Reward systems and their role in organisations have been studied from many perspectives and by multiple disciplines. Economics, sociology and psychology, in particular, have contributed to the growing literature on reward systems. Reward systems have a wide-ranging impact on organisations, and that their impact is greatly affected by their design and by the organisational context in which they operate. Thus, to understand pay systems in organisations, it is necessary to focus on the characteristics of both the organisation and the pay system. Often new lines of business require a different approach and therefore a different reward system. Simply putting, the old reward system in the new business is often not good enough and indeed can lead to failure. On the other hand, developing a new reward system for one part of an organisation can cause problems in other parts because of the comparisons made between different parts. 


Reward management is about the development, implementation, maintenance, communication and evaluation of reward processes. A substantial literature does exist that focuses on the relationship between reward systems and the degree to which participative management is practiced. If an organisation wishes to operate in a participative manner, it needs to change all its systems, including its reward system. This line of reasoning goes back to the early writings on the Scanlon plan and writings of McGregor. They argue rather convincingly that for effective participative management a different approach to pay for performance is required. They go on to suggest that the correct approach is to pay bonuses based on group or plant-wide performance. The argument for this essentially rests on the point that traditional pay plans support individual excellence at the cost of team performance.

For success of participative management team performance needs to be rewarded. Of late, reward system practices are changing in consistent with participative management. For example, gain sharing has become increasingly popular in the last decade, and skill-based pay plans have replaced job-based plans in many manufacturing locations practicing participative management.

Reward systems influence attraction and retention of employees. Overall, those organisations that give the most rewards tend to attract and retain the most people (Lawler, 1971). This seems to occur because high reward levels lead to high satisfaction, which in turn leads to lower turnover and more job applicants.

The best performers represent a particularly interesting retention problem. To retain them, a reward system has to work on a par with those received by individuals performing similar jobs at a similar level in other organisations. The emphasis here is on external comparisons because turnover means leaving an organisation for a better situation as well. One way to accomplish this is to reward everyone at a level that is above the reward levels in other organisations.

When certain specifiable conditions exist, reward systems have been demonstrated to motivate performance. However, performance motivation depends on the situation, how it is perceived, and the needs of people. The connection between performance and rewards must be visible, and a climate of trust and credibility must exist in the organisation. The belief that performance will lead to rewards is essentially a prediction about the future. For individuals to make this kind of prediction, they have to trust the system that is promising them the rewards. Unfortunately, it is not always clear how a climate of trust in the reward system can be established.

Just as reward systems motivate performance, they can motivate the learning of skills and the development of knowledge (Lawler, 1990). Individuals need to see a connection between learning specific skills and a valued reward. Pay for performance systems may motivate learning and development because individuals perceive that they must develop their skills in order to perform effectively. Sometimes pay for performance systems may discourage individuals from learning new skills or motivate them to learn wrong skills. This can happen when the skills that should be learned are not directly related to present performance.

The reward systems in hierarchical organisations acts as a strong motivation to learn those skills that are perceived to lead to promotion. To counter this tendency some organisations are using skill-based pay when they want individuals to add new skills that do not involve promotions.

Reward systems also contribute to the overall culture and climate of an organisation. Depending on how reward systems are developed, administered, and managed, they may cause the culture of an organisation to vary quite widely. For example, they may influence the degree to which it is seen as a human resources-oriented culture, an entrepreneurial culture, an innovative culture, a competence-based culture, and a participative culture.

Reward systems are often a significant cost factor in organisations. Indeed, the pay system alone represents about 40 per cent of an organisation’s operating cost. Pay systems involve direct pay and benefit costs, as well as the costs associated with managing and operating the system. 


One of the important attributes of work organisation is its ability to give rewards to their members. Pay, promotions, fringe benefits, and status symbols are perhaps the most important rewards. Because these rewards are important, the way they are distributed have a profound effect on the quality of work life as well as on the effectiveness of organisations.

Organizations typically rely on reward systems to do four things:

1) motivate employees to perform effectively,

2) motivate employees to join the organisation,

3) motivate employees to come to work, and

4) motivate individuals by indicating their position in the organisation structure.

There are several principles for setting up an effective reward system in an organisation:

  • Give value to the reward system. Employees must have a preference for the types of rewards being offered. Many employees prefer cash awards and plaques. Some employees like to see their name in the company newsletter. Others like the public recognition surrounding award ceremonies.
  • Make the reward system simple to understand. Elaborate procedures for evaluating performance, filling out forms, and review by several levels of management lead to confusion. The system must be easy to understand if it is to be used effectively.
  • Lay down performance standards within the control of the team.
  • Make the reward system fair and effective.
  • Ensure participation in the reward system.
  • Involve people in the reward process and empower them to do the needful.

Most organisations use different types of rewards. Examples of recognition and rewards include money, plaques, trophies, certificates or citations, public recognition, official perquisites, special assignments, parties or celebrations or other meaningful considerations. The most common are wages or salary, incentive systems, benefits and perquisites, and awards. For majority of people, the most important reward for work is the pay they receive. For one thing, an effectively planned and administered pay system can improve motivation and performance.

Money may not actually motivate people. Surprisingly, there is no clear evidence that increased earnings will necessarily lead to higher performance. A great deal of research has been done on what determines whether an individual will be satisfied with the rewards he or she receives from a situation. The following five conclusions can be reached about what determines satisfaction with rewards:

1) Satisfaction with reward is a function of both how much is received and how much the individual feels should be received. When individuals receive less than they feel they should receive, they are dissatisfied. When they receive more than they feel they should, they tend to feel guilty and uncomfortable.

2) People’s feelings of satisfaction are influenced by comparisons with what happens to others. These comparisons are made both inside and outside the organisations they work in, and are usually made with similar people. Individuals tend to rate their inputs higher than others.

3) In addition to obvious extrinsic rewards individuals receive (e.g., pay, promotion, status symbols), they also may experience internal feelings that are rewarding to them. These include feelings of competence, achievement, personal growth, and self-esteem. The overall job satisfaction of most people is determined both by how they feel about their intrinsic rewards and how they feel about their extrinsic rewards.

4) People differ widely in the rewards they desire and how much important the different rewards are to them. One group feels money is the most important, while another group feels interesting work and job content is. Both groups, of course, are able to find examples to support their point of view.

5) Many extrinsic rewards are important and satisfying only because they lead to other rewards, or because of their symbolic value.

An effective reward system should link reward to performance. Workers who work hard and produce more or give better quality results should receive greater rewards than poor performers. Also, criteria for receiving rewards should be clear and employees should know whether they are going to receive rewards for quality performance, innovation, effort or attendance. Management must ensure that workers perceive distribution of rewards as equitable. Furthermore, for organisations to attract, motivate and retain qualified and competent employees, they must offer rewards comparable to their competitors. 


A distinction may be drawn between incentives and rewards. Incentives are forward looking while rewards are retrospective. Financial incentives are designed to provide direct motivation – ‘do this and you will get that’. Financial rewards provide a tangible form of recognition and can therefore serve as indirect motivators, as long as people expect that further achievements will produce worthwhile rewards.

Financial incentives aim to motivate people to achieve their objectives, improve their performance or enhance their competence or skills by focusing on specific targets and priorities. Financial rewards provide financial recognition to employees for their achievements in the shape of attaining or exceeding their performance targets or reaching certain levels of competence or skill. A shop-floor payment-by-result scheme or a sales representative’s commission are examples of financial incentives. An achievement bonus or a team-based lump sum payment are examples of financial rewards. 


Competence-related pay may be defined as a method of rewarding people wholly or partly by reference to the level of competence they demonstrate in carrying out their roles. This definition has two important points: (1) pay is related to competence, and (2) people may be rewarded with reference to their level of competence.

Competence-related pay is not about the acquisition of competence. It is about the effective use of competence to generate added value. Competence-related pay works through the processes of competence analysis of individual competences and levels of competence. 


Skill-based pay links pay to the level of skills used in the job and, sometimes, the acquisition and application of additional skills by the person carrying out the job. The term is sometimes used interchangeably with competence-related pay. But skill-based pay is usually concerned with the skills used by manual workers, including fitters, fabricators, and operators. In competence-related pay schemes, the behaviours and attributes an individual has to use to perform a role effectively are assessed in addition to pure skills. Skill- based pay may in many ways seem to be a good idea, but its potential costs as well as its benefits need to be evaluated rigorously before its introduction. Initially they may provide strong motivation for individuals to increase their skills. But they may outlive their usefulness and hence need to be revised or even replaced if they are no longer cost effective. 


Team-based rewards are payments or other forms of non-financial rewards provided to members of a formally established team which are linked to the performance of that team. Team based rewards are shared amongst the members of teams in accordance with a scheme or ad hoc basis for exceptional achievements. Rewards for individuals may also be influenced by assessments of their contribution to team results. To develop and manage team rewards it is necessary to understand the nature of teams and how they function. Team-based rewards are not always easy to design or manage. 


Profit sharing is better known, older and more widely practiced than gain sharing. Profit sharing is associated with participative management theories. Profit sharing is a group-based organisation plan. The fundamental objectives of profit sharing are: (a) to encourage employees to identify themselves more closely with the company by developing a common concern for its progress; (b) to stimulate a greater interest among employees in the affairs of the company as a whole; and (c) to encourage better cooperation between management and employees.

The logic behind profit sharing seems to be two fold. First, it is seen as a way to encourage employees to think more like owners or at least be concerned with the success of the organisation as a whole. Individual oriented plans often place little emphasis on these broader goals. Second, it permits labour costs to vary with the organisation’s ability to pay.

Some companies have effectively used their profit sharing plans as vehicles foreducating employees about the financial performance of the business. The most important advantage of profit sharing is that it makes labour costs of an organisation variable and adjust them to the organisation’s ability to pay. Most Japanese firms have used this approach to adjusting labour costs for decades. 


Gain sharing is a formula based company or factory-wide bonus plan which provides for employers to share in the financial gain made as a result of its improved performance. The fundamental aim of gain sharing is to improve organisational performance by creating a motivated and committed workforce as part of a successful company. The traditional forms of gain sharing are the Scanlon Plan and Rucker Plan. 

The success of a gain sharing plan depends on creating a feeling of ownership that first applies to the plan and then extends to the operation. When implementing gain sharing a company must enlist the involvement of all employees so that it can increase their identity with, and their commitment to, the plan, and build a large core of enthusiastic supporters. There are three main principles on which gain sharing is based – ownership, involvement, and commitment.

The potential benefits of gain sharing are that if focuses the attention of all employees on the key issues affecting performance and enlists the support of all employees towards this. It also encourages teamwork and cooperation at all levels.

Gain sharing differs from profit sharing in at least three ways. First, under gain sharing, rewards are based on a productivity measure rather than profits. The goal is to link pay to performance outcomes that employees can control. Second, gain sharing plans usually distribute any bonus payments with greater frequency (e.g., monthly or quarterly versus annually). Third, gain sharing plans distribute payment duri ng the current payment rather than deferring them as profit sharing plans often do.

Lawler (1971, 1990) has summarised some of the common results that have been found in research studies of gain sharing plans:

  • Coordination, teamwork, and sharing of knowledge are enhanced at lower levels.
  • Social needs are recognised via participation and reinforcing group behaviour.
  • Attention is focussed on cost savings, not just quantity of production.
  • Acceptance of change due to technology, market and new method is greater because higher efficiency leads to bonuses.
  • Attitudinal change occurs among workers, and they demand more efficient management, better planning, and good performance from their co-workers.
  • Employees try to reduce overtime – to work smarter.
  • Employees produce ideas as well as effort.
  • When unions are present, more flexible administration of union-management relations occur.
  • When unions support the plan, they are strengthened because better work situations and higher pay result.
  • Unorganised locations tend to remain non-union.

There are, however, certain limitations of gain sharing plans. Perhaps the most important is differentially attracting and retaining the best performers. As gain sharing plans do not pay more for better performance, they do not necessarily motivate them to stay. Unlike profit sharing it pays bonus even when the organisation is not earning profits. Moreover, gain sharing plans do not fit in with every situation.


The stock option is the most popular long-term incentive. A stock option is the right to purchase a specific number of shares of company stock at a specific price during a period of time. The price at which the employee can buy the stock is equal to the market price at the time the stock option was granted. The employee’s gain is equal to the market value of the stock at the time it is exercised, less the grant price. The assumption is that the price of the stock will go up, rather than go down or stay the same. Several trends have increased the attractiveness of stock options as a long-term executive incentive and retention tool

Stock options are similar in many ways to profit sharing plans. The basis for payouts is organisational performance in the stock market. Important goals of the plan are:

(a) to motivate employees to act in the best interest of the organisation as a whole; (b) to enhance employee identification with the organisation; and

(c) to have labour costs vary with the organisational performance. Stock options have long been a common programme for executives, but some organizations, like Pepsi-Cola and Hewlett-Packard, grant them to all employees. There is evidence that this approach is becoming more widespread. 


Merit pay is the most widely used approach for paying performance. Merit pay systems typically give salary increases to individuals based on their supervisor’s appraisal of their performance. The purpose of merit pay is to improve motivation and to retain the best performers by establishing a clear performance reward relationship. Considerable evidence suggests that most organisations’ performance appraisal is not done well and as a result, good measures of individual performance do not exist. 


A number of plans exist that help get some or all of the ownership of a company into the hands of employees. These include stock option plans, stock purchase plans, and Employee Stock Ownership Plans (ESOPs). In small organisations in which participative management is practiced it has a good chance of increasing

organisational performance. In a large organisation with little employee ownership, it may positively affect the structure by creating integration across the total organisation if, of course, all employees are included in the ownership plan. Ownership can have a more positive impact on attraction and retention than does profit sharing. The usefulness of employee ownership, however, is likely to be highly situational. For instance, in the case of small organisations they might make profit sharing and gain sharing unnecessary, and if combined with an appropriate approach to employee involvement, they can contribute substantially to employee motivation. In a large organisation they may contribute to the integration of the organisation and to a positive culture. 


Employee benefits are elements of remuneration given in addition to the various forms of cash pay. They provide a quantifiable value for individual employees, which may be deferred or contingent like a pension scheme, insurance cover or sick pay, or may provide an immediate benefit like a company car. It also includes elements that are not strictly remuneration, such as annual holidays. Benefits in general do not exist in isolation. They are a part of comprehensive compensation package offered by the organisation.

The objectives of employee benefits are: (a) to increase the commitment of employees to the organisation; (b) to demonstrate that the company cares for the needs of its employees; (c) to meet the personal security and personal needs of the employees; and (d) to ensure that benefits are cost-effective in terms of commitment, and improvement in recruitment and retention rates.

Benefits represent a large share of total compensation and, therefore, have a great potential to influence the employee, unit, and organisational outcome variables. The empirical literature indicates that benefits do indeed have effects on employee attitudes, retention, and perhaps job choice. Further, it appears that individual preferences may play a particularly important role in determining employee reactions to benefits. Consequently, many organisations have implemented benefit plans that permit some degree of employee’s choice in the hope that a better match between preferences and benefits will be obtained, perhaps at a lower total cost to the employer. 


Employee benefits may be classified as statutory and voluntary. Statutory benefits are to be given to the employees by the organisation regardless of whether it wants to or not. For instance, social security benefits under the Workmen’s Compensation Act, Employees’ State Insurance Act, Employees’ Provident Fund and Miscellaneous Provisions Act, Maternity Benefit Act, and Payment of Gratuity Act are statutory benefits. The Industrial Disputes Act, 1947 also provides for compensation in cases of lay-off, retrenchment and closure of industrial establishments.

The menu of voluntary benefits offered to employees by employers is quite astounding, and carry significant cost to the employer. The major voluntary benefits are: vacations, holidays, special leave, sick leave, health insurance, educational assistance, employee discounts, medical benefits, recreational facilities, subsidised meals in canteens, credit cards, and mobile telephones. 


There are significant individual differences in benefit preferences. Such individual differences, of course, lend greater weight to the need for offering employees a choice in the design of their benefits package. Flexible benefits plan will help control costs and enhance employee satisfaction.

When an employer considers offering benefits to employees, one of the main considerations is to keep costs down. Traditionally, employers attempted to do that by providing a slate of benefits to their employees – irrespective of their need or use. Companies learn, in due course, that these benefits offered did little to motivate their employees, or to provide an incentive to be more productive. Employees viewed benefits as “given”. This fact coupled with the rising costs of benefits and a desire to allow employees to choose what they want led employers to search for flexible benefits.

The term flexible benefits refers to a system whereby employees are presented with a set of benefits and are asked to select, within monetary limits imposed, the benefits they desire. The aim of flexible benefits programmes is to confer specific advantages to both the employee and the employer. The employees have the freedom to choose benefits that are tailored to their specific needs. In some cases, it motivates employees and leads to increased morale. It helps the employer to decide the nature and quantum of benefits, and manage the costs more effectively. Also it helps in attracting and retaining quality employees in an organisation. However, the main disadvantage of flexible benefits is: (a) wrong selection of benefits in some cases; (b) keeping track with changing benefit needs of employees; and (c) the administrative complexities involved in actual operation. 


  • Less attention to tax avoidance
  • Greater simplification of benefit package
  • More attention to individual needs
  • Great emphasis on individual choice
  • A move towards cash rather than benefits in kind
  • Greater concentration on assessing the cost/effectiveness of total benefit package
  • More attention to communicating the benefits package

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