Holistic View of looking at the utility of Variable Pay..... Part 1

Variable pay or performance contingent pay or pay at risk are various names used to denote that component of pay which employees receive only on attaining certain performance targets. In this sense, it is different from base pay ( Generally a combination of basic + Dearness Allowance in India) which is the worth of job and paid to employee irrespective of performance.

I take Agency theory in explaining the rationale behind the variable pay.As per this theory, Principals(stockholders of the company) are risk- neutral i.e. they would have diversified their investments across different investment options, where as Agents( Executives of the company)are risk-averse because their fortunes (Salary,Employment Continuity etc) are tied to a single organization. Hence under normal conditions, Agents try to take conservative decisions which protects their income even at the cost of lost opportunities to the organization. This is not in sync with Principals aspirations who want to have optimize returns from each of the investments. Hence to get alignment between the interests of Principal & Agent, a component of Agent's ( Executive) pay compensation is tied to the firm performance and paid only on achievement of firm objectives .

But the question is under what circumstances does variable pay is effective?

Now lets look at the possible areas where variable pay would be effective. For explanation , lets take variable pay as applied for senior management ( the proportion of variable pay in total compensation would be higher as one moves higher in the hierarchy as their actions can directly influence the organization's outcomes compared to some one at entry level)

Scenario 1:Low Risk Environment

For explanation, lets look at variable pay in companies which are well established in the market place and there are processes in place. Unless the efforts of senior management produces significant results, there is not much use in putting more variable pay because the higher the percentage of variable pay in overall compensation, more compensation the employee demands as he takes a risk by putting a portion of his earnings at risk. Infact in some cases he might be tempted to take decisions which may not be in the best interest of stockholders

Scenario 2: High Risk environment

This is the environment where outcomes are not as predictable as in case of scenario 1. There might be forces which are beyond the control of the executive. Now by putting a large portion of pay under variable pay might work both ways. If the organization performs well because of the overall market scenario, stockholders end up rewarding the executive for outcomes which cannot be directly related to him and when organization doesn't perform well, end up penalizing the executive even when he had done every thing right under this control .This might lead to competent people leaving the organization for places where their actions determine the fate of their compensation

Scenario 3: Moderate Risk Environment

This is the environment which falls some where in between scenario 1 and 2 where there is some level of certainity but at the same time scope for improving the performance of organization based on executive's actions. So this offers for perfect scenario for solving agency problem ( Agent acting to protect his self interest and not working for optimum results of principal)where in by tying up a portion of salary to the results and by providing increased chances of earning higher incomes based on results, alignment can be obtained between the objectives of stockholders and executive

To Summarize, in environment where outcome can be obtained by following set guidelines ( low risk environment) or where outcomes are beyond the control of executive ( high risk environment) , pay for performance may not be the right option where as for moderate risk environment, it is ideal to pay variable pay and at an increasing rate based on performance

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Pay for Performance

PAY is  one factor that shows up as both a source of satisfaction and a source of resentment among employees


Consider the scenario:
you want to attract the star talent to your company , so you pay him salary higher than the market rate .He comes and joins your organisation but the worth he brings to the organisation will very much be neutralised by the reduction in efficiencies of his team mates who compares their compensation with the new guy and gets frustrated as they are paid less than him . Now one may argue that money may not be the only motivator and good hr policies will help in retaining the employees and good performance appraisal system with clearly defined goals will make sure the employee is at desired productivity level.
But then no one can withold an employee from leaving the organisation


No matter how much you raise salaries, though, you won't generate motivation and job satisfaction, because job satisfaction is a function of the content of the job


People are dissatisfied with their pay when they feel it isn't commensurate with their efforts, is distributed inequitably,doesn't reflect the responsibilities of the job,or is out of touch with market realities.If you don't pay competitive wages,people will be unhappy and they will
On the other hand, if people feel that their pay reflects the quality of contribution they are making to their organization,and is equitable with other high-talent performers inside and outside the company,and recognizes the unique contributions that they make,then pay can be a powerful source of true motivation


what is the opportunity for real achievement and genuine accomplishment
Does my job allow me to do something that makes an actual difference?
Do i get recognized through nonmonetary means?
Do i have alot of say in how i do my job or am i totally constricted by standard operating procedures?
Can i learn and grow and develop on this job, or will i be tightening the same nut on the same bolt for the next 30 years?


Look at NGOs


If u cant satisfy people's pocketbooks, then satisfy their souls
Allow people freedom,discretion,and autonomy in doing the job
Increase the amount of challenge
keeping them engaged( this is most abused word and truly deserves a post on itself :P ) should not be of prime importance .let them be idle it doesn't matter


There might be jobs (coders in IT companies can very well connect) how well one try to be motivated there is no intrinsic fun in doing the repetitive job day in and day out . The responsibility as an effective leader is not to compensate the frustrated employee by offering him a pay raise . It might help in retaining the employee for the short term but in the long term the employee is sure to leave the organization . Rather the challenge should be in making the employees connect with the bigger picture of their actions (For ex: Soldiers in border patrol spends hours together manning and looking for intruders (which do not happen on a regular basis, but the major motivation in doing so is the feeling that they are making the country secure every single minute)


some thing on similar lines needs to be thought over for employees in organization and carefully integrate into the culture of the organization


PS: This article comes exactly a day before my final exam of Peformance management systems :P :P

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how can the reward system be improved

Just a passing thought on how to encourage the employees to be top performers

General practice in companies is to set targets at the beginning of the financial year ,conduct mid and final reviews(only time managers share the negative feedback) and group employees according to relative ratings .We also see that some where between the year most employees settle for average ratings (where most fall) and perform accordingly . But is it what the company looking for ??
so what i think is that instead of rating the employees at the year end , give each and every one of them top ratings (say 100 points ) in the beginning of the year . Now cut the points to the employees when ever employee is showing a deviant behavior and let the employee know about it (this solves one problem in conducting performance appraisals as most cases managers do not share negative feedback except in the final appraisal meeting). In this way every employee starts with 100 points and at the end ,based on relative ratings (who is able to retain the max score) would be getting the top rewards

Some important considerations are :
(1)there is a possibility that once employee falls below a certain rating compared to his colleagues , he may start loosing points more often putting less efforts as he feels he already lost his chance and worse may not be supporting the others in hope that they would also loose the points hence dragging the performance of every one down
This i feel can be resolved ,by having lee way in the system where in if the employee puts in efforts over and above what is required , option should be there to get extra points . so in this way , the employee can reach to the position from where he slid down

(2)If implemented in a team based scenario, the point system should be applied to the team as a whole instead of individuals

(3)The expectations or outcomes of the job and standards against which they are measured should be made very clear

(4) Every cut in the rating should be explained to the employee and there should be a proper grievance mechanism to address the concerns

As i mentioned this is just a passing thought and i felt its worth putting in words

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Compensation and Employee Retention

The other day i was analysing on what motivates an employee to work for an organisation. I heard many of my friends say they no longer feel any challenge in the work and it became so routine that they are considering to change the job. Some of these people are high performers on the job and provided increments which are almost double to that of ordinary performers.

Today while reading a chapter on Compensation & Benefits I got the solution for my dilemma
The salary or the pay consists not of 2 parts (Cash Compensation,Benefits like health insurance, Vacations etc ) but 3 parts , the 3 rd one being the most important one and the often overlooked one "Relational Returns"
Relational Returns are the Recognition & Status,Security of job,Challenging work and Learning opportunities

Most of the times the companies looks at the first 2 parts of the pay and ignores the third. Even in case where consideration is given to 3rd part especially Learning opportunities and challenging work there is a difference in perception between what constitutes to be a learning opportunity or a challenging work between employee and employer

This also explains why people tend to help others in social networking sites (self example : I am very active on Pagal guy, from where neither i get any monetary benefits or special benefits except for the recognition, status and  respect from the aspirants ) .

So instead of having a narrow view of looking at limited options in having employee retention , we need to increase our scope and consider other options which are given less thought of

One guiding principle here can be that "if we travel in the same beaten path , we reach the same place every one else had reached"

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