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Business Psychology

Purpose

This essay is written as a briefing paper. It is based on a recent article in an academic/professional journal relating to one of the key topics from the module—“motivation.”

Scope

This briefing paper covers information relating to: (a) theoretical background, (b) research methods, (c) findings, and (d) conclusion of the chosen article.

Objective

This essay provides insight on the practical relevance of the chosen article for a consultancy firm in particular and for the practice of Business Psychology in general.

The article

Overview-  “Bonuses … add a new dimension to the formulation and implementation of company business goals. Properly planned and executed, bonuses can be used to support business strategies, such as quality and customer service, company reputation, and employee hiring and retention polices.

One particular consequence of adopting this approach is that companies will regularly employ subjective performance measures to evaluate the impact of bonuses on strategy and performance,” states the introduction of the article of Nisar (2006, p. 34) based on a research effort published in the Performance Improvement—an international monthly academic/professional journal of the International Society of Performance Improvement (ISPI).

Nisar (2006) shares this insight:  “Recent work in human resource management (HRM) and incentives shows that the effectiveness of a subjective bonus plan depends on how well it is integrated into a company’s organizational and human resources systems. Companies will respond to the incentive problem more effectively if they create an alignment between company goals and individual preferences and tailor their bonus programs to discourage abuse.”

Theoretical background  Nisar makes reference to various theories in the areas of motivation, financial management, and economics relevant to and applied in human resource management (HRM) practices.

Research methods In studying the “payout practices in the financial industry,” the author “conducted a case study research” of five financial institutions. These are “banks engaged in various aspects of finance were initially contacted, and three agreed to allow the participation of their managers in the research. The sample consisted primarily of branch managers, corporate division managers, and head office managers. Of the 400 survey forms distributed, 243 were returned (a response rate of 61%)….Interviews [were also conducted] with two senior human resource (HR) mangers of each organization studied” (p. 35).

Findings

Subject Performance Measures “Financial measures such as profit and output are useful in reducing the likelihood of gamesmanship and cheating. Other performance parameters, such as quality, productivity, cost control, and accounting returns, are also considered important contributory factors in incentives, but they are seldom treated as key variables in pay-performance relations.”

“Empirical studies in the tradition of behavioral psychology suggest that financial measures provide weak direction to workers and make it difficult to communicate how employee actions affect performance goals….bonus targets are often set to channel effort in a certain direction, to the exclusion of other directions. For example, a company might want to channel employees’ discretionary effort in the direction of superior customer service by using a targeted bonus scheme.

However, if the bonus is paid based entirely on customer satisfaction, employees might achieve this result buy giving too many inducements to customers, all at the company’s expense. Behavioral research also indicates that performance measures may in fact be selected under the influence of various competing stakeholder groups.”

“The findings [of Nisar] also suggest that subjective or task-oriented measures (for example, defect rates, skill, productivity, and so on) have the capacity to better signal the activities of workers and thus they can be more useful for motivating employees to take actions desired by the company” (p. 35).

In the study of the five banks, “new bonus pay plans reflected a desire by companies to avoid the potentially distorting effects of focusing too much on a single measure. As a result a wide range of factor is introduced to cover a broad set of business objectives. This is based on the assumption that performance outcomes critically depend on how bonuses are put together with other elements in the organization.

Bonuses linked to other components of wages and employee benefits and tied into the organization’s culture are far more effective than those that are not. Although considerations such as financial and output targets remain important, bonuses are now also geared toward incorporating measures such as attendance, customer service, quality, safety, teamwork, and various other HR-related measures” (p. 35).

“This tendency to use a large number of performance indicators suggests that bonus pay is a multifaceted incentive scheme. It is integrated into pay packages to ensure a balanced compensation policy, linking it to areas such as (a) focusing attention on certain key aspects of the organization’s performance, (b) motivating individuals to achieve specific results in line with business strategy goals, and (c) aligning employee interests with those of the shareholders” (p. 36).

“In this context, subjective bonuses can be easily differentiated from incentives associates with output-based pay. Output-based pay (or traditional bonus pay) involves specific performance measures or signals that need to be realized before a payment is made. The basis on which performance is measured is spelled out very clearly up front, thus leaving no uncertainty to what the outcome will be. Performance targets play a critical role in such a scheme, in that they specify what needs to be done to rap the reward. This often means that output-based schemes use just one or two critical, quantifiable measures (for example, output or profit)” (p. 36).

“When performance in multitask environment becomes critical, single-measure, output-based bonuses will create distortion and reduce the incentive effect,” cites Nisar of Ittner and Larcker (2002). “In work situations an employee is often required to allocate effort across several different tasks. For example, the various dimensions of performance include both the quantity and the quality of the output produced. It is unlikely that employees will have sufficient incentive to allocate their optimum effort to both sets of performance dimensions under schemes with a single unit of measurement.

If the size of the bonus were to be determined by production output, employees might be tempted to increase their rate of production at the expense of quality or customer satisfaction. In contrast, multifactor, multilevel bonus plans are likely to induce employees to exert effort tin all dimensions relevant to production. Subjective bonuses have thus increasingly replaced the previous practice of paying cost and utilization containment bonuses in the service sector and output-based bonuses in the manufacturing sector. Bonuses linked to measures such as employee development, team organization, and quality and customer service are just a few common examples of new and emerging trends.

  • Employee development – “Companies may focus bonus incentives toward targeted areas of employees’ personal or skill development. Bank Y [one of the five banks studied] pays cash bonuses linked to a list of critical success factors in its personal development plan. Under the scheme, employees are eligible for a cash bonus reward that may be determined during their formal review. Bonus rewards are based on the ability to meet specific personal performance goals that have been accessed periodically by both the employee and the employee’s manager. Similarly, retention bonuses are used to entice employees to stay through a long-term project, and these may take a number of forms, such as spot bonuses, premium skills pay, or star pay. Retention bonuses are in general based on the premise that bonus pay clarifies the linkages between effort and performance. The appraisal outcome may result in an upward or downward movement in pay. A person’s pay history matters little as the current performance fully explains the variation in pay. Bonuses are thus a useful way of retaining able employees because outstanding performers are immediately rewarded and there is also a promise of future high rewards.”
  • Teamwork – “Companies typically need to work out whether bonuses are going to be individually based, team based, or a mixture of these two types. One of the advantages of team-based bonuses is that poor performers will be encouraged to raise their game by their colleagues. Peer pressure can often be more powerful than edicts issued by the supervisor. It is also possible to operate several bonus schemes matching incentives to different employee groups while also operating corporate-level schemes to reward all staff for overall company performance. Thus, targets can be set for specific jobs, teams, or departments alongside company-wide elements.”
  • Quality and Customer Service – “Managers now readily recognize that the more traditional, single-factor bonus arrangements need to also make explicitly allow for quality standards. Schemes that were previously primarily concerned with productivity or output now routinely include measures of quality, to prevent gains inefficiency coming at the expense of deterioration in service or product standards….It calculates quality as the number of defects found on a daily and monthly basis. A related performance parameter is the number of innovations introduced by an employee. Bank X [one of the five banks studied] encourages its employees through a special bonus payment to produce ideas that can be used to offer new financial products” (p. 36).

Design of Subjective Bonus Plans – “Bonuses for quality outputs will produce positive outcomes only if the company’s operational procedures are geared toward minimizing defective items.” There are five key factors identified by Nisar associated with this incidence. They are presented below.

  • Promoting Long-term Managerial Behaviors – “Investors … want managers to take actions that increase the long-term value of the company. But a manager may be more concerned about securing short-term personal benefits than maximizing the long-term value of the company….paying managers based on current accounting earnings rather than long-run project value provides no incentive to take decisions today that increase future profits, and in this circumstance managers may give high-value-added activities a low priority. One solution practiced by banks [in the study of Nisar] is to use value-adding bonuses to mitigate managers’ excessively short-term focus” (p. 37).
  • Directing Effort to Company Business Goals – “In the new hypercompetitive environment, it is imperative for almost all commercial companies to commit to higher levels of service provision and customer satisfaction. As a result, cost, quality, and time factors in organizational processes have acquired a new significance in company plans to secure and maintain competitive advantage….Services such as quality, promptness, reliability, timeliness, and value for money, or economy and affordability, are part of a range of measures used to improve nonfinancial performance….Nonfinancial measures may also be a better predictor of an organization’s long-term performance, and they help managers to monitor and assess their progress toward strate3gic goals and objectives” (p. 38).
  • Rewarding Human Capital Acquisition – “Firms that require knowledge-intensive and human capital intensive inputs, such as financial companies, also use special HRM strategies such employee stock ownership and, increasingly, cash bonuses. The growing role of employee financial participation is based on the realization that employees’ stake in the investment and developmental activities of a firm caries as much risk as the shareholders’ investment does. The banks [studied by Nisar] also recognize that a big part of their true value depends on intangible factors such as organizational knowledge, customer satisfaction, product innovation, and employee morale, rather than on physical assets such as real estate. Such organizational capabilities, the collective skills, abilities, and expertise of an organization, are the outcome of investments in staffing, training, compensation, communication, and other human resource areas….Banks use bonuses to encourage the acquisition and utilization of many such capabilities, e.g., training in customer service ” (p. 38).
  • Reducing Complexity in Performance Metrics – “Although companies theoretically reward key performers by tying bonuses to performance measures such as profit or productivity, in practice it is more complex than that….In complex work environments, companies also use performance standards or targets that encompass the interactions between different job dimensions” (p. 39).
  • Supporting Organizational Change – “Many companies are undoubtedly committed to change, but their efforts may not produce the desired results owning to integral barriers to changes, and unsurprisingly, most of these barriers are human. It is important to underline the role rewards and motivation play in promoting change, as they have the capacity to create effective performance through a well-defined incentive program. For example, giving employees a bonus incentive can support organizational innovations through its effect on employee commitment to new productive systems. Bonus plans can also foster desired organizational change by communicating new operation goals. As a practical tool, bonuses can be offered at the completion of a change program, with measurable performance yardsticks indicating the milestones achieved….Many existing motivational paradigms, expectancy theory included, start with the premise that organizations get the behavior they reward, so any attempt at directing employee effort in a particular direction must be accompanied by an appropriate reward system….rewarding performance in a change environment requires a strategy that pays employees more for their ideas and knowledge and less for their seniority and job position….The need for a more variable compensation plan cannot be more urgent than it is in fast-changing environments” (p. 39).

Strategy for Paying a Subjective Bonus – “Paying bonuses linked to company business goals is an important value-adding strategy because an improvement in the incentives for employees to learn new skills, make decisions, and solve problems promotes a greater exploitation of innovations in both technologies and organizational systems. It is possible to obtain company goals in quality and customer service while also ensuring higher levels of productivity outcomes. It is in this context that questions about the trade-offs that companies make in choosing an optimal bonus pay plan practice become important” (pp. 39-40).

Conclusion

“Bonus pay has traditionally been an established part of employee compensation; however, linking it to business strategy is relatively new although growing in popularity. Most companies now accept this approach as a credible employee reward strategy that has many particular advantages when compared with traditional output- or profit-based bonus programs. Yet the factors that make these plans more effective in adding value to company operations are not fully understood.

The primary goal of bonus pay plan is to ensure that employe3es make an effective contribution to the commercial success of the company and assist company progress toward securing market competitiveness. Bonuses can be used for developing company-specific skills, hiring or retaining key workers, improving quality and customer services, and various other business-related outcomes” (p. 40).

Article’s practical relevance

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The practical relevance of the article in relation to the theories of motivation for a consultancy firm in particular is that the article presents a new if not radical view toward improving human performance or eliciting excellent human performance through the use of “bonus.” The most interesting part of this article is that it is an account of the result of a research effort.

And finally, the practical relevance of the article in relation to the practice of Business Psychology in general is that business enterprises must learn to appreciate the results of research works made for human resource management as an important functional unit of a business organization.

References

Nisar, T. M. (2006, September). Subjective Performance Measures in Bonus Payouts. Performance Improvement, Volume 45, Number 8, International Society for Performance Improvement, pp. 34-40.

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