minimum wage
Exempt employees are not covered by the
FLSA and include executive, administrative,
and professional employees

History of Minimum Wage Rates

DavisBacon Act and
WalshHealey Public Contracts Act
DavisBeacon Act
Requires that contractors and subcontractors on federal
construction contracts in excess of $2,000 pay prevailing
wage rates for locality of project
Prevailing wage rate is determined by secretary of labor
Has normally been the same as prevailing union rate for the
Overtime of time-and-a-half For more than 40 hours per
WalshHealey Public Contracts Act
Requires that organizations manufacturing or furnishing
materials, supplies, articles, or equipment in excess of
$10,000 to the federal government pay at least the minimum
wage for the industry as determined by the secretary of labor
Defense Authorization Act of 1986 stipulated overtime as
being hours worked over 40 in a week

Federal Wage Garnishment Law
and Equal Pay Act
Federal Wage Garnishment Law
Garnishment A legal procedure by which an employer is
empowered to withhold wages for payment of an employees
debt to a creditor
Law limits amount of an employees disposable earnings that
can be garnished in any one week and protects employee
from discharge because of garnishment
Law did not substantially alter state laws on this subject
Equal Pay Act
Illegal to pay different wages to men and women for jobs that
require equal skill, effort, and responsibility and are
performed under similar conditions
Does not prohibit payment of wage differentials based on
seniority systems, merit systems that measure earnings by
quantity and quality of production, or systems based on any
factor other than sex
Union Contracts

If an organization is unionized, the wage

structure is usually largely determined through
collective bargaining process
Because wages are a primary concern of
unions, current union contracts must be
considered in formulating compensation
Union contracts can even affect nonunionized
For example, the wage rates and increases
paid to union employees often influence
wages paid to employees in nonunion

Impact of Comparable Worth
Theory holds that while true worth of jobs to employer may
be similar, some jobs (especially those held by women)
are often paid a lower rate than other jobs (often held by
Determining worth of the jobs in question is difficult
How should job worth be established?
U.S. courts have generally rejected cases based on
comparable worth claims
Although comparable worth has generally floundered in
court, it has received considerable attention
At the collective bargaining table
In the political arena

The Importance of Fair Pay
Little doubt exists that inadequate pay can have a very negative
impact on an organization
Pay dissatisfaction can influence employees feelings about their
jobs in two ways:
Can increase desire for more money
Can lower attractiveness of the job
An employee who desires more money is likely to engage in
actions that can increase pay
These actions might include
Joining a union
Looking for another job
Performing better
Filing a grievance
Going on strike
The Importance of Fair Pay
All of the consequences (except performing better) are
generally undesirable by management
Better performance results only in those cases where pay
is perceived as being directly related to performance
When job decreases in attractiveness, the employee is
more likely
To be absent or tardy
To quit
To become dissatisfied with the job itself

Model of the Consequences of Pay

Pay Equity
Equity theory of motivation holds that
Employees have a strong need to maintain a balance
between what they perceive as their inputs to their jobs
and what they receive from their jobs in the form of
Employees who perceive inequities will take action to
eliminate or reduce them
Pay equity concerns whether employees believe they
are being fairly paid
For example, if an employee believes he or she is
underpaid, that employee will likely reduce
expended effort by working more slowly, taking off
early, or being absent
Similarly, if an employee believes she or he is being
overpaid, that employee is likely to work harder or
for longer hours
Pay Equity
Several dimensions of equity to be considered when
looking at pay equity
Internal equity Addresses what an employee is
being paid for doing a job compared to what other
employees in the same organization are being
paid to do their jobs
External equity Addresses what employees in
other organizations are being paid for performing
similar jobs
Individual equity Addresses issue of rewarding
individual contributions; is very closely related to
the pay-for-performance question
Organizational equity Addresses how profits are
divided up within the organizations

Pay Equity
Employee interpretations of pay equity are based on their
Organizations should make these perceptions as
accurate as possible
An employee can also feel good about one or more equity
dimensions and feel bad about others
For example, an employee may feel good about his or
her pay in comparison to what friends working in other
organizations are making
She or he may also believe the company profits are
fairly distributed within the company
However, this same person may be very unhappy
about his or her pay relative to several other people in
the same organization

Pay Satisfaction Model
Based on the idea that employees will be satisfied with their
pay when their perception of what their pay is and of what
they think it should be agree
Happens when employees feel good about internal and
external equity of their pay
Present pay is a primary factor influencing an employees
perception of equity
Persons wage history and perception of what others are
getting also have an influence
For example, employees who have historically
received high pay tend to lower their perception of
present pay
Similarly, the higher the pay of friends and peers, the
lower ones individual pay appears to be
These factors account for the fact that two people may view
the same level of pay in a very different manner
Pay Satisfaction Model
An employees perception of what pay should be depends on
several other factors, including
Job inputs
Includes all the experience, skills, and abilities an
employee brings to the job in addition to the effort the
employee puts into it
The perceived inputs and outcomes of friends and peers
Refer to the individuals perception of what friends and
peers put into their jobs and what kind of pay they get in
Nonmonetary outcomes
Refer to the fact that certain nonmonetary rewards can
sometimes substitute for pay, at least up to a point
It makes allowances for employees who believe their pay exceeds
what they think it should be
Research has shown that in such cases, people often
experience feelings of guilt, inequity, and discomfort
Model of the Determinants of Pay

The Role of the Human Resource
Manager in the Reward System
Role of human resource manager in overall organizational
reward system is to assist in its design and to administer
the system
Administering the system Carries responsibility of
ensuring that system is fair to all employees and that it
is clearly communicated to all employees
Ensuring that the system is fair places burden of
minimizing reward inequities and employees
perceptions of reward inequities squarely on the
human resources manager
Little doubt exists that organizations need to do a better
job of explaining and communicating their compensation
system to employees
Many tools and techniques are available to assist
human resource managers in designing and
administering compensation systems
Summary of Learning Objectives
Define organizational rewards
Distinguish between intrinsic and extrinsic rewards
List several desirable preconditions for implementing a
pay-for-performance program
Define job satisfaction and list its five major components
Summarize the satisfactionperformance relationship
Define compensation, pay, incentives, and benefits
List several pieces of government legislation that have had
a significant impact on organizational compensation
Explain the equity theory of motivation
Discuss internal, external, individual, and organizational