Strategic compensation practices and organizational performance

Incentive Pay: Strategic Compensation and Its Impact on Human Resource Management in the United States

Compensation refers to a wide array of benefits and pay that a company uses to reward employees for performance. Strategic compensation refers to any type of compensation strategy that is aimed at rewarding good performance. Because the variety of companies and their internal structure varies wildly, strategic compensation strategies can vary wildly. For example, many direct sales companies where employees are actually independent contractors use strategic compensation strategies, giving prizes for hitting certain sales goals and increasing compensation percentages with sales. On the other end of the spectrum, large corporations almost always include stock options in higher-level compensation strategies, which directly ties the degree of financial reward to overall corporate performance. Individual companies can tailor their compensation strategies to what their firm does, the number of employees, and what is likely to motivate those employees. Perhaps most importantly, strategic compensation strategies always carry the risk of backfiring, because if they are not appropriately tailored to reward strong performance in a timely manner, they may actually discourage employees from effective and efficient performance. Moreover, it is important to keep in mind that different types of strategic compensation might impact different levels of employees in different ways, so that compensation strategies should take into account different job responsibilities and levels of autonomy.

Furthermore, it is important to keep in mind that what works in the United States may differ from what works in other countries. While there is a largely global business environment, the regulations, rules, and business norms that govern U.S. corporate structure may make some types of strategic compensation more critical in the United States. For example, in most industrialized nations, the availability of universal healthcare means that health insurance as part of an overall compensation structure is not that important. Furthermore, different rules regarding maternity leave, family and medical leave, and retirement savings can all make international models inapplicable to an American setting without making some significant alterations to those strategies.

Knowledge Management Capacity

Of course, strategic compensation does not exist in isolation in any business environment. Instead, strategic compensation packages and idea are often indicative of a greater attitude towards recognizing and rewarding employee innovation. As a result, it should come as no surprise that companies that practice strategic human resources practices are more likely to have greater knowledge management capacity (Chen & Huang, 2009). Knowledge management capacity is positively related to innovation performance (Chen & Huang, 2009). Therefore, it is critical to examine an entire corporate culture when looking at the relationship between employee performance and strategic compensation or incentive pay practices, since other factors, such as knowledge management capacity, can and do play a mediating role between those practices and performance.

Without examining the entire culture, it becomes too tempting to confuse correlation with causation. The reality is that a workplace environment is never going to replicate the conditions one would need for an experiment, which would allow one to isolate different factors and determine causation. Moreover, the same type of businesses that are willing to consider and adopt strategic compensation strategies are probably more likely to develop other practices that also increase innovation. As a result, the best conclusion that people can draw is that strategic compensation practices are one factor that has been linked to increased innovation and employee performance, but whether they would lead to performance increases in the absence of other business-level supports for innovation appears questionable.

One of the most interesting things about strategic pay programs is that, like other human resource management practices, strategic compensation programs need to take employee characteristics into account if they are going to be effective. Knowledge plays a mediating role between collaborative human resources management practices and innovative activity (Lopez-Cabrera et al., 2009). At the most basic level, this suggests that the better-suited the employees are for the tasks they are asked to perform, the more effective a strategic compensation program is likely to be. This scenario makes sense. After all, more knowledgeable employees start out as better-suited to perform their duties, which means that they are going to be able to more quickly hit performance goals and targets, which allows them to trigger the positive results of the strategic compensation programs.

Of course, it is not always possible to hire employees who are able to begin doing the job immediately. What that means is that, if a company wants to have a strategic compensation program that is effective, it needs to ensure that employees are empowered to do their jobs in a competent manner. As a result, it seems important that training programs are adequate to ensure, not just that employees are prepared to competently perform their jobs, but that they are able to excel and hit the goals of the strategic compensation program. What this means is that training programs may need to go beyond basic programs or standard on-the-job training if a company has a strategic compensation program and considers this incentive structure a critical part of its performance management strategy.

Social Effects of Incentive Pay

While it is clear that incentive or performance-based pay has economic costs for a company, what is not as clear is that incentive pay options can bring a variety of non-economic costs to the business structure. It is important to look beyond economic costs to examine whether other factors also impact the efficacy (or lack thereof) of incentive-based pay. What seems to be clear is that strategic compensation has an impact that goes beyond the employee that is actually being compensated and can impact performance throughout an organization. Strategic compensation can impact how coworkers perceive the fairness of the firm, and how coworkers are motivated to perform. As a result, Larkin et al. suggested that the best model for compensation would be team-based, seniority-based, and flatter than a traditional strategic compensation scale (Larkin et al., 2012).

This does not mean that they reject the idea of strategic compensation or of paying for performance. At some point, it is imperative to link pay to performance, and, in almost all jobs pay is linked to performance in some manner. Moreover, it can be important to link performance to pay at lower levels in order to encourage innovation and strong performance at all different levels. One of the errors that some companies make in their strategic compensation strategies is only implementing incentive pay at higher levels, which can increase the risk of negative social effects. After all, no employees want to see someone else reap benefits from their hard work if they do not reap those benefits, themselves; that can actually work as a disincentive to strong performance. Unfortunately, this is the type of structure that people see in many modern businesses, where executives and management may receive significant incentive pay structures that are not even remotely in alignment with lower-level employee pay structure.

Perhaps the best comparison-contrast example of these type of competing employee compensation strategies comes from a comparison of the nation's two largest wholesale warehouse stores, Sam's Club and Costco. Sam's Club, which is owned by Wal-Mart, is known for paying its employees small amounts and lacks a strong strategic compensation package for lower-level employees. The company is marked by high turnover rates and declining profits per store. In contrast, Costco is noted for a strong overall employee strategic compensation program, which not only results in higher per-hour pay per employee but also has a strong retirement program, employee stock option benefits available for all employees, and a very strong benefits package. Costco has much lower turnover rates than Sam's Club, and, as an overall company is thriving, despite having prices that compare to or are marginally higher than the Sam's Club price range.

Other Factors Impacting Pay

Of course, incentive pay and strategic performance structures are not the only factors that are linked to pay. Overall company performance is linked to pay, at least in higher levels of management, particularly at the executive level. Therefore, one of the interesting facets of strategic performance schedules is that they may look at things that have not been made into performance measures. For example, companies with good environmental performance records have higher CEO pay, but this higher pay is not correlated with explicit environmental pay policies (Berrone & Gomez-Meija, 2009). What this suggests is that strategic compensation, on its own, is insufficient to change behavior. Instead, it suggests that strategic performance is prt of the One business facet that is known to have a tremendous impact on an organization is the characteristics of the executives in charge of the business. While executive characteristics are often viewed distinctly from incentive compensation programs, the reality is that executive characteristics can and do interact with strategic compensation programs, so that they can reinforce one another or conflict with one another. The type of strategic compensation and the level of responsibility for performance play important roles in the efficacy of those programs. Stock options are an important element of strategic compensation programs, but, as one might expect, they are not always sufficient to ensure performance. For high-performing people with a high level of control, stock options can provide significant incentive for performance. In other words, stock options can "amplify the implications of executive ability, such that option-heavy incentive schemes will increase the performance of talented executives but worsen the performance of low-ability executives" (Wowack & Hambrick, 2010).

However, the role of stock options changes when one looks at different levels of employees and how those employees interact with the company. It has already been established that providing the CEO or outside directors with stop options increases risk taking, and that this impact is stronger for outside directors than it is for a CEO (Deutsch et al., 2010). Interestingly enough, the effects are not cumulative, but substituting. "If both the outside directors and the CEO are provided with stock option compensation, outside directors incentives weaken the effect of the CEO's incentives on firms' risk taking" (Deutsch et al., 2010). Of course, risk-taking behavior cannot be substituted as a measure of performance. In some circumstances, risk-taking will improve firm performance, but, in other circumstances, risk taking is going to decrease performance. That is the nature of risk. Moreover, this may not translate to employees below the executive level because the lower the employee, the less likely the employee is to be able to engage in risk-taking behavior because of more constrained options. Therefore, one cannot assume that the impact of strategic compensation strategies like stock options on executives will translate to other levels of employees.

The Role of Corporate Structure in Strategic Compensation

Of course, it is critical to recognize that strategic compensation practices are not applied universally across firms. While there are a wide variety of business ownership forms available, in many ways they come down to two different types of firms: family owned and non-family owned firms. As one might anticipate, the level of family involvement in a firm impacts its use of strategic compensation. Nepotism helps explain this in many ways, since one would expect performance to be less important than family relationships in firms that exist, in many ways, to provide a means of support to the family structure. The greater the involvement of founding family members in the top management team, the less likely the top management team is to use performance measures in its strategic target setting and incentive practices (Speckbacher & Wentgas, 2012). This is especially true, as one might expect, in smaller firms, with increasing firm size having a moderating impact on the negative correlation between family involvement in the top management team and the use of performance measures in strategic target setting (Speckbacher & Wentgas, 2012).