Theories of Compensation
In order
to understand which components of remuneration are more effective, we need to
understand the conceptual framework or theories or employee remuneration. Three
such theories are reinforcement and expectancy theories, equity theory and
agency theory.
Reinforcement and Expectancy Theories
The
reinforcement theory postulates that a behaviour which has a rewarding
experience is likely to be repeated. The implication for remuneration is that
high employee performance followed by a monetary reward will make future
employee performance more likely. By the same token, a high performance not
followed by a reward will make its recurrence unlikely in future. The theory
emphasizes the importance of a person actually experiencing the reward.
Like the
reinforcement theory, Vroom’s expectancy theory focuses on the link between
rewards and behaviour. Motivation, according to the theory, is the product of
valence, instrumentality and expectancy. Remuneration systems differ according
to their impact on these motivational components. Generally speaking, pay
systems differ most in their impact on instrumentality the perceived link
between behaviour and pay. Valence of pay outcomes remains the same under
different pay systems. Expectancy perceptions often have more to do with job
design and training than pay systems.
Equity Theory
Adam’s
equity theory says that an employee who perceives inequity in his or her
rewards seeks to restore equity. The theory emphasizes equity in pay structure
of employees’ remuneration. Employee’s perceptions of how they are being
treated by their firms are of prime importance to them. The dictum ‘a fair day
work for fair day pay a sense of equity felt by employees. When employees
perceive inequity, in can result in lower productivity, higher absenteeism or
increase in turnover.
Agency Theory
The agency
theory focuses on the divergent interests and goals of the organization’s
stakeholders and the way that employee remuneration can be used to align these
interests and goals. Employers and employees are the two stakeholders of a
business unit, the former assuming the role of principals and the latter the
role of agents. The remuneration payable to employees is the agency cost. It is
natural that the employees expect high agency costs while the employers seek to
minimize it. The agency theory says that the principle must choose a
contracting scheme that helps align the interest of the agents with the
principal’s own interests. These contracts can be classified as either behaviour-oriented
(e.g. merit pay) or outcome oriented (e.g. stock option schemes, profit
sharing, and commission). At the first sight, outcome-oriented contracts seem
to be the obvious solution. As profits go up, rewards also increase.
Remuneration falls when profits go down.
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