Compensation, Rewards, and Employee Turnover
We argued in Chapter 2 that emphasizing the role of pay levels and pay satisfaction in understanding turnover decisions can be a misconception that managers turn to too quickly when diagnosing why employees are leaving. However, compensation is about much more than simply the amount in a paycheck. In this chapter we will examine three principles regarding the effective use of compensation and rewards as motivators for retaining key employees. The first principle we will discuss is that, as we saw in Chapter 2, although it is not all about pay, the structure and procedures associated with compensation and rewards can be important motivators of employee performance and retention. The second principle focuses on the importance of fairness in equity in thinking about how compensation and rewards can influence retention. The third principle we will examine in this chapter is that compensation and rewards can be explicitly tied to retention strategies for even greater effectiveness in managing employee turnover.
Principle 1: Compensation Structure xand Procedures Matter
The Research Evidence
As discussed in Chapter 2, pay does not drive turnover as much as many managers might think, maybe even less than some of the data might suggest due to the reasons already discussed. As a matter of fact, Robbins and Judge assert that pay tends to correlate with job satisfaction up to an annual salary of about $40,000. Above $40,000, they state that, “there isn’t much of a relationship there.”1
But, this is only part of the story. Think about it. Most of us wouldn’t work for our current employer for free. So, of course the amount of pay matters in some cases. Just as Robbins and Judge state above, at lower levels, one’s pay is strongly correlated with their job satisfaction. Still, the amount of one’s pay remains just part of the picture. In addition to amount, structure, procedures, and type matter, too. Structure refers to the amount of pay dispersion across organizational levels. As the “Occupy Wall Street-ers” and “99 Percent-ers” brought to our attention in 2011, pay dispersion is an increasingly important facet of compensation. It is a fact that since about 1970, the gap between the rich and poor in America has grown substantially.2 Bloom and Michel have shown that wide gaps between the lowest paid and the highest paid employees increase the likelihood that managers and other employees will voluntarily leave an organization.3
Pay procedures refer to the determination and administration of pay levels, raises, and variable pay as well as the actual administration of pay. All things being equal, the level of one’s pay, especially in comparison to viable alternatives as perceived by the employee, does make a difference. Pay level may also be seen by some employees as a signal as to how much the organization values them. We will have more to say on this later in the chapter. Suffice it now to say that leading the market in pay for strategically important positions may reduce turnover among key personnel.4 Margaret Williams and her colleagues found that procedures such as determination and administration of pay raises among other pay procedures can have an effect on employee turnover through employees’ perceptions of organizational support. Employees’ higher levels of satisfaction with pay procedures are associated with higher perceptions of organizational support, which in turn reduces their likelihood to voluntarily turnover.5 The way that variable pay is determined matters, too. Variable pay can be briefly described as pay for performance (versus pay for time, or pay for butts in seats). Pay for performance makes sense, and the old adage is true—you get what you pay for. (If you pay for performance, you are likely to get performance. If you pay for butts in seats, you are likely to get just that.) Todd Zenger showed that more valuable employees tend to be attracted to (and stay longer with) firms that closely tie pay to performance while less valuable employees tend to be attracted to (and stay longer with) firms that do not closely tie pay to performance.6
Type of pay can also be a strong motivator. “Cash is king” is a common mantra, but it is important to remember, especially in times when cash may be less abundant, that compensation may be made in ways other than cash. Alternatives to cash include stock-based compensation, common benefits such as insurance and retirement plans, and fringe benefits such as the use of company cars, etc. Effective stock-based compensation may include stock options, employee stock purchase plans (ESPPs), and employee stock ownership plans (ESOPs). The idea behind any stock-based compensation is to align employees’ interest with that of the stockholders. If they have a sense of ownership, it is likely to translate into a sense of stewardship. Granting employees stock options gives them the option to buy a certain number of shares of company stock at a certain price (the strike price) for a given period of time, usually 5 to 10 years. Ben Dunford and his colleagues have shown that stock options do have an effect on executive turnover.7 Employee stock purchase plans usually allow employees to purchase a limited number of shares of the company’s stock at a reduced rate from fair market value. A variation of this is to allow the employee to purchase a limited number of shares at market value and provide a company “match” in the form of additional shares. ESOPs are also a very effective way to transfer ownership of a firm from the founders to the employees. They are usually tenure-based, salary-based, or both, and they offer tax advantages to the founders (they can diversify their stock portfolios while deferring taxation on capital gains), as well as the company (the contributions may be tax deductible) and its employees (the gains can be deferred under qualified retirement plans). (Of course the authors make no claim of tax advice and encourage the reader to consult their own tax attorneys or accountants for tax advice). In addition to stock-based compensation, the company can also provide common benefits such as insurance and other retirement plans, and fringe benefits such as use of company cars, discount pricing, etc. Nancy Sutton has shown that companies offering higher levels of insurance and retirement benefits generally experience lower levels of employee turnover.8
Tailoring the types of rewards to what employees value can increase the impact of rewards on retention. For example, what do top performers value? Of course no two employees are the same, but a 2003 survey by Watson Wyatt revealed the following cash-based reward programs as the five most highly valued programs by the top 10% of employees at 16 US companies: (1) cash-based long-term incentive plans, (2) cash-based short-term incentive bonuses, (3) on the spot cash-based recognition, (4) custom compensation plans, and (5) stock options. The same survey revealed the following as the five most highly valued non cash-based reward programs by the same top 10% of employees: (1) defined contribution retirement plans, (2) advancement opportunities, (3) defined benefit retirement plans, (4) flexible schedules, and (5) career development.9
Total reward strategies recognize these compensation and non-compensation based rewards, and Robert Heneman wrote an excellent report for the SHRM foundation describing the components and values of total rewards strategies.10 Heneman partitions total rewards into compensation (including base pay, merit pay, incentives, promotions, and pay increases), benefits (including health and welfare, paid time off, and retirement), and personal growth (including training, career development, and performance management). Used in tandem and guided by company strategy, these total rewards have employee level positive effects (such as increased productivity and job satisfaction, and decreased employee complaints and turnover) as well as organizational level positive effects (increased revenue and profits, and decreased costs and customer complaints). There is even evidence that too much emphasis on extrinsic rewards (e.g., pay) can stifle the intrinsic motivation that originates within the individual for performing well, having completed a task, or enjoying one’s work.11 Clearly, cash may be king, but a full deck includes many other important cards as well.
Getting Started with Motivating Retention Through Compensation and Rewards
As the foregoing discussion highlights, there is much more to compensating employees for retention than just paying them more money. Level of pay does matter, as do the structure (dispersion) of pay, procedures (determination and administration of levels, raises, and variable pay), and type of pay (whether it is in cash or noncash alternatives). It is important to take a look at each of these aspects of pay in the context of the industry, strategy, and culture of the organization.
In Summary, Managers of Compensation and Rewards Programs Should:
•consider paying some strategic positions above the market rate,
•remember the importance of pay dispersion on employee morale,
•determine and administer compensation and rewards fairly requiring the development of an effective performance management system,
•keep in mind that cash is not the only effective form of compensation, and
•tailor rewards to employee needs and values.
Principle 2: Fairness and Equity Are Important Compensation Considerations
“It’s not fair.” Managers hear it often. But what do employees mean when they talk about “fair”? How do they calculate what’s fair? John Stacy Adams offers his equity theory as an explanation for employees’ calculations of fair.12
The Research Evidence
According to Adams’ equity theory, employees like to know that what they get out of their job as compared to what they put into it is roughly the same as that of what comparable other people get out of and put into their jobs. Employees may compare their input–output ratio to other employees inside the firm or other employees outside the firm. (“I work as hard as her. Why does she make so much more?”) They may also compare their ratio to what they experienced previously either inside or outside the firm. (“I thought becoming a manager would have made things so much better, but now that I am a manager, I work twice as many hours for only 15% more.”) Finally, employees may compare their input–output ratio to their “ideal selves” (the self that they wish or hope they might be). (“My plan was to have retired by now and live off my savings. But I’m now working harder than ever, paycheck to paycheck.”) These different comparison groups (external others, internal others, previous selves, and ideal selves) are what are known as one’s referents. This perspective is similar to one of the most influential theories of employee turnover: the theory of organizational equilibrium. A key tenet of this theory is that individuals make the decisions whether to continue participating in an organization based largely on the balance between their perceived contributions to the organization and the perceived inducements offered by the organization in return.13
Brian Helshizer found that perceptions of pay equity are significant in managing employee commitment and turnover.14 Later research corroborated his findings in that reductions in turnover were shown to be a result of reward systems that employees perceive as fair in terms of equity theory.15
Getting Started with Generating Perceived Equity in Compensation and Rewards
In determining pay and rewards systems, it is important to consider equity both internally and externally. To ensure external equity, make sure that you know what similar jobs are paid in other similar organizations, for example, through the use of salary surveys. Comparison organizations should be those that your employees could reasonably leave your company for. Make sure that you include geographical cost of living adjustments in your calculations, and that you are comparing similar jobs. Similar job titles are not enough; the job descriptions, duties, and KSAs necessary to perform the jobs, as well as the environment and working conditions should be taken into consideration as well.
To ensure internal equity you will first want to make sure that similar jobs are paid similarly. Beyond this, it is important to establish a fair system for providing merit increases and performance bonuses with clearly described and transparent procedures and standards communicated to all employees. Additionally, you may want to also consider educational and experiential differences among employees as well as geographic differences for cost of living adjustments. All of these determinants should be communicated clearly and honestly to employees so that they know how pay differences in similar positions are determined.
In Summary, to Manage Employees’ Perceptions of Pay Equity:
•know what similar jobs are paying in similar organizations,
•pay similar jobs within your organization similarly,
•use objective criteria such as education, experience, performance, and geography to determine pay differences within your company, and
•understand what referents employees use to make their equity calculations,
•clearly communicate standards and procedures used to make pay decisions to all employees.
Principle 3: Linking Compensation and Rewards to Retention May Help Manage Turnover
One final consideration when discussing the use of compensation and rewards in managing employee turnover is linking pay and rewards to tenure milestones. The effective use of this strategy can be very successful in managing employee retention.
The Research Evidence
Studies have shown that many different types of rewards can be linked to tenure requirements and have a positive effect on employee retention. Benefits with relatively long-term vesting schedules such as stock options, ESOPs, and retirement plans have been shown to effectively manage turnover.16 The idea is that when employees see tangible benefits to remaining loyal over a three to five year period, they are more likely to invest that time with the company. Of course the vesting period should be long enough to provide employee retention benefits for the employer, but short enough as to not make the investment in time commitment seem overwhelming to the employee. Traditional vesting schedules for these types of benefits have been three to five years. Some companies are playing with shorter (two-, or even one-year) vesting schedules.
In addition to the benefits discussed above, with their long-term vesting schedules, other rewards such as performance bonuses, skill-based pay, and even on-the-spot rewards can provide for shorter-term retention management. Most organizations that offer annual performance or profit-based bonus plans have recognized that employees considering leaving will often stay until just after their bonuses are paid out. The balance here is to make sure that bonuses are paid out soon enough after performance for employees to conceptually link the reward to the performance, but to have a long enough stretch of time between bonuses to encourage employee retention. This is a balance that all organizations will have to find based on their own culture and strategy, but quarterly seems to be about as often as necessary while annually is the recommended maximum.
A strategy that combines skill-based pay with training and development opportunities may also help manage turnover. As discussed previously, we once managed a project where the majority of employee turnover in one particular department was within the first 180 days. One of the strategies we used to reduce turnover was to offer base pay raises upon successful completion of training at intervals of 90 and 180 days. Employees who successfully completed training were able to perform more complex tasks, and were therefore provided with a slight pay increase and a promotion. This was very effective in reducing turnover during the first 180 days.
Another creative solution noted by Paula Malone was the use of on-the-spot rewards when employees were “caught” doing a great job. The on-the-spot cash bonuses were effective in providing the conceptual link of the reward to the performance. And to manage retention, employees who received on-the-spot cash rewards were eligible for a $200 quarterly drawing and an annual drawing in which they received public recognition by the top management team.17
Getting Started with Linking Compensation and Rewards with Employee Retention
In linking rewards to retention milestones it is a good idea to provide rewards for both long-term (e.g., retirement, stock options, ESOPs) retention goals and short-term (e.g., training and skill-based plans, recognition programs, quarterly semiannual, or annual performance bonuses) retention goals. By laddering different retention-based compensation and rewards programs it may be possible to keep a continuous regiment of payments and anticipation of payments such that retention is continuously encouraged.
In Summary, in Linking Compensation and Rewards to Retention, Consider:
•providing benefits and rewards with long-term vesting schedules,
•providing rewards with shorter-term schedules, and
•laddering retention based rewards programs.