Incentive Pay and Strategic Compensation in U.S. HR Management

Introduction to Strategic Compensation

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 aimed at rewarding good performance. Because companies and their internal structures vary widely, strategic compensation strategies can vary just as widely. 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 commission percentages with volume. 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. If they are not appropriately tailored to reward strong performance in a timely manner, they may actually discourage employees from effective and efficient work. Moreover, different types of strategic compensation may impact different levels of employees in different ways, so compensation strategies should account for varying job responsibilities and levels of autonomy.

It is also important to recognize 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 America than elsewhere. For example, in most industrialized nations, the availability of universal healthcare means that health insurance as part of an overall compensation package is not especially significant. Furthermore, different rules regarding maternity leave, family and medical leave, and retirement savings can all make international models inapplicable to an American setting without significant modification.

Knowledge Management Capacity

Strategic compensation does not exist in isolation in any business environment. Compensation packages and ideas are often indicative of a broader organizational attitude toward recognizing and rewarding employee innovation. As a result, it should come as no surprise that companies that practice strategic human resource 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). It is therefore 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 easy to confuse correlation with causation. The reality is that a workplace environment will never replicate the controlled conditions of an experiment that would allow one to isolate different factors and determine causation. Moreover, the same types of businesses that are willing to adopt strategic compensation strategies are probably also more likely to develop other practices that increase innovation. The best conclusion one can draw, therefore, is that strategic compensation practices are one factor linked to increased innovation and employee performance — but whether they would produce performance gains in the absence of other organizational supports for innovation remains questionable.

One of the most interesting aspects of strategic pay programs is that, like other human resource management practices, they need to account for employee characteristics in order to be effective. Knowledge plays a mediating role between collaborative human resources management practices and innovative activity (Lopez-Cabrales et al., 2009). At the most basic level, this suggests that the better suited employees are for the tasks they are asked to perform, the more effective a strategic compensation program is likely to be. More knowledgeable employees are better positioned to perform their duties from the outset, enabling them to more quickly reach performance goals and trigger the positive reinforcement built into strategic compensation programs.

Of course, it is not always possible to hire employees who can begin performing at full capacity immediately. If a company wants its strategic compensation program to be effective, it must ensure that employees are empowered to do their jobs competently. Training programs therefore need to go beyond basic instruction or standard on-the-job training — they must be robust enough to position employees to excel and meet the specific goals embedded in the compensation program. This is especially true when a company treats its incentive structure as a critical component of its overall performance management strategy.

Social Effects of Incentive Pay

While it is clear that incentive or performance-based pay carries economic costs for a company, what is less obvious is that incentive pay can also bring a variety of non-economic costs to the business. It is important to look beyond economic costs to examine whether other factors affect the efficacy of incentive-based pay. What seems clear is that strategic compensation has an impact that extends beyond the individual employee being compensated and can affect performance throughout an organization. Strategic compensation influences how coworkers perceive fairness within the firm and how they are motivated to perform. As a result, Larkin et al. suggested that the best compensation model would be team-based, seniority-based, and flatter than a traditional strategic compensation scale (Larkin et al., 2012).

This does not mean that Larkin et al. rejected 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 tied to performance in some manner. It can also be important to link performance to pay at lower organizational levels in order to encourage innovation and strong performance across the board. One error that some companies make is implementing incentive pay only at higher levels, which can increase the risk of negative social effects. No employees want to see colleagues reap benefits from work in which they themselves have shared, without receiving comparable rewards — this can function as a direct disincentive to strong performance. Unfortunately, this is the type of structure seen in many modern businesses, where executives and managers may receive significant incentive pay that is not remotely aligned with lower-level employee compensation.

Perhaps the clearest real-world illustration of these competing compensation philosophies comes from a comparison of the nation's two largest wholesale warehouse retailers, Sam's Club and Costco. Sam's Club, owned by Walmart, is known for low hourly wages and a minimal strategic compensation package for lower-level employees. The company is marked by high turnover rates and declining per-store profits. Costco, by contrast, is noted for a strong overall strategic compensation program that not only results in higher per-hour pay but also includes a robust retirement program, employee stock option benefits available to all employees, and a comprehensive benefits package. Costco has much lower turnover rates than Sam's Club and, as an overall company, continues to thrive — despite having prices that are comparable to or only marginally higher than Sam's Club.

Conclusion

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