Organizational Psychology (PSY510)
REWARD SYSTEMS: PAY
Pay is the first reward system available to managers or owners. The pay system is one of the most important
mechanisms that firms and managers can use to attract, retain, and motivate competent employees to
perform in ways that support organizational objectives. It also has a direct bearing on the extent to which
labor costs detract from or contribute to business objective and profitability.
The HR department plays an important role in designing administrative rules and procedures to ensure fair
allocation of pay, control labor costs, and maintain parity with competitor's pay levels for similar jobs.
However, organizations face many choices in terms of which pay policies and practices to use. The
challenges for top mangers, in consultation with the HR personnel, are to pick those that are most
appropriate to the firm. Most managers of all levels of the organization enjoy some discretion in making pay
decisions for subordinates. Such decisions should be equitable and relate to criteria such as unique skills,
performance level, and the flexibility to perform multiple tasks.
An employee's pay cheque is certainly important for its purchasing power. In most societies, however, a
person's earnings also serve as an indicator of power and prestige and are tied to feelings of self-worth. In
other words, compensation affects a person economically, sociologically, and psychologically. For this
reason, mishandling compensation issues is likely to have a strong negative impact on employees and,
ultimately, n the firm's procedure.
The wide variety of pay policies and procedures presents managers with a two-pronged challenge: to design
a compensation system that:
1. enables the firm to achieve its strategic objectives and
2. is molded to the firm's unique characteristics and environment.
Usually mangers and owners are different in terms of:
o Using pay as an incentive. Managers tend to pay more since they are more interested in the
well-being of the company in the long run. Owners are interested more in short-run profits, in
o Risk taking: Managers tend to take greater risk while owners have a long term perspective and
take fewer risks. They are concerned about losing their investment.
o Time horizons: As mentioned earlier, managers have a short term perspective and owners
have a long term perspective.
Research shows a number of things that are related to pay as reward:
1. Pay increases motivation
2. The more money given, the more employees want. This means that as the employees get more money
as reward for performance, they tend to be focused more on money only rather than on the job.
3. Reduction in pay will lead to lowering of morale
4. Money means different things to different employees depending on age, gender, status, family, etc.
5. If the gap (spread) in pay is more in a team of workers, performance of team is low
6. Rewarding team rather than person is more motivating
Methods of Pay
1. Base Pay
It is the first and the largest element of total compensation. It comprises fixed pay an employee receives on
a regular basis, either in the form of a salary or as an hourly wage. It is determined by market conditions
2. Merit Pay
It is paid according to predetermined criteria, e.g. cost of living
3. Pay for Performance
Simply put, pay-for-performance is that more the work done, the more the pay; bonus or stock options. Pay
for performance systems, also called incentive systems, reward employee performance on the basis of three
a) Individual employees and work teams differ in how much they contribute to the firm-not only
in what they do but also in how well they do it.
b) The firm's overall performance depends to a large degree on the performance of individuals
and groups with the firm.
Organizational Psychology (PSY510)
c) To attract, retain, and motivate high performances and to be fair to all employees, a company
needs to reward employees on the basis of their relative performance.
Individual incentive plan
At the most micro level, firms attempt to identify and reward the contributors of individual employees.
Individual-based pay plans are the most widely used pay-for-performance plans in industry. Individual
bonus programs are given on a one-time basis and do not raise the employee's base pay permanently.
Bonuses tend to be larger than merit pay increases because they involve lower risk to the employer.
Bonuses can also be given outside the annual review cycle when employees achieve certain milestones
or offer a valuable cost-saving suggestion.
Awards, like bonuses, are one-time rewards but are given in the form of a tangible prize, such as a paid
vacation or a television set etc.
The advantages of individual-based pay-for-performance plans are:
o Performance that is rewarded is likely to be repeated
o Individuals are goal oriented and financial incentives can shape an individual's goals over time.
o Assessing the performance of each employee individually helps the firm achieve individual
The disadvantages of individual-based pay-for-performance plans are:
o Create competition and destroy cooperation among peers and
o Sour working relationships between subordinates and supervisors.
Team-based incentive plan
In an attempt to increase the flexibility of their workforces, a growing number of firms are redesigning
work to allow employees with unique skills and backgrounds to tackle projects or problems together.
For instance, at Compaq Computer Corp., as many as 25 percent of the company's 16,000 employees
are on teams that develop new products and bring them to market. Employees in this new system are
expected to cross job boundaries within their team and to contribute in areas in which they have not
Team-based pay plans normally reward all team members equally based on group outcomes. These
outcomes may be measured objectively or subjectively whether the criteria for defining a desirable
outcome are broad or narrow. As in individual-based programs, payments to team members may be
made in the form of a cash bonus or in the form of non-cash awards such as trips, time off, or luxury
Team-based pay plans may include:
Gain sharing plan: where team/group performance is rewarded as a whole when the organization
gains as a result of the contribution of the group.
Profit sharing; where profit is shared by employees in an organization. Whatever the profit of the
organization is, the employees get a certain percentage in it.
Advantages of team-based-pay-for-performance plans
o They foster group cohesiveness.
o They aid performance measurement
Disadvantages of team-based-pay-for-performance plans
· Possible lack of fit with individualistic cultural values
· The free-riding effect
· Difficulties in identifying meaningful groups
· Inter-group competition leading to a decline in overall performance
New Pay Techniques
Commissions beyond sales to customers
It is an incentive plan in which employees are given commission on factors other than sales to customers.
These factors may include customer satisfaction etc.
Rewarding leadership roles
This incentive plan is linked with the leadership ability of the managers. It is based on employee satisfaction
and the ability of the manger to produce the desired results for the organization.
Organizational Psychology (PSY510)
Rewarding new goals
As indicated by the name, this plan is linked with the employee's ability to achieve other goals than the core
goals of profits and sales. These goals may include an improved productivity or customer satisfaction etc.
Pay for knowledge
This plan is based on the knowledge of the workers in the organization. For example in a team, some of the
employees may be more knowledgeable than the others, therefore, they are paid more.
Under this plan, employees are paid on the basis of their skills rather than the job they perform.
This plan tends to reward the competencies of the employees which are not visible but are useful for the
organization. For example an employee may know more than one language.
This refers to setting a range of pay within which certain employees may exist. For example, the pay range
for middle level managers may be 10,000 to 50,000. The top management may increase pay within these
limits and does not need any pay grading system.
· Mejia, Gomez. Balkin, David & Cardy, Rober. (2006). Managing Human Resources (Fourth Edition). India:
Dorling Kidersley Pvt. Ltd., licensee of Pearson Education in South Asia.
· Luthans, Fred. (2005). Organizational Behaviour (Tenth Edition). United States: McGraw Hill Irwin.
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