Detail various types of person-focused pay plans. Describe reasons why companies adopt person-focused pay plans, and identify types of position

MHR 6901, Compensation Management 1

Course Learning Outcomes for Unit VII Upon completion of this unit, students should be able to:

8. Summarize the potential impact of training and development on employee compensation. 8.1 Detail the various types of person-focused pay plans. 8.2 Describe the reasons why companies adopt person-focused pay plans. 8.3 Describe the advantages and disadvantages of person-focused pay plans.

Course/Unit

Learning Outcomes Learning Activity

8.1 Unit Lesson Chapter 5 Unit VII Essay

8.2 Unit Lesson Chapter 5 Unit VII Essay

8.3 Unit Lesson Chapter 5 Unit VII Essay

Required Unit Resources Chapter 5: Person-Focused Pay

Unit Lesson In a previous unit, we talked about merit and incentive pay, which are traditional forms of pay. Now we can look at another plan, which is called person-focused pay. Person-focused pay programs are new and not considered a traditional pay system. Person-focused pay plans are designed to reward employees for acquiring job-related knowledge and skills rather than simply performing a job. Employers may want to adopt a person-based pay program when it is important to stay current in skills—such as when technology is changing, and technology is a major part of the organization. Ambitious people thrive in such environments as they want to stay current in their fields as technology changes. An organization interested in being competitive in the global environment may also be interested in person-focused pay programs as a compensation plan of choice. Person-focused pay plans are referred to as either pay-for-knowledge or skill-based pay plans, both of which reward employees for acquiring job-related knowledge or skills. Pay-for-knowledge rewards employees for learning specific curricula or programs. Skill-based pay is pay for specific skills. When a worker masters job- related skills, he or she is rewarded for obtaining them. The person-focused pay plans look at horizontal knowledge, vertical knowledge, or the depth of a skill. Horizontal skills are those skills that are fundamental to the job or are similar skills. Vertical knowledge refers to those skills traditionally considered as supervisory skills including scheduling, coordinating, training, and leading. The depth of skills refers to the level of specialization or expertise for a particular job (Martocchio, 2020). Central to person-focused pay is the word competency. A competency is a skill that enables an employee to orchestrate and apply combinations of knowledge and skills consistently over time to perform work successfully in the required work situations. Foundational competencies represent the competencies that

UNIT VII STUDY GUIDE

Person-Focused Pay Plans

MHR 6901, Compensation Management 2

UNIT x STUDY GUIDE

Title

provide the foundation for success in school and in the world of work, and industry-related competencies are specific to an industry or industry sector. Organizations often establish core competencies for their employees as part of their strategic plans. The competencies identified as core competencies are essential to the success of an employee performing a particular job. For example, a core competency for a human resources (HR) manager would be communication. An HR manager would not be successful without the ability to communicate. An organization may have several reasons why they would want to adopt a person-focused pay program. First, this type of pay program would remove the view of pay as an entitlement and establish the view of pay as a reward for acquiring and implementing job-relevant knowledge and skills. Secondly, technological innovations are making some jobs obsolete, and this requires workers to gain new and different skills. In addition, due to increased global competition, companies in the United States must become more productive, and in order to do this, U.S. workers must become better educated. There are different types of person-focused plans as discussed below.

 Stair-step model: This includes jobs from the same job family, but the jobs differ in terms of complexity.

 Skills-block model: This plan also applies to jobs within the same job family but refers to an employee’s progress to increasingly complex jobs. These skills, however, do not build on each other. This model requires horizontal and vertical skills.

 Job-point accrual model: This plan encourages employees to develop skills from different job families. This pay plan allows employees to gain points for developing skills in different job areas. The number of points earned allows the employee to earn more compensation.

 Cross-departmental model: Employees develop critical skills that can be used in other departments. This model allows the organization to cover different departments when there are shortages in staff or to meet seasonal fluctuations for products or services.

When making comparisons to the traditional pay models, we can see that person-focused pay plans use a market base for skills valuation whereas the traditional or job-based plan uses a market base for job valuation. In the person-focused pay plan, basic pay increases are awarded on an employee’s acquired skill set and proficiency while the traditional job-based pay plan increases are based on obtaining a job-defined goal or seniority. In terms of job promotions, person-focused pay awards a promotion based on a specific skill set while a job-based plan promotes employees based on exceeding job performance standards. The key advantages for employees in the person-focused approach include job variety and job enrichment. The person-focused pay plan provides job enrichment and job security because it creates a more intrinsically motivating and interesting work environment. The key advantage of the job-related plan is simply getting paid for job performance. You do a job, and you get paid. Another key advantage of the person-focused pay plan includes flexibility in work scheduling. For the employers, the person-focused pay plan reduces the need for staffing. For example, multi-skilled employees can be used in various areas of the organization as personnel shortages develop across the organization. Additionally, to be globally competitive, employees need leading- edge skills. Disadvantages of the person-focused pay plans include a possible increase in hourly labor costs, increased training costs, and an increase in overhead costs. It may be that the person-focused pay plan may not mesh well with the existing system, particularly when working in a union environment. The most important consideration with a person-focused pay plan is allowing the employees the opportunity to apply the new skills learned in productive ways. Obviously person-focused pay programs are not for every organization, but the person-focused pay program is an effective compensation strategy if designed and implemented properly.

MHR 6901, Compensation Management 3

UNIT x STUDY GUIDE

Title

Reference Martocchio, J. J. (2020). Strategic compensation: A human resource management approach (10th ed.).

Pearson. https://online.vitalsource.com/#/books/9780135201930

Learning Activities (Nongraded) Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit them. If you have questions, contact your instructor for further guidance and information. Each chapter of your textbook contains a case study related to the main theory or concept within the chapter. Review the case studies to gain a better understanding of the course materials as they relate to compensation considerations. Feel free to discuss the chapter case studies with your classmates in the Student Break Room forum.

Running head: TITLE OF ESSAY 1

Title of Essay

Name

University

SAMPLE FORMAL ESSAY

This is the running head. The words “Running head:” should only appear on the title page. On all subsequent

pages, the header should consist of the title in all capital letters. Be sure that the title within the running

head is 50 characters or less including spaces.

Paper Format

 1 inch margins

 Double spacing

 Suggested font-Times New Roman 12 pt.

 Paragraphs indented .5 inch (usually default Tab)

TITLE OF ESSAY 2

Title of Essay

There are key elements that are necessary to be successful in online learning as well as

with most careers. These skills are useful for those in roles of leadership to maintain order and

productivity. In my career as a training coordinator, skills such as organization, time

management, and communication are paramount.

Organization is an optimal skill to help efficiency. It is a necessary ability that enhances

learning through orderly schoolwork and increases productivity in one’s job through systematic

documentation. This process allows for files and documents to be arranged so that they can be

easily accessed (Hamilton, 2013). Paperwork organization allows for training documents to be

updated and placed in specific binders for dissemination to team members. Additionally, it is

imperative to keep email files organized so that tasks are not forgotten or overlooked. Just as

years ago when paper mail had to be sorted, email must be sorted or grouped into appropriate

folders (Weber & Horn, 2011). Great organization skills make keeping and accessing

information efficient.

Time management is an element or skill that allows employees as well as students to get

the most out of the allotted time. “It’s been estimated that reading, responding, and doing

something with business e-mail can consume two to four hours each and every day!” (Weber &

Horn, 2011, p. 33). Prioritizing tasks and scheduling events allow one to maximize productivity

(Hamilton, 2013). When time is scheduled and work is ordered, the most important things get

done first. It does not matter if an unexpected meeting is called; the imperative jobs have been

accomplished or planned. Highlighting the most important tasks ensures that those take first

place and do not get overlooked in a rush. Along with time management comes the ability to be

flexible. Flexibility allows for rearrangement of schedules to make sure all responsibilities are

When paraphrasing information, text citations should include the author(s) and the year of publication.

Direct quotations require the listing of the author(s), year of publication, and the page or paragraph number.

This is the running head.

Center the full title of the document. Not Boldface.

TITLE OF ESSAY 3

taken care of in an acceptable amount of time. Effective time management is a constantly

evolving skill.

Communication is an ability that is equally required in course work as well as the

corporate world. To convey information in a clear and concise manner is key whether one is

training someone or writing a research paper. There are so many various methods in which to

communicate (Hamilton, 2013). It is essential to use an appropriate medium so that the message

is received. Day to day communication such as email and phone conversations must be

professional as well as grammatically correct. It is also important to maintain proper etiquette

when communicating online or through email (Hamilton, 2013). Additionally, training

communication is much like teaching in that information must be imparted or taught to others.

One must take into account the different types of learners that will be on the receiving end.

Communication should be auditory, visual, and kinesthetic in order to be optimal. Having the

ability to clearly relay key thoughts and ideas to others is a valuable skill.

There are three elements that have proven to be key to productivity in master’s programs,

in the professional world, and in everyday life. Organization, time management, and

communication are skills that should be honed and crafted as one continues in his or her degree

or career path.

TITLE OF ESSAY 4

References

Hamilton, A. (2013). Essay writing in a virtual environment. Nashville, TN: Music City Press

Inc.

Weber, R.M., & Horn, B.D. (2011). Taming your inbox. Journal of Financial Service

Professionals, 65(4), 33-36. Retrieved from Business Source Complete database.

This is an example of a reference list. All text citations must have a

corresponding entry on the reference list.

Note: An essay that will be copied and pasted into Blackboard will include the references below the essay;

however, essays that will be uploaded on a Word document should have a separate reference page, title page, and

running head.

The word “References” should be centered at the top of the page

and is not boldface.

Human Resource Management, July–August 2016, Vol. 55, No. 4. Pp. 697–719

© 2015 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI:10.1002/hrm.21740

Correspondence to: Sanghee Park, Assistant Professor, School of Management and Labor Relations, Rutgers,

The State University of New Jersey, Piscataway, NJ, 08854, Phone: (848) 445-1051, Fax: (732) 445-2830,

E-mail: [email protected]

EVALUATING FORM AND

FUNCTIONALITY OF

PAY-FOR-PERFORMANCE PLANS:

THE RELATIVE INCENTIVE

AND SORTING EFFECTS OF MERIT

PAY, BONUSES, AND LONG-TERM

INCENTIVES

S A N G H E E P A R K A N D M I C H A E L C . S T U R M A N

Using two-year longitudinal data from a large sample of US employees from a

service-related organization, the present study investigates the relative effects of

three forms of pay-for-performance (PFP) plans on employees’ job performance

(incentive effects) and voluntary turnover (sorting effects). The study differenti-

ates between three forms of pay: merit pay, individual-based bonuses, and long-

term incentives. By defi nition, these PFP plans have different structural elements

that distinguish them from each other (i.e., pay plan form) and different charac-

teristics (functionality), such as the degree to which pay and performance are

linked and the size of the rewards, which can vary both within and across plan

types. Our results provide evidence that merit raises have larger incentive and

sorting effects than bonuses and long-term incentives in multi-PFP plan environ-

ments where the three PFP plans are operating simultaneously. Only merit pay

has both incentive and sorting effects among the three PFP plans. The implica-

tions for the PFP-related theory, as well as for the design and implementation of

PFP plans, are discussed. © 2015 Wiley  Periodicals, Inc.

Keywords: pay-for-performance plans, incentive effect, sorting effect, compensation

698 HUMAN RESOURCE MANAGEMENT, JULY–AUGUST 2016

Human Resource Management DOI: 10.1002/hrm

Even with a

substantial body of

research discussing

the effects of

particular PFP

interventions, PFP

research has typically

failed to consider the

complex, multiplan

environments

in which many

organizations invest

and many employees

face.

examinations of individual PFP plans. Most stud- ies examine a single form of PFP at a time, par- ticularly in laboratory studies (e.g., Bandiera, Barankay, & Rasul, 2007; Cadsby et al., 2007; Eisenberger, Rhoades, & Cameron, 1999; Kwong & Wong, 2014), but also in organizational settings (e.g., Banker, Lee, Potter, & Srinivasan, 1996, 2001; Dunford, Boudreau, & Boswell, 2005; Eisenberger et al., 1999; Pearce et al., 1985; Schaubroeck, Shaw, Duffy, & Mitra, 2008). Other work provides only broad overviews of PFP plans’ effects, such as in strategic HR management research that typically asks general questions about the extent to which employees are covered by PFP (e.g., Bhattacharya, Gibson, & Doty, 2005; Delery & Doty, 1996; Gerhart & Milkovich, 1992; Toh, Morgeson, & Campion, 2008; Wright, Gardner, Moynihan, & Allen, 2005). This previous work has certainly been valuable for providing information on the nature of PFP effects; however, the generalizability of theory and findings from single-plan focal stud- ies to multiplan environments is questionable.

Many companies use multiple types of PFP simultaneously (Cohen, 2011; Gerhart & Fang, 2014; Gerhart et al., 2009; Rynes et al., 2005). A 2010 WorldatWork Survey showed that 92 percent of companies use merit raises, 80 percent provide some form of individual-based variable pay pro- gram (not including sales commissions or merit raises), and 57 percent use some sort of perfor- mance-sharing plan. The same survey conducted in 2012 (WorldatWork, 2012) showed this to be an increasing trend, with 95 percent offering merit pay, 84 percent with some form of individual- based variable pay program, and 58 percent using some form of performance sharing. While these surveys do not explicitly report the number of dif- ferent incentive plans covering the same employ- ees, mathematically, we can extrapolate that at least three-quarters of companies use at least two forms of PFP, and over one quarter are simultane- ously using three different PFP plans. Despite this prevalent complexity, though, there is minimal research considering the relative effectiveness of different PFP plans.

Studying PFP explicitly within the more com- plex environment of multiple PFP plans is critical to gain a better understanding of the relative effec- tiveness of different PFP forms. This study makes several contributions to our understanding of the effectiveness of PFP. First, this study considers multiple PFP plans simultaneously in multi-PFP plan environments. As previously noted, most prior PFP research has considered a single PFP plan at a time, with it either being explicitly on a single plan, or unstated or unexplored if other PFP plans were operating simultaneously. It is unclear

T heory and empirical evidence indicate that, in general, pay-for-performance (PFP) plans have positive effects on employee job performance (e.g., Gerhart & Fang, 2014; Gerhart & Rynes, 2003; Jenkins,

Mitra, Gupta, & Shaw, 1998; Lawler, 1971; Zenger, 1992). A common component of compensation systems, PFP plans are referred to as “pay that varies with some measure of individual or orga- nizational performance” (Milkovich, Newman, & Gerhart, 2013, p. 335). Theory attributes the influences of PFP plans to two broad sets of effects: incentive effects and sorting effects (Cadsby, Song, & Tapon, 2007; Gerhart & Fang, 2014; Gerhart & Milkovich, 1992; Gerhart & Rynes, 2003; Gerhart, Rynes, & Fulmer, 2009; Rynes, Gerhart, & Parks,

2005). Incentive effects represent the influence of PFP plans through employee motivation, based on the premise that PFP plans can increase employee motivation and, hence, employee performance. Sorting effects alter the composition of the workforce, in that PFP plans can affect the quality of workers who apply for jobs (Lazear, 1986; Rynes et al., 2005) and the performance level of those leaving the organiza- tion (Salamin & Hom, 2005; Shaw & Gupta, 2007; Trevor, Gerhart, & Boudreau, 1997). While there are still some examples of ineffective PFP plans (e.g., Beer & Cannon, 2004; Kahn & Sherer, 1990; Lawler, 2000; Pearce, Stevenson, & Perry, 1985; Pfeffer, 1998), the prepon- derance of evidence shows that PFP plans have positive effects (cf., Gerhart & Fang, 2014; Gerhart et al., 2009). Yet, even with a substan- tial body of research discussing the effects of particular PFP interven-

tions, PFP research has typically failed to consider the complex, multiplan environments in which many organizations invest and many employees face (Gerhart et al., 2009; Rynes et al., 2005). This lack of consideration of more multifaceted envi- ronments presents a theoretical gap for under- standing and testing how relevant PFP theories apply in more complex environments, and a practical gap for organizations needing to predict the sort of effects they should expect from their multiplan environments.

While the literature on PFP plans is quite extensive (for reviews, see Gerhart & Fang, 2014; Gerhart et al., 2009; Guthrie, 2007; Rynes et al., 2005), prior PFP research is largely based on specific

Human Resource Management DOI: 10.1002/hrm

EVALUATING FORM AND FUNCTIONALITY OF PAY-FOR-PERFORMANCE PLANS 699

What makes the study

of compensation

systems complex is

that some aspects

of PFP plans are

different by definition

(e.g., the reward

is permanent, a

one-time payment,

or will take time

before the reward is

vested), while other

characteristics can

vary both within and

across plan types

(e.g., the strength

of the relationship

between performance

and rewards, the

award size).

should differ in terms of both their incentive and sorting effects (Gerhart et al., 2009). What makes the study of compensation systems com- plex is that some aspects of PFP plans are differ- ent by definition (e.g., the reward is permanent, a one-time payment, or will take time before the reward is vested), while other characteristics can vary both within and across plan types (e.g., the strength of the relationship between performance and rewards, the award size). While prior use of theories regarding a single type of plan has typi- cally yielded general predictions that PFP plans should have posi- tive effects, such a holistic approach misses important characteristics of PFP plans and has questionable (or at least untested) generalizability to considering the simultaneous effects of multiple PFP plans. Based on pay plans’ mechanisms, we can differ- entiate between pay form and func- tionality, which can vary depending on different pay practices, thus delineating where hypotheses can be created based on the type of PFP being provided (i.e., pay plan defi- nition, or form) and those based on the specific characteristics of the PFP plan (i.e., pay plan functionality).

What’s in a Name Anyhow: The Effect of Different Pay Forms

PFP plans come in a variety of forms, both in terms of the level of the per- formance metric (e.g., individual, team, unit) and the type of award it provides (e.g., recognition, non- monetary awards, lump-sum cash awards, long-term incentives [LTIs], and permanent pay increases). It is beyond the scope of any one study to contrast every potential PFP plan, and so we begin to address the noted gap in compensation research by considering three increasingly common PFP plans: merit pay, indi- vidual-based annual performance bonuses, and LTIs. The first two of these are indi- vidually based and rewarded; the third is awarded to an individual and the size of the award depends in part on individual performance, but ultimately the value of the award depends on the overall market performance of the organization and vest- ing requirements.

Merit pay is a form of reward in which individ- uals receive permanent pay increases (i.e., raises) as a function of their individual performance

whether the predictions for individual PFP plans would generalize when it is explicitly known that other PFP plans are in operation. Furthermore, by applying PFP-related theories to the context of multiple PFP plans, we are examining a previously unexplored set of processes. It is not immediately evident what the effects of one PFP plan would be after controlling for the effects of other PFP plans, especially if the plans have related effects. This study extends PFP theories to consider the context of multiple PFP environments, where a portfolio of PFP plans cover employees.

Second, we contribute to the compensation lit- erature by considering a gap between research and practice. Practically, we inform managers about how different PFP plans should be combined to increase employee performance in their organi- zations. It is clear that organizations are invest- ing significant sums of money into multiple PFP forms (WorldatWork, 2010, 2012). With a sizable and growing number of employees being covered by two or more PFP plans, the lack of research on the relative effectiveness of such plans represents a notable gap in applicable research knowledge. While many argue that practitioners should take an evidence-based approach to management pol- icy (e.g., Rousseau, 2006; Rousseau & McCarthy, 2007), the lack of research addressing this spe- cific situation represents another notable discon- nect between research and practice (e.g., Cascio & Aguinis, 2008; Rynes, Giluk, & Brown, 2007), a particular problem in the area of compensation (Deadrick & Gibson, 2007; Rynes et al., 2007).

The purpose of this article is to apply existing PFP-relevant theory to differentiate between the effects of multiple PFP plans implemented simul- taneously. We propose that a structural approach to understanding PFP plans can be used to form predictions on the relative effectiveness of dif- ferent PFP plans for both incentive effects and sorting effects. By considering the specific char- acteristics of PFP plans, we can build theory to predict not just the general (directional) effects of PFP plans, but the relative effectiveness of plans. Furthermore, we can extend theory to the purpose of considering the simultaneous effects of multi- ple PFP plans.

A Structural Approach to Compensation Plans

Multiple types of PFP plans are often used through a combination of individual-based rewards (e.g., merit pay, lump-sum bonuses, and individual incentives) and/or group-based rewards (e.g., gain sharing, profit sharing) (Gerhart et al., 2009; Milkovich et al., 2013). Every pay form has advan- tages and disadvantages, and these programs

700 HUMAN RESOURCE MANAGEMENT, JULY–AUGUST 2016

Human Resource Management DOI: 10.1002/hrm

A pay plan’s name

reveals information

about its award,

but simply calling

something a PFP plan

does not necessarily

mean it links pay with

performance.

it links pay with performance. A number of theo- ries suggest that the strength of the PFP link will lead to beneficial incentive and sorting effects (Lambert, Larcker, & Weigelt, 1993); thus, the degree to which pay and performance are linked is a critical characteristic of any PFP plan (Milkovich et al., 2013; Zenger, 1992).

Expectancy theory proposes that employees make rational decisions based on the character- istics of the incentives they are facing (Bartol & Durham, 2000; Fusilier, Ganster, & Middlemist, 1984; Vroom, 1964), hence, positing that, all else being equal, motivation will be stronger if there is a stronger link between performance and rewards (Bartol & Durham, 2000; Bonner & Sprinkle, 2002; Kahn & Sherer, 1990; Lawler, 1971). Thus, finan- cial rewards that are strongly tied to individual performance increase employees’ effort, and this increased effort is supposed to lead to increases in performance (Bonner & Sprinkle, 2002; Lawler, 1971). Similarly, agency theory predicts that if per- formance can be monitored and tied to awards, then the rewards system can improve individual performance (Bartol & Locke, 2000; Eisenhardt, 1989). Agency theory also posits that a strong PFP plan can help solve the risk-sharing problem that organizations often experience in agency relation- ships by leading people who are highly risk-averse and less productive to leave their jobs (Cadsby et al., 2007; Eisenhardt, 1989). Tournament the- ory suggests that employees compete for higher rewards, and so a stronger link between perfor- mance and rewards should be associated with greater effort to achieve the higher awards (Becker & Huselid, 1992). At the same time, the competi- tion among individuals attracts high performers but increases voluntary turnover of poor perform- ers (Bloom & Michel, 2002; Shaw & Gupta, 2007). Even though some have argued that equity the- ory is counter to PFP, it has been recognized that equity does not mean equality (Brown, Sturman, & Simmering, 2003; Trevor, Reilly, & Gerhart, 2012). To maintain equity across employees, it is necessary to link pay and performance so that individuals’ ratios of performance to rewards are maintained across performance levels.

To understand the potentially different effects of PFP plans, we must, therefore, specifi- cally examine the strengths of the associations between performance and rewards. Research has provided examples of widely disparate relation- ships between pay and performance under nomi- nal PFP plans. For example, research has shown varying relationships between raises and perfor- mance under merit plans (e.g., Harris, Gilbreath, & Sunday, 1998; Kahn & Sherer, 1990; Markham, 1988). Similarly, some research has examined

ratings (Heneman & Werner, 2005). The pay plan is usually based on an individual’s performance, assessed by an employee performance appraisal (Rynes et al., 2005; Schwab & Olson, 1990). Merit pay shares elements of both variable pay and fixed pay. It is variable in that the pay raise depends on individual performance, and thus new raises must be re-earned each year. It is fixed, though, in that any given merit raise increases base pay, and thus regardless of future performance levels, that new base pay will continue to be received even if performance changes (barring employee termination).

Bonus pay is a monetary reward given in addi- tion to employees’ fixed compensation (Milkovich et al., 2013). Bonuses are ostensibly based on indi- vidual performance but do not increase employ- ees’ base pay (Sturman & Short, 2000). This type of pay plan has been widely used in organizations to motivate employees’ performance, and surveys report that the popularity of bonus pay is increas-

ing (cf. Sturman & Short, 2000; WorldatWork, 2012). Individual- based performance bonuses are attractive from the company’s per- spective because the one-time ca

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