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Variable reward schemes
Contingent and variable pay
Whereas fixed pay is contractually offered by employers to employees for their working
activity, regardless of the quality and level of their contribution and performance and of
the results produced by these, contingent and variable pay are awarded by organizations
to individuals only whether some requirements and predetermined targets have
respectively been fulfilled and met.
The Oxford Dictionary defines the adjective contingent as referred to something “subject
to chance, occurring or existing only if certain circumstances are the case” and
dependent hence on something else. Contingent pay can therefore be deemed as the
component of a reward package whose payment actually depends on something else to
occur and which cannot therefore be taken as axiomatic by the individuals concerned.
The adjective variable is instead defined by the Oxford Dictionary as: “not consistent or
having a fixed pattern; liable to change and able to be changed or adapted”. The idea of
variable pay could consequently be associated with the component of pay which,
differently from fixed pay, might be subject to change and adaptation over time. Indeed,
in the concept of variable pay is also included the option that, the case being, this
component might entirely be removed from the overall financial reward package
received by an employee; albeit this is not always an easy feat to achieve in practice by
reason of the legal-related constraints.
Both adjectives are associated with the idea of variableness and unsettledness and the
difference between the two essentially seems to mostly be identifiable in terms of
nuances. The adjective contingent specifically links changes to something to occur,
whereas the term variable only stresses the likely circumstance that changes may
happen. Indeed, from the reward management point of view, it can be contended that,
in any case, both variable and contingent pay depend on or are directly linked to the
occurrence of some other events or circumstances to happen.
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As suggested by Armstrong (2010), the difference between the two forms of unsettled
pay can essentially be identified and described on the basis of the different reason for
the additional component of pay being offered to a person.
Contingent pay
Money supplements in the form of unfixed pay can be offered to individuals both for the
level of knowledge, competence, expertise and skills these have acquired and for their
outstanding performance and superior contribution to organizational success. Both cases
represent forms of contingent pay, meaning by that that in both cases an additional
component of financial reward is offered to individuals only whether some specific events
occur or under specific circumstances.
In general, but neither necessarily nor exclusively, the additions granted to individuals in
the form of contingent pay for their qualities can directly be consolidated into base pay.
Whether individuals’ base pay rate is determined according to employee capabilities,
skills and expertise this is usually called person-based pay (Armstrong, 2010). In this
case despite the payment of a financial reward supplement is linked to the existence of
some specific requirements or prerequisites, this is actually immediately consolidated
into base pay in that such elements have been or have presumably been assessed
before the beginning of the working relationship and once gained by individuals these
qualities are deemed to stably rest with them.
These kinds of additions, once consolidated into base pay, do not need to be re-earned;
by contrast, since individual outstanding performance and superior contribution might
not be repeated in the future, employers usually avert to consolidate into base pay
extras offered to employees on the basis of such occurrences.
It emerges therefore that contingent pay, according to the reason for this being offered
to individuals, can be consolidated into base pay or otherwise.
Variable pay
Variable pay can be defined as the component of a financial reward package which is
offered by employers to individuals for the attainment of pre-set and pre-identified
targets and objectives. In this case additions tend to invariably be kept separated from
base pay in that exclusively linked to events which will not necessarily occur in the future.
In order to be repeated, this type of additions needs therefore to be re-earned every
year.
Variable pay essentially constitutes another form of contingent pay, also in this case in
actual fact money supplements will be paid whether and only if some specific events
occur. The conceptual distinction between the two different types of unsettled pay is
actually rather blurred; this is why, possibly just in order to avoid falling into the
terminological trap, some Authors (for instance Torrington et al, 2008), simply and more
in general refer to variable and contingent pay as incentives. Indeed, perhaps exactly for
the same reason, Suff and Reilly (2004) maintain that payment-by-results, performance
and financial participation schemes can all be considered forms of variable pay.
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The existence of variable and contingent pay schemes clearly implies organizations to
have in place sound and effective ways to assess and measure performance, contribution
and objective-attainment in order to be properly managed. As we will discuss later,
measuring these variables actually represents a difficult feat for the managers concerned.
Albeit employers can hardly determine the worthiness of contingent pay without having
recourse to a whatever form of performance assessment, some employers have
identified and are trying to test some alternative methodologies in order to determine
their staff pay. One of these is based on a general assessment of: the individual’s
potential and performance, the consideration of his/her colleagues level of pay and the
identification of the likely rate of pay he/she would receive whether working with a
different employer in the same market (Armstrong, 2010).
The most traditional form of contingent pay, and the less effective indeed, is represented
by the service-related pay method. According to this approach pre-set pay increases are
annually paid to employees only on the basis of their length of service. In this case
hence the occurrence on which pay increments are determined is simply represented by
the circumstance that an employee is still holding his/her post.
Findings of CIPD (2011) research revealed that whereas this approach is practically
deserted by the private sector services (8.3 per cent) and manufacturing and production
employers (1.8 per cent) it is still rather widespread amongst public sector employers
(57.0 per cent) and voluntary, community and not-for-profit organizations (22.8 per
cent).
The scope of contingent and variable pay
As discussed earlier, the psychological contract, albeit unwritten, can be considered as
every other type of covenant a synallagmatic, bilateral contract. Following its
hypothetical signature it becomes hence binding for both parties which, as a
consequence, assume mutual rights and obligations.
The psychological contract is essentially underpinned by a reciprocal promise: on the one
hand employees pledge to be loyal to the employer and to work with diligence and care;
on the other hand employers undertake to respect and adequately pay employees for
their work. Indeed, employers, on the basis of the psychological contract, vow to pay a
salary, that is, a base pay or fixed salary to staff for their contribution to the production
of the business output. Whereas some employees should demonstrate to have gained
some additional skills, expertise and knowledge employers will promote these to a higher
job level or grade, complementing this move with a larger base salary and eventually a
higher degree of responsibility.
According to this viewpoint, both contingent and variable pay should not therefore be
regarded as part of the psychological contract. In theory, base pay should hence be
considered satisfactory by employees in exchange for their work; in practice, however,
contingent and variable pay have firmly become part of every reward package and as a
consequence indirectly part of the psychological contract too. Irrespective of the way
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these are offered to individuals every employee does not consider a job offer on the
basis of the base salary only, but rather on the basis of the overall value proposition or
total reward package offered by an employer.
But whether base pay is, or should be, sufficient to reward people for their contribution
to a business output, why employers offer to employees additional sums of money in the
form of supplements? Essentially because, inasmuch as base pay is used to reward
individuals for their standard, average or ordinary contribution, contingent and variable
pay are by and large employed by organizations to reward and recognize individuals’
outstanding contribution, above-average performance, competencies and achievements.
The reason why employers are offering individual pay additions and supplements in the
form of contingent and variable pay is hence that to encourage and foster superior
performance, professional development and higher levels of employee involvement and
participation.
Indeed, over time employers’ intent to have recourse to rewards has steadily broadened.
So that contingent and variable pay, by means of the different formula and schemes it
can be provided to staff, is the more and more used by organizations not only to
encourage sustained and outstanding performance and participation, but also to engage
and motivate individuals, enhance their commitment, influence their behaviour and
attract and retain quality staff.
Reward can thus be considered somewhat of an endogenous and exogenous form of
marketing. In this case, however, employers’ intended objective is by no means that to
sell any goods or item, but rather to influence people behaviour, also in terms of
performance, avert quality staff to leave the business and encourage external talents to
join the firm. By means of a differently formulated reward-mix employers offer
employees not what they like to offer, but what individuals are expected and would
desire to receive. Additional cash, as we have seen and as we will further see, is not
necessarily and invariably what individuals want in addition to their base pay, but, even
though in different proportions and differently according to the changing circumstances
and the different stages of their lives, money invariably represents part and even a not
negligible part of the ideal reward package individuals aim to receive.
Whether, and eventually to what extent, employers are successful in the attainment of
their intended objectives clearly depends on the circumstances, on the effectiveness and
consistency of the total reward packages they offer to their employees and on how
successfully these will be able to meet individuals wants and expectations. Managing
rewards, in order to achieve their intended aim, clearly represents a fairly tricky feat for
employers and managers as well. Total reward and the bundling effect on which this
approach relies can actually help, but organizations need to have clear ideas on what
specific objectives they want to pursue from the outset and consistently identify the
most suitable means to be used in order to attain the intended results. The final outcome
and the overall success of such initiatives depend on how well businesses formulate,
communicate and manage their value proposition, on how effectively results are
monitored and on how promptly the eventually required amendments are introduced.
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Performance-Related Pay
Essentials of Performance-Related Pay
One of the most used and at the same time contentious approaches to contingent pay is
definitely represented by performance-related pay. A survey carried out in the UK by e-
reward in 2009 showed that 84 per cent of respondents having recourse to contingent
pay schemes used performance-related pay methods.
The mechanism of performance-related pay programmes is essentially based on linking
pay increases directly to individual performance and results. This method enables
employers to reach increased level of organizational performance and, by assigning as
far as possible to individuals targets directly contributing to the achievement of the
organizational goals, to increase chances to attain the company objectives.
Table 37 – Performance-Related Pay Mechanism
The performance-related pay approach takes as axiomatic that two specific activities can
and are hence carried out by employers; more specifically:
a) That a set of “pre-agreed objectives” have been clearly identified (CIPD, 2012),
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b) That these can objectively be measured over a pre-defined period of time, usually
identified with a year (Torrington et al, 2008).
The financial award granted on the basis of a performance-related pay scheme
implementation can either be consolidated into base pay or awarded by means of non-
consolidated lump sums. According to these arrangements cash supplements can
therefore be offered both in the form of pay progression and bonuses (CIPD, 2012).
Making the case for introducing performance-related pay programmes
Thanks to the several objectives it might enable, at least in theory, employers to achieve,
performance-related pay actually appears to be a particularly attractive approach to
manage reward budgets. As suggested by Torrington et al (2008), performance-related
pay can help organizations to:
Attract and retain good performers;
Rise individuals and organizational performance targets;
Make clear individuals roles and tasks;
Identify and agree with employees opportunities for development;
Reward employees avoiding to necessarily giving them career advancements.
Albeit Torrington et al (2008) also list staff motivation enhancement amongst the likely
benefits provided by performance-related pay, the existence of a direct cause-effect
relationship between these arrangements and increased levels of motivation cannot be
taken as axiomatic. The CIPD (2012), for instance, considers the establishment of such a
link questionable.
It is actually rather tricky establishing, at least in abstract terms, whether a direct line of
sight between performance-related pay approaches and motivation can plausibly be
identified. Considering motivation as a reason, that is, a motive for individuals doing
something or otherwise and that the effects of performance-related pay approaches are
basically associated with financial benefits, the conclusion should be that such a
relationship should actually be rather unlikely to exist. Notwithstanding, it should also be
considered that the hygiene characteristic of money is usually associated with the
medium to long run, whereas it is widely acknowledged that money might produce some
impact on motivation in the short term. Since performance-related pay schemes are
typically associated with spell of time covering a year, it cannot then be completely
excluded that, at least in theory, these arrangements may be productive of some
positive impact on individual motivation. Nonetheless, this cannot clearly be considered
as a universal rule in that it actually depends on the circumstances, or rather, on the fact
that these approaches are used or introduced in presence of the favourable conditions.
As will be seen later analysing this approach from the empirical point of view, over the
years research has produced contrasting results.
Notwithstanding, performance-related pay approaches can turn to be particularly
effective for helping employers to foster and embed in organizational culture the
concepts of high-performance, equity and fairness (CIPD, 2012).
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According to Arrowsmith et al (2008) and Marginson et al (2008) performance-related
pay schemes, reinforcing communication of organizational aims and making it easier for
managers monitoring strategic objectives, can enable employers to attain a more
positive outcome in terms of performance management. The Authors also highlight the
impact that performance-related pay schemes can have on curbing personnel costs.
Developed in association with low base pay schemes in fact the variable elements of pay
could be controlled by means of the organization’s profit.
One of the consequences usually associated with the introduction of performance-related
pay schemes is the development and reinforcement of individual employee relations to
the detriment of the collective ones (Torrington et al, 2008). This point is, to some
extent, also linked to the harmful effects produced by the implementation of these
arrangements upon the bargaining power of trade unions officials within organizations.
Essentially based on a meritocracy approach, that is, a tenet according to which best
performers should be rewarded better than those who have not contributed as effectively
as these to the attainment of organizational objectives, performance-related pay should
definitely represent the most sought approach by employees and managers as well.
Linking salary to performance these arrangements should ultimately be perceived as the
best approach to reward by everyone. As suggested by Behn (2004), it is actually hardly
imaginable linking pay to any other element, let alone could that element be identified
with length of service or “longevity”, which is the element traditionally taken into
consideration by the public sector employers. Regardless of the way financial
recognitions are granted, these should be offered to best performers rather than to
individuals who, for instance, have simply worked for the organization for a longer period
of time. In the latter case the employer would seriously risk putting in place “the wrong
incentives” (Behn, 2004) and communicating the wrong message.
The underpinning principle of this approach could therefore be considered based on the
glaringly obvious and it could hardly be argued that this approach should not be pursued
by organizations aiming at enhancing their overall organizational performance. As
suggested by the CIPD (2012) in fact performance-related pay actually represents a
proper means to effectively link individuals reward to business aims and objectives or, in
the Torrington et al (2008) words, a method enabling employers to “ensure that
organizational priorities become individual priorities” (Torrington et al, 2008).
Once again, managers’ role is crucial. According to the tasks carried out by each
individual within the organization, as far as applicable, they will need to include amongst
their direct reports’ objectives organizational objectives. Such an approach would indeed
enable organizations to drastically increase the chances of attaining their intended
results and hence organizational objectives (Torrington et al, 2008).
Mismatch between performance-related pay design and execution
Although in theory the performance-related pay approach should represent the most
effective means to reward people within organizations, it usually causes a great deal of
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troubles and difficulties when implemented in practice. It is indeed by reason of all these
difficulties that the approach has attracted fierce controversy ever since it was developed
and introduced within firms.
As suggested by Torrington et al (2008), controversy surrounding the recourse to