Problem 5 - Rewards and performance

Question 1

Douglas - are financial incentives related to performance?

Aim + type of study

Answer 1

Aim: to investigate the strength of the relationship between financial incentives and performance

Type of study: meta-analysis

Question 2

Douglas - are financial incentives related to performance?

Introduction

Answer 2

• Impact of financial incentives are complex (differences in utility of money, social comparisons that it evokes, group norms, and organisational structure).
• Debate whether financial incentives improve performance.
• Proponents: the most potent influence on employee performance and other desired behaviours.
• Opponents: financial incentives supplement intrinsic rewards, controls employee behaviour externally (reducing self-determination and intrinsic motivation) and encourages people to focus narrowly on tasks to finish it quickly and take few risks.

Question 3

Douglas - are financial incentives related to performance?

Theories on incentives

Introduction

5

Answer 3

1. Expectancy theory = tying financial incentives to performance increases extrinsic motivation to expend effort and consequently performance.
2. Reinforcement theory = tying money to performance will reinforce performance.
3. Goal-setting theory = financial incentives increase acceptance of different performance goals, enhancing performance.
4. Cognitive evlauation theory = performance-contingent financial incentives erode intrinsic motivation and thereby diminish task performance.
5. Equity theory = people are motivated to reduce inequity, but makes no specific predictions regarding the relationship of financial incentives and performance per se, although deviations from fairness may erode the association of financial incentives to performance.

Question 4

Douglas - are financial incentives related to performance?

Previous findings

Introduction

Answer 4

• Lab and field experiements show the positive effects of financial incentives on performance quantity, although a similar effect was absent with respect to performance quality.
• Expectancy theory reviews also support the positive relationship between financial incentives and task performance.

Question 5

Douglas - are financial incentives related to performance?

Methods of the meta-analysis

Answer 5

• 39 studies
• Moderators: setting, task type (intrinsic/extrinsic), and theoretical framework.

Question 6

Douglas - are financial incentives related to performance?

Results

Answer 6

• Setting consistently moderated the financial incentives-performance relationship.
• Task type is ambiguous = average corrected correlation is only slightly lower for intrinsic tasks.
• Theoretical framework varied.

Question 7

Douglas - are financial incentives related to performance?

Conclusion

Answer 7

• Financial incentives were not related to performance quality = supports expectancy theory the most, reinforcement, and goal-setting theories BUT does not support cognitive evaluation theory.
• Setting and theoretical framework moderated the relation but task type did not = the strongest relationship was in experimental stimulations.
• Overall, this study shows the generalisable positive relationship between financial incentives and perofrmance (quantity).

Question 8

Gunderson - economics of personnel and human resource management

Personnel economics

Answer 8

It deals with the ineternal labor “market” of firms, where human resource policies and workplace practices tend to be governed by internal rules and authority more than by prices.
* Economic phenomena = fixed hiring costs, asymmetric information, option values.
* Personnel phenomenon = deferred compensation, pensions, mandatory retirement.

Question 9

Gunderson - economics of personnel and human resource management

Fixed hiring costs

Core concepts in Personnel economics

Answer 9

Definition: includes recruitment, training, severance, legal risk, payroll taxes.

It influences hiring strategies:
* Employers prefer long hours from existing workers over hiring.
* May lead to labor hoarding during downturns.
* Encourages use of temporary contracts to avoid fixed costs.
* Inhibits job sharing and worksharing.

Question 10

Gunderson - economics of personnel and human resource management

Deferred compensation

Core concepts in Personnel economics

Answer 10

Definition: workers are underpaid early, and overpaid later (seniority wages, pension).

Benefits:
* Includes long-term commitment and reduces turnover.
* Encourages honesty and performance (acts like a performance bond).
* Reduces monitoring needs.
* Solves asymmetric information (ex: hidden motivation).

Risks:
* Employers may terminate just before high-pay periods unless constrained by union or reputation.

Question 11

Gunderson - economics of personnel and human resource management

Pension and mandatory retirement

Core concepts in Personnel economics

Answer 11

Definition:
* Serves as tools to implement deferred compensation.
* Mandatory retirement defines the “end date” to overpayment contracts.

Pensions create incentives:
* Early retirement through pension strikes.
* Retention through increasing accruals over tenure.

Regulatory bans affect whole HR incentive systems.

Question 12

Gunderson - economics of personnel and human resource management

Tournament theory

Core concepts in Personnel economics

Answer 12

Definition:
* Promotions structured like contexts (ex: VP -> CEO).
* Pay resembles “prizes” rather than marginal productivity.

It incentivises:
* Contenders to work harder for the top spot.
* Existing CEO to maintain performanc.e

Risks:
* Reduces collaboration
* Encourages sabotage or collusion.
* Needs credible commitment to reward winners.

Question 13

Gunderson - economics of personnel and human resource management

Teams and Pay equality

Core concepts in Personnel economics

Answer 13

• Pay dispersion: trade-off between individual and team incentives.
• High dispersion = rewards individual effort (ex: in sales).
• Egalitarian pay = encourages team cooperation.
• Peer pressure works better in small teams (solves 1/N problem).
• Matching personalities to team structure is strategic.

Question 14

Gunderson - economics of personnel and human resource management

Compensating wage differentials

Core concepts in Personnel economics

Answer 14

• Valuation of nonwage job aspects (ex: risk, hours, pension, stability).
• Method: hedonic wage regression.

Application:
* Safety incentives
* Justification for tax-shifted lower wages.
* Basis for equal pay for work of equal value (“hay points”).

Question 14

Gunderson - economics of personnel and human resource management

Option value of employment

Core concepts in Personnel economics

Answer 14

Continuing employment includes:
* Salary + potential future promotions (“option”).
* Pensions + early retirement packages.

Executives need higher base pay: fewer promotion options remain.

Critical in employee retirement timing and effort decisions.

Question 15

Gunderson - economics of personnel and human resource management

Asymmetric information and rigidities

Core concepts in Personnel economics

Answer 15

Workers prefer small wage cuts over layoffs, yet firms lay off - why?
* Explanation: employers would bluff to cut wages; layoffs prove actual financial distress.
* Strikes and “up-or-out” rules also deter employer bluffing.
* Tenure: encourages seniors to hire/train better juniors.
* Displacement costs create discipline.

Question 16

Gunderson - economics of personnel and human resource management

Winner’s curse in Raiding

Core concepts in Personnel economics

Answer 16

• Hiring from competitors may backfire: incumbent firm may know the employee is not worth matching.
• Outside firm wins only by mistake.
• Exception: public shocks (ex: budget cuts) or better fit.

Question 17

Gunderson - economics of personnel and human resource management

Monopsony power

Core concepts in Personnel economics

Answer 17

Firms as wage-setters in local labor markets:
* Must pay all employees more to raise wage for new hire.
* Explains persistent vacancies without wage hikes.
* Leads to nonwage strategies: bonuses, relocation packages.
* Pays more for hard-to-equate credentials to avoid across-the-board raises.

Question 18

Gunderson - economics of personnel and human resource management

Fairness as strategy

Core concepts in Personnel economics

Answer 18

Fairness is not just a moral goal - it improves performance, retention, and contest participation.

Examples:
* Job security fosters training and innovation.
* Fair evaluations encourage promotions effort.
* Due process supports deferred compensation schemes.
* Pension generosity boosts reputation for long-term deals.

Question 19

Gunderson - economics of personnel and human resource management

5 cross-cutting themes

Answer 19

• Principal-Agent problems: aligning incentives when monitoring is costly.
• Asymmetric information: many HR policiess are designed to elicit truthful behavior.
• Incentives over monitoring: firms often prefer system design to direct supervision.
• Behavioural outcomes are often rationale: practices like layoffs or tenure seem irrational but serve deeper functions.
• System interdependence: changing one element (ex: banning retirement) affects the whole HR ecosystem.

Question 20

Gunderson - economics of personnel and human resource management

Critiques and limitations

Answer 20

• Taulogical risk: risk of “explaining everything” post hoc.
• Focus on elite jobs: theories are often based on executies; less applicable to broader workforce.
• Data scarcity: lack of linked firm-employee performance data hampers empirical testing.
• Toolbox vs theory: current approach is ad hoc; lacks unified personnel economics theory.
• Disciplinary isolation: needs integration with psychology, sociology, and organisational behaviour.

Question 21

Henk - Enhancing performance through pay and reward systems

Aim

Answer 21

Explores whether compensation systems actually enhance employee performance, using multiple psychological, organisational, and economic theories.

It highlights the conditions under which compensation improves motivation and performance, and when it backfires.

Question 22

Henk - Enhancing performance through pay and reward systems

Expectancy theory

Key theoretical perspectives

Answer 22

Core idea: motivation is a function of 3 beliefs:
1. Expectancy: belief that effort leads to performance.
2. Instrumentality: belief that performance leads to rewards.
3. Valence: the value attached to the reward.

Application to pay systems: performance-related pay is effective only if:
* Employees believe their effort will result in measurable performance.
* There is trust that high performance will be rewarded.
* The reward (ex: bonus, salary increase) is meaningful to the employee.

Barriers:
* Low transparency in reward systems -> breaks instrumentality.
* If appraisals are seen as biased, expectancy/instrumentality collapses.
* Organisational cynicism (distrust in fair rewards) reduces motivational effect.

Takeaway: for financial incentives to motivate, the performance-reward link must be clear, credible and valued.

Question 23

Henk - Enhancing performance through pay and reward systems

Organisational behaviour modification (OB Mod)

Key theoretical perspectives

Answer 23

Core idea: behaviour that is positively reinforced will be repeated.
* Based on Skinnerian behaviourism: stimulus-response reinforcement.

Types of reinforcement schedules:
* Fixed Ratio (FR): reward every X actions -> fast acquisition, quick extinction.
* Variable ration (VR): randomized rewards -> slower extinction, higher persistence (like gambling).

Application to pay:
* Bonuses, commissions, and piece-rate systems act as reinforcers.
* Proven to increase productivity, especially in repetitive tasks.
* Meta-analysis: OB Mod leads to approx 17% performance increase.

Critical conditions:
* Reinforcement must be contingent (only for performance).
* Timing matters: immediate feedback and reward are more effective.
* Works best when the behaviour is observable and measurable.

Takeaway: financial incentives work when they act as consistent, immediate, and contingent reinforcers.

Question 24

# Henk - Enhancing performance through pay and reward systems Goal-setting theory | Key theoretical perspectives

Answer 24

Core idea: specific, difficult, and accepted goals increase performance, especially when supported by feedback. Pay-system implications: * Pay can increase goal commitment if goals are clear and challenging. * Best used in conjunction with: feedback systems, public goal setting, and performance monitoring. Caution: * Vague bonus criteria reduce effectiveness. * If goals are seen as unattainable, motivation declines. * Requires credibility of the system and competence of the employee. Takeaway: pay can enhance performance by reinforcing goal commitment, but goal clarity and credibility are essential.

Question 25

# Henk - Enhancing performance through pay and reward systems Equity and justice theory | Key theoretical perspectives

Answer 25

Core idea: motivation is influenced by perceived fairness in reward distribution. Comparison process: * Workers compare their input/output ratio (effort/pay) to others (colleagues, past self, or ideal). * Inequity (especially under-reward) leads: lower motivation, reduced performance, turnover or counterproductive behaviours (ex: retaliation) Types of injustice: * Distributive justice: fairness of actual outcomes (ex: pay). * Procedural justice: fairnes of processes (ex: performance appraisal system). * Interactional justice: fairness in interpersonal treatment (ex: respectful feedback). Moderators: * Personality traits (ex: low agreeableness, high negative affectivity) -> stronger reactions to inequity. Takeaway: perceptions of fairness in pay and performance appraisal are crucial for maintaining motivation.

Question 26

# Henk - Enhancing performance through pay and reward systems Cognitive evaluation theory | Key theoretical perspectives

Answer 26

Core idea: external rewards can undermine intrinsic motivation (IM) by shifting perceived control. Key mechanism: * Intrinsic motivation thrives on: autonomy (sense of control) and competence (feeling effective). * Rewards perceived as controlling -> reduce autonomy -> reduce IM. Types of pay and their effects: * Task-contingent pay: can reduce IM if seen as controlling. * Performance-contingent pay: mixed results - may support or undermine IM depending on perception. * Unexpected pay or non-contingent rewards: usually neutral to IM. * Verbal rewards: tend to enhance IM by reinforcing competence. Takeaway: financial rewards can backfire when they reduce perceived autonomy; their motivational effect depends on how they are framed.

Question 27

# Henk - Enhancing performance through pay and reward systems Reflection theory | Key theoretical perspectives

Answer 27

Core idea: people derive meaning from pay, and this meaning affects motivation and behaviour. Four meaning dimensions of pay: 1. Instrumental - enables survival, luxury, etc -> primary motivation for most. 2. Comparative - reflects status; leads to social comparisons and competitive behaviours. 3. Control - can be used to regulate others or signal power. 4. Symbolic - tied to identity, recognition, and self-worth. Implications: * Pay is not just a monetary transaction - it carries psychological meaning. * Differences in individual meaning assigned to pay can affect satisfaction, self-esteem, and organisational commitment. Takeaway: pay systems affect performance not only through size, but through what pay symbolises to the indivual

Question 28

# Henk - Enhancing performance through pay and reward systems Agency theory | Key theoretical perspectives

Answer 28

Core idea: deals with aligning interests between principal (employer) and agent (employee). Assumptions: * Agents are self-interested and risk-averse. * Principals seek to incentivise agents without monitoring everything. Two contract types: * Behaviour-based contracts: salaries, supervision. Used when tasks are observable. * Outcome-based contracts: bonuses, commissioons. Used when tasks are hard to monitor. Risks and challenges: * Outcome-based pau requires risk premiums to compensate for uncertainty. * In multi-task jobs, incentives can distort behaviour (ex: only focusing on what's rewarded). * Trust and information asymmetry are central problems. Takeaway: performance-related pay aligns goals under uncertainty, but increases complexity and potential for unintended consequences.

Question 29

# Henk - Enhancing performance through pay and reward systems Meso-/Macro-level theories | Key theoretical perspectives

Answer 29

* Resource dependence: groups with vital resources can secure better pay. * Tournament theory: large pay gaps incentivises effort, but too large -> risk taking and demotivation at lower levels. * Labor market theory: pay set by supply-demand, not employer discretion. * Efficiency wage theory: higher-than-market pay attracts better talent and reduces shirking.

Question 30

# Henk - Enhancing performance through pay and reward systems Effective pay systems | Evidence on pay systems

Answer 30

Piece rates: * Strong positive effects on quantity. * Less used due to modern task complexity. Performance bonuses (ProMES): * Strong evidence of success, especially when tied to specific job metrics. * Group bonuses effective only under: clear goals, meaningful tasks, and group cohesion. Skill-based pay: * Encourages continuous learning * Costly but often worth it. Gain sharing/Scanlon plans: * Foster collective performance and culture. * Increases communication, cohesion, and moderate financial rewards.

Question 31

# Henk - Enhancing performance through pay and reward systems Inneffective or risky pay systems | Evidence on pay systems

Answer 31

Merit rating: * Consistently ineffective and demotivating. * Fails due to low reliability of ratings, ambiguous feedback, small rewards, attribution biases, and infrequent appraisals. Profit sharing: * Weak link between effort and outcome (poor "line of sight"). * May foster involvement but unclear performance benefits.

Question 32

# Henk - Enhancing performance through pay and reward systems Conditions for successful pay systems

Answer 32

* Clear performance-pay link (line of sight). * Perceived fairness (equity and justice). * High trust in appraisal and reward systems. * Skill alignment: higher skill -> more tolerance for variable pay. * Appropriate for task complexity: predictable tasks = fixed pay might suffice.

Question 33

# Henk - Enhancing performance through pay and reward systems Conclusion: "Contingency of contingent pay"

Answer 33

* Pay can enhance performance, especially individual performance. * But success is condition: depends on the task, system design, organsiational culture, and individual traits. * ROP (results-oriented pay) must be embedded in broader HRM strategy. * Group-based and long-term systems still underused depspite growing interdependence.