Compensation and Incentives: Practice vs.

Theory
GEORGE P. BAKER, MICHAEL C. JENSEN, and KEVIN J. MURPHY

Introduction
In this paper, the authors have discussed aspects of compensation where current economic theory and actual practice seem particularly disassociated, and summarize empirical evidence that is inconsistent with our traditional economic theories. The practices which are satisfying the employees are many than tangible rewards.

The Absence of Pay-for-Performance Compensation Systems

Nonmonetary rewards for performance can be important, tend to focus on monetary rewards because individuals are willing to substitute nonmonetary for monetary rewards & because money represents a generalized claim on resources. Non- monetary rewards can take many different forms such as including praise from superiors and co-workers, implicit promises of future promotion opportunities, feelings of self-esteem that come from superior achievement and recognition.

Is Pay an Effective Motivator?

Monetary rewards are counterproductive(ineffective). Money actually lowers employee motivation, by reducing the intrinsic rewards that an employee receives from the job. Similarly, Slater concludes that Getting people to chase money produces nothing but people chasing money. Using money as a motivator leads to a progressive degradation in the quality of everything produced.

Contd..
Kohn says: Incentives Can Be Bad for Business, offers three reasons why merit-pay systems are counterproductive. First, rewards encourage people to focus narrowly on a task, to do it as quickly as possible, and to take few risks. Second, extrinsic rewards can erode intrinsic interest. Finally, people come to see themselves as being controlled by a reward.

Contd..
Hamner says Ruin Motivation with Pay argues that merit systems decrease motivation because managers systematically mismanage pay-for-performance programs. Aggressive pay-for-performance systems ultimately involve distinguishing workers on the basis of their performance, and there is a large behavioural literature arguing that treating employees differently from each other is detrimental to employee morale.

Criticism
Monetary pay-for-performance systems indicates not that they are ineffective but rather that they are too effective: strong pay-for-performance motivates people to do exactly what they are told to do. Here the arguments about whether people are motivated by money or whether they should be motivated by money

Promotion-Based Incentive Systems

Promotions in organizations serve two important and distinct purposes. 1)Individuals differ in their skills and abilities, jobs differ in the demands they place on individuals, and promotions are a way to match individuals to the jobs for which theyre best suited. 2)Role of promotions is to provide incentives for lower level employees who value the pay and prestige associated with a higher rank in the organization.

Promotion-Based Incentives vs. Bonus-Based Incentives

Promotions are used as the primary incentive device in most organizations. The important problem with promotion-based reward systems is that they require organizational growth to feed the reward system. This means such systems can work well in rapidly growing firms, but are likely to generate problems in slowly growing or shrinking firms. Promotion-based schemes will be used more and prevalent in large organizations and growing industries with many hierarchical levels than in smaller organizations with fewer levels.

Contd..
Bonus-based incentives, this depends on years bonus of the years performance, Bonus schemes can, in principal, provide incentives for all individuals in the organization, regardless of their ability, position, and promotion opportunities. Bonus-based incentives will be more important at higher levels in the organization since the probability of future promotion is lower; the CEO is not promotable and therefore his or her financial incentives must come from bonuses. Bonus-based systems will be more prevalent in declining industries and smaller organisation.

Profit-sharing Plans
Profit-sharing, in which an individuals compensation is tied to the overall performance of the firm, has become increasingly popular in U.S. Corporations. A recent New York Stock Exchange survey indicates that seventy percent of firms with profit-sharing plans report that they lead to improved productivity. gain sharing can play an important role in motivating people to be more productive.

Biased and Inaccurate Performance Evaluations

The general reluctance of managers to give poor performance evaluations to employees is puzzling but consistent with welldocumented evidence that most people believe their performance is better than average. In a study, one indicates that 58% of a sample of white-collar clerical and technical workers rated their own performance as falling within the top 10% of their peers in similar jobs, 81% rated themselves in the top 20%. Another study of 1,088 managerial and professional employees found an even stronger bias: 47% rated their own performance in the top 5%, 83 % rated their performance in the top 10%, no one rated their performance below 75%.

Contd..
The biased perceptions of individuals regarding their own performance may explain why supervisors appear to have a strong aversion to giving subordinates poor evaluations. Forced-ranking systems will generate considerable conflict in organizations. Visible rewards will not be granted for superior performance unless there is significant incentive for superiors to undertake the unpleasant task of telling subordinates that they are poor or even average performers.

Compensation Surveys and the Relation Between CEO Pay and Firm Size
Compensation increases with firm size, larger firms the larger pay, for example, may employ better qualified and better paid CEOs. It also suggests that CEOs can increase their pay by increasing firm size.

Conclusion
Monetary rewards are not only the rewards but non monetary benefits are also important. As employes are interested with non monetary rewards which have significant role but monetary also plays a important role as the reward for some employees.