OB C4

Theoretical Foundations of Reward Systems in Organizational Behavior

Reward systems are traditionally placed in the latter sections of organizational behavior textbooks, but their placement at the conclusion of the introductory environment context is strategic for two primary reasons. First, within the framework of social cognitive theory, the environmental variable in the triadic reciprocal interaction model consists of both external and organizational contexts. Alongside structural design and culture, the reward system represents the remaining major contextual variable. Social cognitive theory posits that human behavior cannot be fully understood without considering the regulatory influence of rewards. Reward consequences and contingencies play a vital role in influencing employee perceptions of organizational support and leadership. As noted by Bandura, a visionary strategic plan and well-designed structures remain hollow unless individuals are rewarded for performance improvement. Simply put, "you get what you reward!"

Second, the emphasis on organizational reward systems early in the curriculum highlights the emerging importance of human capital and intellectual capital. In the current competitive paradigm, human capital is central to maintaining a competitive advantage. Sustaining, retaining, and leveraging this capital requires strategic attention to reward systems. Since humans represent a significant cost to organizations, there is increasing focus on analyzing the return on investment ($ROI$) of this capital. The reward system is thus recognized as a vital dimension of the organizational environment.

Money as the Dominant Organizational Reward

While organizational reward systems include money, recognition, and benefits, money remains the dominant and foremost reward. Organizations utilize money in various forms—including salary, bonuses, and incentive pay—to motivate performance and encourage retention. Research indicates that while the importance of money varies by individual and industry, it often ranks at the top of employee motivators. Manfred Kets de Vries observed that while people say money isn't everything when they have enough, the typical scenario is that the more one has, the more one wants. Steven Kerr noted that money is universally accepted and that individuals will often take drastic measures to obtain it. Conversely, research shows that $82\%$ of employees in the United States and $76\%$ worldwide would accept a pay cut to pursue a "dream job."

Money explains behavior at work by providing a foundation for commerce; businesses are started to generate wealth. Symbolically, money represents four critical attributes: achievement and recognition, status and respect, freedom and control, and power. It helps individuals attain physical objectives such as automobiles and houses, as well as psychological objectives like self-esteem. As Donald Trump noted, "Money was never a big motivation for me, except as a way to keep score. The real excitement is playing the game."

Agency Theory and the Economic Perspective on Pay

Agency theory is a finance and economics approach used to understand behavior within and outside corporations. It focuses on the diverse interests of stakeholders—stockholders, managers, and employees—and how reward systems align these goals. In large corporations, managers act as agents for owners/stockholders. Conflicts arise because owners typically seek to maximize personal wealth and stock value by minimizing costs, whereas agents may expend resources on activities that do not directly contribute to owner wealth.

Risk-taking and time horizons also differ between agents and owners. Owners may be risk-aversive, preferring conservative actions to minimize loss, while managers may take higher risks for profits or market share, as incorrect decisions may not impact them as severely as the owners. Furthermore, owners have long-term time horizons, while managers often have short-term horizons due to job tenure requirements or bonuses tied to quarterly performance. This short-term focus was identified as a major contributor to the $2008$ economic crisis. Critics point to company scandals where managers inflated profits to improve their own performance metrics, as seen in cases like Nortel. Despite these criticisms, agency theory provides significant insights into pay as a reward.

Research on the Effectiveness of Pay

Pay can be positively reinforcing and, if properly designed, impacts individual, team, and organizational performance. In the oil industry, CEOs such as those at Exxon Mobil may be compensated $40.3\text{ million}$, while new petroleum engineering graduates earn approximately $80,000$ and experienced "roughnecks" earn around $100,000$. Employees often work for long-term rewards like deferred compensation or partner status in law firms. Morale suffers when pay is cut, as employees view it as an "insult" to their self-worth. Research indicates that reward systems strongly influence trust in the workplace.

Individual differences affect how pay impacts groups. A study of $1,644$ baseball players on $29$ teams over a nine-year period found that the greater the pay spread on a team, the more poorly players performed. However, compensation expert Edward Lawler notes a strong relationship between total payroll and games won, arguing that high payrolls are necessary to attract top talent. There is ongoing debate regarding the massive pay disparity between CEOs and frontline workers; a public poll revealed that $87\%$ of respondents believe executives get rich at the expense of ordinary workers.

In Maslow’s hierarchy, money is often associated with basic needs, but it also provides status and achievement. Behavioral research via meta-analysis of $72$ studies found money to be an effective reinforcement strategy. While some psychologists once argued that extrinsic rewards like money decrease intrinsic motivation, a meta-analysis of $96$ experimental studies concluded that rewards generally do not decrease intrinsic motivation. The effectiveness of money depends on how it is administered; it must be objective, fair, and contingent on performance behaviors.

Traditional Methods of Administering Pay

Traditionally, organizations use base pay and merit pay, often supplemented by other programs. Base pay consists of an hourly wage or annual salary determined by market conditions. For example, a part-time worker might earn $12.00\text{ per hour}$, a new graduate $36,000\text{ annually}$ (roughly $692\text{ weekly}$), and an experienced engineering manager $110,000$. Base pay is most competitive at the entry level and often loses competitiveness over time.

Merit pay is tied to predetermined criteria and can be a flat sum (e.g., $3,000$) or a percentage (e.g., $6\%$). A combination might involve giving a $6\%$ increase up to a maximum of $5,000$. Merit pay identifies three types of employees: the stars (who make a difference), the middle group (who get the job done), and the bottom group. Shortcomings of merit pay include nebulous criteria, difficulty in quantifying specialist outputs, and its tendency to become "catch-up" pay to resolve salary compression. Salary compression occurs when the gap between new hires and veteran employees closes due to market demand.

Individual and Group Incentive Plans

Individual incentive plans, such as the piece rate system from the scientific management era, pay based on output or quality. For example, Woolverton Inn housekeepers receive extra pay for meeting $95\%$ of a $40$-item checklist. Salespeople typically earn commissions (e.g., $10\%$). Lincoln Electric has used incentives to help factory workers earn over $100,000\text{ annually}$. Some plans use a "drawing account" against which a salesperson takes money to be repaid from future commissions. Individual bonuses can be massive; former Annaly Capital Management CEO Michael Farrell earned a bonus of $29\text{ million}$, calculated as $0.25\%$ of stockholder equity. Stock options allow executives to buy stock at a fixed price, though they can lead to high-variance risks. A study found that CEOs with many options often deliver more big losses than big gains.

Group incentive plans, like gainsharing, share productivity gains with teams. In gainsharing, costs are baselined; if it costs $30\text{ million}$ to produce $240,000$ printers ($125\text{ per unit}$), and a team reduces the cost to $112\text{ per unit}$, the $13\text{ per unit}$ savings are shared (e.g., on a $75:25$ basis). Weyerhaeuser uses "goalsharing" to reduce waste and increase safety. Profit sharing involves distributing a portion of profits to an escrow account or immediately to employees. Employee Stock Ownership Plans ($ESOPs$) allow employees to gain a stake in ownership through company-funded loans paid off by profits. While popular, group plans can suffer from "social loafing" where rewards are distributed equally regardless of individual contribution.

New Pay Techniques and Strategies

Contemporary organizations are redesigning pay to reflect changes in technology and globalization. "Smart reward" systems focus on evidence-based metrics, communication, and core values. Notable new pay approaches include:

1. Commissions beyond sales: Commission is tied to customer satisfaction and team profit goals rather than just volume.

2. Rewarding leadership effectiveness: Bonuses tied to employee satisfaction scores (e.g., Nationwide Insurance).

3. Rewarding new goals: Aiming at cycle time, quality measures, and customer satisfaction top-to-bottom.

4. Pay for knowledge workers in teams: Linking pay to the performance of professional teams or virtual groups.

5. Skill pay: Paying based on demonstrated productivity or service skills.

6. Competency pay: Rewarding abstract knowledge like social skills, international context, or technology.

7. Broadbanding: Collapsing numerous salary levels into a few grades with wide ranges (e.g., condensing three levels ranging from $25,000$ to $80,000$ into one). This promotes flexibility and reduces administrative layers.

Recognition as an Organizational Reward

Recognition involves both formal programs and social recognition (informal praise, appreciation). Social recognition has a significant impact at all organizational levels. Nonfinancial rewards are advantageous because they can be given frequently and immediately, unlike pay which is often reviewed only annually. Recognition can take the form of increased responsibility or empowerment. Studies show only $30\%$ of employees feel an obligation to stay with their current employer, but recognition of work-life balance and creative contributions boosts loyalty. To manage recognition, organizations should use communication tools (Intranet), educate managers, and make recognition part of performance management.

Examples of formal systems include Dierbergs Family Market’s "Extra Step" program, which rewards employees for proactive customer service with gift certificates or lunch with the CEO. Hotel Sofitel Minneapolis uses "Service Champions" francs; $3$ francs earn a $35$ gift certificate, while $10$ francs earn a day off with pay. The Fremont Hotel & Casino in Las Vegas awards its "Employee of the Month" $100$, show tickets, and eligibility for a Hawaii trip. Kimley-Horn allows any employee to award another a $55$ recognition check on the spot. Even simple rewards, like the "cheesehead" foam hat given by Tricon’s CEO for low turnover, can have deep emotional impact.

OB in Action: Some Easy Ways to Recognize Employees

Managers can use diverse, simple methods to recognize personnel:

1. Provide concentrated, focused recognition in a private office meeting.

2. Use a revolving trophy inscribed with names.

3. Send fax, email, or voice mail thanks to remote employees.

4. Attach a recognition note to a paycheck.

5. Take support staff to lunch after a promotion or win.

6. Display photos of managers congratulating employees.

7. Have senior managers attend team meetings for recognition.

8. Invite the team to a house celebration for project milestones.

9. Assign mentoring roles to experts to show trust.

10. Repeat positive remarks heard from others immediately.

11. Identify and use the specific types of praise employees prefer.

12. "Catch people doing things right."

Benefits as Organizational Rewards

Benefits constitute between $30\%$ and $35\%$ of wages and salaries. Efficiency wage theory suggests that firms paying better benefits save money by hiring more productive talent. Traditional benefits include mandated offerings and standard insurance. Mandated benefits include Social Security (retirement and Medicare taxes), workers’ compensation (covering accidents regardless of fault), the Family and Medical Leave Act of $1993$ (providing $12\text{ weeks}$ of unpaid leave for firms with $50+$ employees), and unemployment insurance (tax ranging from $0.1\%$ to $5\%$).

Insurance benefits cover health, life (often $2\times$ annual salary), and disability. The Patient Protection and Affordable Care Act ($ObamaCare$) of $2010$ mandates Minimum Essential Coverage and penalizes large employers ($100+$ in $2015$, $50+$ in $2016$) who do not offer affordable coverage. Pension benefits include IRAs and $401(k)$ plans. Time-off benefits include vacation (typically ranging from $1$ to $4\text{ weeks}$), religious holidays, and sick leave. Wellness programs focuses on physical health; some firms pay individuals to lose weight (e.g., $10\text{ per pound}$) or for unused sick days.

Life cycle benefits include child care (on-site at SAS) and elder care (referral services or long-term care insurance). Employee Assistance Programs ($EAPs$) help with alcohol, drugs, or marital issues. Flexible, "cafeteria-style" benefit plans allow employees to spend a budgeted amount on the benefits that best suit their needs (e.g., more life insurance for young families). While high-cost and often taken for granted as an entitlement, benefits are essential for attraction and retention.

Questions & Discussion

1. In what way does agency theory provide understanding for pay as an important component of the organizational reward system? Answer: It explains the goal conflict between owners and agents regarding risk, time horizons, and cost management.

2. Is pay an effective organizational reward? Does the fact that the CEO makes $20\text{ times}$ as much as the lowest-paid person affect performance? Answer: Pay remains effective but complex; extreme disparities can lead to perceptions of unfairness and lower employee morale.

3. "The team with the highest payroll usually ends up in the World Series." How does this relate to pay? Answer: It suggests that high pay is the primary mechanism for attracting and retaining the best talent in a free-agency market.

4. Why supplement traditional pay with pay-for-performance? Answer: Traditional pay does not adequately reward superior output or penalize low performance.

5. How do new pay techniques solve modern challenges? Answer: Techniques like broadbanding and skill pay increase organizational flexibility and support knowledge-based work.

6. Why develop recognition programs instead of just giving money? Answer: Recognition is more frequent, less costly, and fills an enduring psychological need that money alone cannot satisfy.

7. What role do benefits play in the reward system? Answer: They create an environment for long-term commitment and support the physical/mental well-being of the workforce.

Case Study: Rewarding Teamwork at Behlen Manufacturing

Behlen Manufacturing Company in Columbus, Nebraska, employs $1,100$ people organized into $32\text{ teams}$. They utilize a core base-pay supplemented by variable rewards. Team members share gains (up to $1.00\text{ per hour}$) when they meet productivity goals based on pounds of product produced. Employees also receive $20\%$ of profits; recently, this resulted in a bonus equal to $3\text{ weeks}$ of salary. Additionally, an $ESOP$ provides stock equal to $2\%$ of base salary annually. Senior managers participate in the same system proportional to their business unit’s gross margin. Over eight years, this system saved the firm $5\text{ million}$ and consistently exceeded profit goals.