Compensation as a human resources management (HRM) practice is the linkage between reward and employee satisfaction. Modern organizations can adopt various HRM practices to enhance employee satisfaction. The form and structure of an organization’s HRM system can affect employee motivation levels in several ways. HRM practices in general and compensation systems in particular have been shown to be highly related to organizational performance. Reward systems are concerned with two major issues: performance and rewards. Performance includes defining and evaluating performance and providing employees with feedback. Rewards include bonus, salary increases, promotions, stock awards, and perquisites.
Organizations have considerable discretion in the design of pay policies and the choices made have consequences for organizational performance. Organizations that are similar in terms of types of employees and jobs, product, market, size, and so on may choose compensation system designs that differ in their effectiveness for attaining similar goals. Also, large corporations with several different businesses may have multiple reward systems. And while they may share some fundamental philosophies and values, they may differ according to particular business setting, competitive situation, and product life cycle. Thus multiple reward systems can support multiple cultures (or subcultures) within one organization.
HRM practices such as profit sharing, results oriented appraisals, and employment security have relatively strong universalistic relationships with important accounting measures of organizational and financial performance. Pay level and pay structure are each important for understanding the organizational level implications of pay policy. Pay level practices and pay structures interact to affect resource efficiency, employee satisfaction, and financial performance. Different elements of a compensation plan are considered regarding the relationship between pay systems and organizational performance.
The universalistic relationship between the use of compensation and performance also supports both an agency theory and a behavioral theory explanation. Agency theory posits that basing employee rewards on profits ensures that employee interests are aligned with owner interests. Many profit-sharing plans do not distribute profits equally among employees. Instead, profits are distributed differentially according to employee performance. Compensation systems as a major HRM practice can motivate skilled employees to engage in effective decision making and behavior in response to a variety of environmental contingencies.
Alternative Compensation Systems
Employees are one of the most valuable resources companies have to remain competitive. Managerial compensation strategies differ significantly across organizations, particularly with regard to variable pay. Organizations tend to make different decisions about pay contingency, or variability, rather than about base pay, since contingent pay is more associated with financial performance. In general, organizations implement merit pay or incentive compensation systems that provide rewards to employees for meeting specific goals. Fewer employees work under individual incentive plans while greater numbers of individuals work under some type of group incentive system. A substantial body of evidence has focused on the impact of incentive compensation and performance management systems on group performance. In addition, protecting employees from arbitrary treatment, perhaps via a formal grievance procedure, may also motivate them to work harder because they can expect their efforts to be fairly rewarded.
Development of compensation systems other than wages on a monthly basis, benefits required by law, and bonuses is necessary. Compensation in modern organizations should pay more attention to alternative and more sophisticated compensation systems, such as performance-related pay systems, profit-sharing systems, share-ownership systems and stock options, nonfinancial motives, and benefits not required by law. In this way, compensation as a major HRM practice increases the level of satisfaction and enhances fairness perception of employees working at various functional units and different hierarchical levels.
In a dynamic, unpredictable environment, organizations might achieve this by using organic HRM systems that promote the development of a human capital pool possessing a broad range of skills and that are able to engage in a wide variety of behavior. Today, organizations face environments characterized by increasing dynamism and competition and sustainable fit can be achieved only by developing and applying HRM practices, such as sophisticated compensation systems promoting employee financial participation. Organizations that adopt a greater number of prescribed practices are likely to gain a short-term competitive advantage and enjoy superior performance. However, the implementation of these practices is not always an easy task.
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- P. Brown, M. C. Sturman, and M. J. Simmering, “Compensation Policy and Organizational Performance: The Efficiency, Operational, and Financial Implications of Pay Levels and Pay Structure,” Academy of Management Journal (2003);
- Gerhart and G. T. Milkovich, “Organizational Differences in Managerial Compensation and Financial Performance,” Academy of Management Journal (1990);
- Kerr and J. W. Slocum, “Managing Corporate Culture Through Reward Systems,” Academy of Management Executive (2005);
- P. Schwab, “Impact of Alternative Compensations Systems on Pay Valence and Instrumentality Perceptions,” Journal of Applied Psychology (1973).
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