The Case for Organizationally-Based Incentives

by David Creelman | Posted | Total Rewards

The Case for Organizationally-Based Incentives

In my last blog post I discussed some questions posed by Sara Rynes around incentive compensation plans. Here are two more (see Rynes 2002). Are these statements true or false?

  1. There is a positive relationship between the proportion of managers receiving organizationally-based pay incentives and company profitability.
  2. New companies have a better chance of surviving if all employees receive incentives based on organization-wide performance.

I won’t keep you in suspense: both of these are true. The latter statement is particularly interesting because we are not talking about how incentive-based compensation can “help a bit”; we are talking about the difference between surviving and perishing.

The evidence

Rynes has the research to back up her statements. A study by Gerhart & Milkovich (1990) found that companies with 80% managerial eligibility for stock options had 25% higher return on assets than companies where only 20% of managers were eligible. Research by Welbourne & Andrews (1996) also found that new companies which placed a high value on their employees (as coded from prospectuses) and that included high levels of organizational performance-based pay had dramatically higher five-year survival rates (92%) than those which were low on both dimensions (34%).

When you read the details of the research you realize we have to be careful about using the word “true”.  For example, we can look at the question: Does the preponderance of academic research lead you to believe that organizationally based compensation models are a good idea? It’s possible to say that’s true. But it doesn’t work as a statement: Research shows you should always have organizationally based pay incentives. That overstates the certainty of the research.

Studies are never definitive, but as a reward professional given the choice of listening to the academic evidence and listening to a manager who thinks these kinds of incentives are rubbish, well, I’d lean towards the academic evidence.

Moving from research to reality

To really make sense of the research we need to move from the raw academic findings towards a hypothesis about the causal mechanism that leads from widely shared incentives to survival and success. Personally, I imagine two types of companies: the firm where there is an inner circle which makes the decisions, considers those outside the circle as hired hands, and as a result keeps the organizational performance incentives to themselves. The other type of firm is one where many people are seen as “insiders” and therefore incentives are more widely shared. So my interpretation is that it is the firm where more people feel like insiders that performs better.

It would be ideal to have academic evidence that my “two types of firm” model is a reasonable reflection of reality; however, we always hit a point where the only available evidence is a logical argument based on practical experience. We should not shy away from logical models based on practical experience, and when a model is aligned with academic research or results from our own analytics we feel all the more confident that it will be helpful.

The value of a logical model, and the causality it implies, is that it gives us a bigger game to play beyond just changing our incentives plan. We know that incentives are part of a tactic to have people feel like valued team members rather than hired hands. That has implications beyond reward, and we clearly need a coordinated effort among a number of HR departments to achieve that.

I suppose part of what I am asking you to do is be analytically minded, not just in terms of getting the numbers right, but also in understanding the big picture of which reward is just one part. We are not in HR just to push papers from one side of the desk to another. We are there to make wise decisions based on available evidence and that often that leads us to think beyond the compensation department.

References:

Gerhart, B., & Milkovich, G.T. (1990). Organizational differences in managerial compensation and financial performance. Academy of Management Journal, 33, 663–691.

Rynes, S.L., Colbert A.E. & Brown, K.G. HR professionals’ beliefs about effective human resource practices:  correspondence between research and practice, Human Resource Management, Summer 2002, Vol. 41, No. 2, Pp. 149–174

Welbourne, T.M., & Andrews, A.O. (1996). Predicting the performance of initial public offerings: Should human resource management be in the equation? Academy of Management Journal, 39, 891–919.

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