Compensation, Incentives and Organizational Change: Ideas and Evidence from Theory and Practice

Abstract

Academics and practitioners from a wide range of backgrounds agree that bringing about sustainable, productive changes in organizations is difficult. They disagree, however, on why this is the case. Consequently, they disagree on the most effective approaches to analyzing and solving organizational problems, and on the most effective approaches to implementing solutions. At the heart of the disagreement are differences over the factors that motivate individuals to change their behavior. Behavioral changes on the part of individuals are required for organizational change, and compensation systems affect behavior. Thus, it is critical to consider the role that compensation systems play in the process of organizational change. The paper explains why establishing a strong, positive relation between rewards and performance is critical to bringing about value-creating organizational change. Throughout it draws on ideas and evidence, both old and new, from theory and practice. The ways in which well-designed compensation systems create value in organizations are grouped into four broad categories. Specifically, compensation systems: 1. Improve the motivation and productivity of employees, 2. Promote productive turnover in personnel, 3. Mobilize valuable specific knowledge by allowing effective decentralization, and 4. Help overcome organizational inertia and opposition to change. The paper also analyzes the issue of timing in the implementation of a new compensation system. Conventional wisdom in the field of organizational behavior advocates changing compensation systems only after new "strategy and structure" are designed and implemented. In contrast, I provide arguments and evidence in support of changing compensation systems "early." By early, I mean that compensation systems should be redesigned after managers identify and adopt an over-arching objective for the firm, but before they have completely specified how that objective translates into a new strategy and/or structure.