"No other incentive or motivational technique comes close to money."
Such a quotation reflects the dominant view that pay-for-performance incentive systems have a motivational effect. In fact, many feel that the primary aim of incentives is to enhance extrinsic motivation by satisfying an individual employee's needs indirectly through means of pay and bonuses.
Extrinsic motivation is the importance placed on external rewards, such as bonuses and promotion, or the threat of wage cuts or dismissal. In an agency theory context, incentive contracts designed to encourage extrinsic motivation are held to be indispensable. Similarly, expectancy theory argues that linking incentives to performance motivates employees to increase their effort and performance.
The other form of motivation, intrinsic motivation, captures the aspects of doing work for its own sake, provides psychological benefits of well-being, accomplishment, increasing responsibility, self-actualization, and is self-sustaining.
Research has shown that remuneration issues play a critical role in organizations; however, there has been little advice that companies could use in terms of when certain incentive system designs have been more (or less) appropriate.
The use of pay-for-performance plans is growing, and there is a trend to increasing variable pay as a percentage of total remuneration. However, most economics-based incentives research has been at the chief executive officer level, whereas few studies have examined incentives at the business unit or for front-line employees.
The philosophy behind pay-for-performance plans suggests that pay is linked to performance by setting specific targets and then rewarding individuals for achieving these targets.
Agency theory is based on compensation contracts designed to balance trade-offs between risk and incentives for individuals and groups in order to align the interests of managers and shareholders. Agency theory focuses on extrinsic rewards that are tangible and quantifiable. Actions are rewarded and punished, and so this determines employees' actions and effort and performance. Therefore, pay is a powerful lever to influence extrinsic motivation.
Many argue that money is a poor motivator and can actually impede intrinsic motivation, such as reducing creativity and innovation. In fact, the specific focus on extrinsic motivation may distract attention from the task; this has been termed the "hidden cost of rewards". This view has been incorporated in the "crowding theory". When an activity is intrinsically appealing (e.g. challenging), the positive effects can be undermined if extrinsic rewards are also linked to the activity and crowd out intrinsic motivation. This, in turn, can reduce performance.
Expectancy theory argues that a pay-for-performance system influences job satisfaction. Supporting this view, research on the relationship between work motivation and job satisfaction has found significant positive association, and indicates that as work motivation increases, job satisfaction increases. In relation to extrinsic motivation, a positive association with job satisfaction has also been found.
While the dominant argument has been for a positive association between extrinsic motivation and job satisfaction, intrinsic motivation can increase as a result of work enhancement programmes that have increased work morale. When employees' enjoyment of their job increases, intrinsic rewards may undermine the extrinsic motivation. The proponents of self-determination theory argue that pay-for-performance can have a positive effect on intrinsic motivation by being supportive and encouraging employee autonomy and self-esteem. However, self-determination theory remains silent on whether extrinsic motivation will decrease, if intrinsic motivation increases.
"Pay satisfaction had the strongest association with job satisfaction. The practical implications of this for managers are to pay their front-line employees well and job satisfaction will be high."
Supportive work environments, which encourage intrinsic motivation, will result in increased job satisfaction and more effective performance. When pay-for-performance systems link individual and organizational performance, employees can see their work is important, which in turn increases their job satisfaction because they are able to fulfil high-order needs, such as self-esteem.
Pay fairness is an important issue in the design of pay-for-performance systems. Research suggests that perceptions of fairness are often based on social comparisons. Employees often make equity judgments based on comparisons with others who may be co-workers, or based on other similarities, such as organizational status. The problem is that an individual's perceptions of inequities in pay can have a detrimental impact on an employee's motivation and performance. For example, the perception that one was overpaid or underpaid lowers intrinsic motivation. However, only a few studies have examined intrinsic and extrinsic motivation with pay fairness.
Another important element in the design of pay-for-performance systems is goal clarity. Goal clarity has been held to be important, as it leads to increases in motivation. However, it is difficult to design clear goals that are ambitious and relevant. The combination of well-specified and clear goals is important, as employee behaviours that are associated with specific organizational goals can increase firm performance, and can also give greater intrinsic meaning to the individual's job.
A case study was conducted at a retailer that is a large and fast-growing non-food retailer in Australasia, and which has a pay-for-performance plan for front-line employees.
This retailer pays a performance incentive payment (bonus) to all permanent employees, both part time and full time. The fact that this payment extends to the shop floor level is interesting, as well as its magnitude, which is equivalent, on average, to one week's pay every six months for every employee. An internal company document states that the performance incentive payment is designed to reward people for achieving pre-established goals. The bonus is paid pro rata on the number of hours worked per week. A period of three months is enforced before a team member is eligible to receive this payment.
In calculating the bonus payment, a maximum potential payment is set for a full-time employee working a 40-hour week. Deductions are made from this maximum potential payment based on the percentage of achievement of organizational, store, department, and individual goals. Goals relating to the performance incentive payment range from very broad company-wide goals and standards to specific individual appraisals. An example of a companywide goal is the expectation that for every 1 per cent over the targeted earnings before interest and tax (EBIT), an extra 2 per cent is added to the potential incentive payment. Alternatively, for every 1 per cent below the targeted company EBIT, 1 per cent is deducted from the potential payment. Store goals relate to such measures as the budgeted sales figures, as well as the wage budget. Included in the goals to be assessed by area are the amount of write-offs and shrinkage. Departmental goals are also important, and, in the service department, such goals as the number of deleted lines and voided sales are considered. An individual performance-based appraisal is also conducted between the departmental manager and each employee for every bonus period.
In addition to fixed pay and bonuses, employees receive a number of other benefits. These benefits include a staff discount (including extended family), a day off on their birthday and a range of social activities (e.g. weekends away).
The study examined the implications of a pay-for-performance system on intrinsic and extrinsic motivation and job satisfaction of front-line employees at a retailer. Positive associations were found between pay and intrinsic motivation and intrinsic motivation and job satisfaction, while there was a negative association between extrinsic motivation and job satisfaction. Pay satisfaction had the strongest association with job satisfaction. The practical implications of this for managers are to pay their front-line employees well and job satisfaction will be high.
While focusing on extrinsic rewards has merit, future research needs to draw on behavioural models from psychology and sociology to recognize the potential of intrinsic, as well as extrinsic rewards to motivate employees. This study found pay satisfaction and intrinsic motivation are positively correlated and some evidence that "crowding in" does occur with intrinsic motivation increasing and extrinsic motivation decreasing.
One of the most interesting findings from the case study was that around half of the front-line employees rate extrinsic and intrinsic motivation as of high importance. In a retail outlet where the minimum wage is the norm, to find employees that are high on both intrinsic and extrinsic motivation is a pleasant surprise. This evidence provides support for the argument that intrinsic and extrinsic motivation could be complementary in organizational settings.
The study revealed that 82 per cent of the employees who provided qualitative comments considered store and departmental goals were clear, which is pleasing for the retailer. Clear goals are important to ensure that employees understand what is expected from them; this enables them to focus their effort and leads to higher levels of motivation.
A substantial number of employees who are high on both extrinsic and intrinsic motivation, who exhibit high levels of autonomy, perceive their pay is unfair. This indicates that pay fairness and equity are not determined by one's motivation levels or even goal clarity. However, the 40 per cent of employees who perceived that pay was unfair generally held views that this was driven by comparisons to others or that pay was not reflective of their effort. These findings support social comparison and equity theory that pay inequities can have important outcomes.
This is a shortened version of "Motivation, pay satisfaction, and job satisfaction of front-line employees", which originally appeared in Qualitative Research in Accounting & Management, Volume 8 Number 2, 2011.