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Reward and incentive compensation and organisational performance:evidence from the semiconductor industry

Chin-J u TsaiUniversity of Warwick

Chin-J u.Tsai@wbs.ac.uk

Abstract: The link between reward and incentive compensation and organizationalperformance has attracted increasing research interest in recent years. This paperexamines that link by testing two sets of hypotheses: organizational performance ispositively associated with (1) the use of reward and incentive practices, such as profit-

related payment schemes, employee share-ownership schemes, profit-sharing schemesand group performance-related pay schemes; and (2) the effective use of reward andincentive compensation practices. The hypotheses were tested empirically using datacollected from interviews with 25 HR managers and surveys of 21 senior operationsmanagers and 1129 employees in Taiwanese semiconductor companies. The results of thestatistical analysis demonstrate that companies using profit-related payment schemesoutperform other companies; and the effective linking of reward and incentivecompensation to employee performance is positively related to organizationalperformance.

Keywords Reward; variable pay; organizational performance; Taiwan.

The need for organizations to develop a performance-enhancing system capable offacilitating the best management and development of their employees, and increasingtheir competitiveness, has made the links between HRM and organizational performancean important agenda item in the field of HRM. Across the core areas of HR practicessuch as recruitment, training and development, performance management, employeeinvolvement and rewards, the association between rewards and performance is one of themost studied subjects in the management literature. It is commonly believed that ifrewards are used effectively, they can motivate individuals to perform and thus can have

a positive effect on organizational performance.

Taiwans semiconductor industry ranks as one of the most innovative and successfulglobal industries. It has the worlds largest contract manufacturer of semiconductors andthe second largest semiconductor design industry. Like many high-tech companies inwestern countries, Taiwans semiconductor firms have implemented many new types ofreward scheme, such as profit sharing, profit-related payment, and employee share-ownership plans. This raises the issue of whether the industrys reward and incentivecompensation practices have contributed to it achievements.

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To examine the relationship between reward systems and organizational performance,this studyempirically tests the association between organizational performance and (1) the use ofcertain reward and incentive compensation practices, and (2) the effective use of rewardand incentive compensation practices in the context of a newly industrialized economy,Taiwan, with a focus on its semiconductor design industry. The study aims to address thefollowing two questions: First, is the use of certain reward and incentive compensationpractices positively related to organizational performance? Secondly, is there a linkbetween organizational performance and the effective use of reward and incentivecompensation practices?

Theoretical and empirical background and research hypotheses

The effectiveness of skilled employees is likely to be limited if they are not motivated to

perform. One of the means that organizations can use to enhance employee motivationand performance is to provide performance-related compensation (Delaney and Huselid,1996). A reward and compensation system is based on the expectancy theory, whichsuggests that employees are more likely to be motivated to perform when they perceivethat there is a strong link between their performance and the reward they receive (Fey andBjorkman, 2001; Guest, 2002; Mendonca, 2002). In other words, the compensationsystem (e.g. profit sharing) contributes to performance by linking the interests ofemployees to those of the team and the organization, thereby enhancing effort andperformance (Kalleberg and Moody, 1994; Huselid, 1995; Kling, 1995). Four commonlyused variable pay schemes are profit-related payment, employee share- ownership plans(ESOP), profit-sharing schemes, and group performance-related schemes. Profit-related

pay schemes provide employees with tax-free payments linked to the profitability of theircompanies. An ESOP allows employees to take a stake in the company they work forthrough shares of stock that are awarded to them. A profit-sharing plan rewardsemployees with a part of a companys profits for their contribution to the companyssuccess. The reward can be in the form of cash, shares or a combination of both. Groupperformance-related schemes reward a group or team of employees with a cash paymentfor achieving an agreed target. These schemes are all designed to enhance companyperformance by aligning the interests of employees with the financial performance oftheir companies.

Several studies have revealed the positive effects of reward and incentive systems on

organizational performance. Banker and Lees (1996) empirical research, which is basedon data from 34 stores of a major retailer over 77 months, supports the theoreticalprediction that stores that implement an incentive plan will experience a positive impacton sales, profit and customer satisfaction. A study based on data from the US NationalOrganizational Study, conducted by Kalleberg and Moody (1994), also found that profitsharing is positively correlated with product quality, product development, profit,customer satisfaction, and growth in sales. Cook (1994 in Kling, 1995) found that the useof profit sharing was positively associated with higher productivity in an analysis of 841manufacturing establishments.

Drawing on the above empirical and theoretical studies, we hypothesize:

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Hypothesis 1: There will be a positive relationship between organizational performanceand (a) the use of a profit-related payment scheme; (b) the use of anemployee share-ownership scheme; (c) the use of a profit-sharing scheme;

(d) the use of a group performance-related pay scheme.

Hypothesis 2: There will be a positive relationship between organizational performanceand the effective use of reward and incentive compensation practices.

Methods

Sample

The companies under study are Taiwans semiconductor design companies. The samplewas drawn from the Taiwan Semiconductor Suppliers Directory (Chen, 2001).Companies were included in the sample frame if they employed more than 80 employeesat the time of conducting the fieldwork. The fieldwork began by negotiating access inJanuary 2003 and ended in August 2003 when the collection of survey questionnaireswas completed. The decision to include only companies employing more than 80employees was based on the results of previous empirical research into Taiwans HRMpractices (e.g. Huang, 2000; Zhu et al., 2000), which indicate that the larger the firm themore likely it is to have a formal organizational unit dealing with human resources. Thesampling criterion of companies with more than 80 employees was in fact adjusted from

an initial criterion of 200 as the semiconductor design companies were later found toinclude a few large firms and many small firms.

Data sources

Interviews and the survey method were the two main approaches used for collecting datain the study.

Interviews Data on reward and incentive compensation practices were collected fromsemi-structured interviews with HR managers. Of the 74 semiconductor design

companies listed in the directory, 38 were suitable for inclusion. 36 companies wereexcluded because five companies had closed down and 31 companies employed less than80 employees. Of the 38 companies in the sample frame, interviews were conducted with25 HR managers. It was impossible to gain access to the other 13 companies: sixcompanies refused to take part in the study; four were unable to establish effectivecontact; and three had merged with other companies. The response rate for the eligiblecases was thus 65.8 per cent. An analysis of the structural characteristics of thecompanies in the sample frame shows that the interviewed firms did not significantlydiffer from them in terms of the number of employees employed, ownership, companystatus, and company activity. HR managers were asked to indicate whether certain rewardand incentive compensation practices had been implemented in the companies, the

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reasons and purposes for employing or not employing certain practices, and theapproaches they used to implement certain practices.

Survey questionnaires In addition to interviews, three different questionnaires wereused to collect data: (1) the Company and Employee Profile Questionnaire (CEPQ); (2)the Management Practices and Organizational Performance Survey (MPOPS); and (3) theEmployee Opinion Survey (EOS). The CEPQ was designed to gain information abouteach companys foundation year, company ownership, the employee profile, etc., andwas completed by HR managers at the end of the interviews. Organizational performancedata were collected through the use of the MPOPS, which was completed by a senioroperations manager in each company. Senior operations managers are suitable informantsbecause they should have a better knowledge than other managers about organizationalperformance as in most cases they are accountable for their companies sales and profits.In addition to organizational performance data, the MPOPS was designed to collect

information relating to the state of market competition. To assess whether reward andincentive compensation practices have been implemented effectively, we used a separatequestionnaire, the EOS, to collect data on employees evaluation of the effectiveness ofreward and incentive compensation practices in their companies. Employee assessment iscapable of providing objective information as it collects responses from many employeesrather than one response from a single manager in each company. Furthermore,employees are more likely to provide accurate evaluation than managers as they are themain subjects of reward practices implementation. Following previous studies (e.g. Cullyet al., 1999; Wright et al., 1999; Barnard and Rodgers, 2000) that focused theinvestigation of a particular key job or the largest group of employees, employees withthe job title engineer (e.g. software engineer, layout engineer), regardless of their job

level and job nature, were chosen to be the respondents for the EOS. Engineers werechosen because they are the core workforce directly involved in producing the primarygoods or services of the organization, and because they are the largest occupational groupin the semiconductor designcompanies. Information collected from the CEPQ shows thatengineers compose around 70 to 80 per cent of the total employee population in eachsurveyed company.

The interviewed HR managers played a crucial role in the overall achievement of thefieldwork outcomes. At the end of the interviews, each interviewee was asked to fill inthe CEPQ; a total of 25 CEPQs were completed. HR managers were also invited to ask asenior operations manager who was familiar with companys overall operations results to

complete a MPOPS and then post this back to the researcher. After several follow-upphone calls, 21 sets of MPOPS were returned. In addition, the 25 HR managers wereinvited to participate in the employee opinion survey. Managers in 10 companies agreedto do so. With the help of the researchers friends and their friends who worked in thecompanies, employee surveys were conducted in a further six companies. This amountedto a total of 16 companies participating in the employee survey. In total, 2,188 sets ofquestionnaires were distributed to employees in the 16 companies. The number ofquestionnaires distributed in each company was determined by calculating the samplesize required for a 95 per cent confidence level (Anderson et al., 1994; Devore and Peck,1994). After a period of follow-up, 1,261 questionnaires were returned; and, after

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eliminating those questionnaires with more than 20 per cent of questions unanswered andthose completed by non-engineers, there were 1,129 questionnaires useable for analysis,which yielded a response rate of 51.6 per cent.

Measures

Dependent variable -- organizational performance The measurement oforganizational performance includes two subjective assessment dimensions: perceivedfinancial performance and perceived non-financial performance. The former includesmarket share, growth in sales, and profitability; and the latter covers the quality of theproduct or service, the development of a new product or service, and customersatisfaction. These aspects were adapted from previous studies including Kalleberg andMoody, 1994; Dyer and Reeves, 1995; Delaney and Huselid, 1996; Harel and Tzafrir,

1999; Huang, 2000; Fey and Bjorkman, 2001. A total of six questions were designed toassess the dependent variable. Senior operations managers were asked to evaluate howtheir companies were performing compared with competing organizations doing the samework. The answers to the questions were recorded on a five-point Likert scale rangingfrom 1 (a lot worse than average) to 5 (a lot better than average).

There are four reasons for using subjective data. First, the use of such data permits ananalysis of companies for which objective performance data are not available/accessible.Secondly, subjective measures of performance are used in similar types of research, andthe use of such measures has been shown to be fruitful (see, for example, Delaney andHuselid, 1996; Youndt et al., 1996; Cully et al., 1999; Bae et al., 2003). Thirdly, the

managers perception of organizational performance might be more valid than accountingdata because of the problem of inconsistency in accounting measurement (Cully et al.,1999). Finally, the collection of subjective performance data provides a broad perspectiveon organizational performance so that we can include not only financial but also non-financial dimensions of performance indicators.

Independent variable (1) ---the presence of reward and incentive compensationpractices During the interviews, HR managers were asked to indicate whether theyhave employed the following four practices: profit-related payment, employee share-ownership scheme, group performance-related pay and profit sharing. Their answers wererecorded as 1 if companies had implemented certain policies and practices and 0 if

they had not done so.

Independent variable (2) ---the effectiveness of reward and incentive compensationpractices The Employee Opinion Survey (EOS) was designed to collect informationrelating to the effectiveness of an organizations reward and incentive compensationpractices. Employees were asked to assess the effectiveness of the practice in theircompanies on a 1-5 Likert scale, where 1 =strongly disagree and 5 =strongly agree.An instrument of eight items was designed to investigate whether the companys rewardand incentive compensation practices were effectively linked to employees performance.

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The reward and incentive compensation practices cover both financial aspects such aspay, and non-financial aspects such as recognition and praise. The eight questions are:a. There is a strong link between how well I perform my job and the likelihood of my

receiving .recognition and praise.high performance appraisal ratings.an increase in pay/salary.promotion.

b. I am satisfied with the amount of recognition I receive when I do a good job.c. Pay increases are based on group performance rather than personal performance.d. Generally, I feel this company rewards employees who make an extra effort.e. The companys reward and incentive compensation scheme/package strongly

emphasizes employees performance.

Control variables Eight control variables were included in this study in order tocontrol the sources of potential extraneous variance: the size of the firm; the age of thefirm; ownership; the number of managers as a percentage of all employees; theunionization level; the number of competitors; the degree of market competition; and thecurrent state of the market. The first five sets of data were drawn from the CEPQ,completed by HR managers, and the rest were from the MPOPS, completed by senioroperations managers. It is to be noted that the control variable for the level ofunionization was later excluded from the statistical analysis as the findings fromfieldwork interviews revealed that there have been no trade unions in Taiwanssemiconductor industry.

Analyses and results

The relationships between organizational performance and the use of reward andincentive compensation practices (H1)

Hypotheses 1 (a)~(d), which propose positive relationships between organizationalperformance and the use of reward and incentive compensation practices, were tested bymatching and analyzing data collected from senior managers perceptions of company

performance, and interviews with HR managers. The six organizational performanceindicators were classified into two categories: financial performance (including marketshare, growth in sales, and profitability) and non-financial performance (including qualityof product or service, development of new product or service, and customer satisfaction).

The scale reliability Cronbach of the financial performance and non-financialperformance was 0.78 and 0.67 respectively. Each reward and incentive compensationpractices was coded as a dummy variable, with 1 indicating that the company hadimplemented the practice, and 0 indicating that the company had not done so. Thesehypotheses were first tested by computing correlation and then regression. However,hypothesis H1(c) was not tested, because all the surveyed companies had profit-sharing

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schemes in place. Table 1 presents descriptive statistics and Spearman correlations for allvariables. The results of correlation analysis show that the use of an employee share-ownership scheme is significantly but negatively correlated with non-financialperformance (r =-.48, p

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Table 1 Means, standard deviations and correlations for all variables

Variables Mean s.d. 1 2 3 4 5 6 7 8 9 1 Financial performance 3.59 .792 Non-financial performance 3.71 .49 .64**3 Profit-related payment .84 .37 .32 .404 Employee share-ownership scheme .83 .38 -.30 -.48* -.195 Group performance-related pay scheme .67 .48 .28 .39 .64** -.036 Log of total employment 2.27 .33 .23 .23 .24 -.36 .197 Log of company age .92 .18 -.30 -.04 .30 -.22 -.04 .298 Ownership 1.32 .48 .04 -.12 -.04 .30 .16 -.40 -.35

9 No. of managers as % of total employees 2.28 1.02 -.12 .14 -.42 .06 -.29 -.24 .07 -.0110 Number of competitors 2.68 .47 .13 -.06 .00 .17 -.22 -.06 -.15 .00 -.0811 Degree of competition 4.34 .70 -.05 -.07 -.01 .19 -.11 .46* .17 -.06 -.24 12 Current state of market 1.49 .72 .12 -.15 -.21 .37 -.40 -.15 -.16 -.28 .22

N= 21

** Correlation is significant at the 0.01 level (2-tailed).

* Correlation is significant at the 0.05 level (2-tailed).

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The results of correlation analysis provided preliminary observations for hypotheses-testing.Each of the hypotheses was further tested using ordered probit regression analysis. This methodserves as an appropriate framework for statistical analysis because of the ordinal character of thedependent variables (Daykin and Moffatt, 2002; Greene, 2002; Kennedy, 2003; Koop, 2004). Tosee whether the null hypotheses of no association with performance could be rejected, thefollowing two-step procedures were used in the six regressions, three predicting financialperformance and three predicting non-financial performance. In the first step, the set of controlvariables and each of the three reward and incentive compensation practices were entered into aregression equation. The results for these regressions are reported in Table 2.

Table 2 Summary of ordered probit regression results for organizationalperformance (1)

Financialperformance

Non-financialperformanceVariable

Coef. St.Err. b/St.Er. Coef. St.Err. b/St.Er.

Profit-related payment scheme 2.78 1.59 1.75 3.25 1.74 1.87Employee share-ownership scheme -2.27 1.97 -1.15 -2.41 1.68 -1.44Group performance-related pay scheme 1.15 1.24 1.22 1.00 1.03 .98

N=21** Significant at the 0.01 level.* Significant at the 0.05 level (2-tailed).

The regressions include the following control variables: total number of employees, company age, ownership, the number ofmanagers as a percentage of all employees, number of competitors, degree of competition, and current state of the market.

The regression results show a different picture from the results of correlation analysis presentedearlier. Of the six possible combinations, none is statistically significant. The results show thatthose independent variables we hypothesize as having a positive association with performanceturn out to be statistically insignificant. One possible reason for this is that some controlvariables pick up the effect of these independent variables. To see whether this is the case, in thesecond step, we repeated the analyses in step one after removing those control variables withb/St.Er

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Table 3 Summary of ordered probit regression results for organizationalperformance (2)

Financialperformance

Non-financialperformanceVariable

Coef. St.Err. b/St.Er. Coef. St.Err. b/St.Er.

Profit-related payment scheme 2.66* 1.27 2.10 3.15* 1.41 2.23Employee share-ownership scheme -1.77 1.19 -1.49 -2.44 1.36 -1.79Group performance-related pay scheme 1.20 1.03 1.17 .87 .87 1.00

N=21** Significant at the 0.01 level.* Significant at the 0.05 level (2-tailed).The regressions for financial performance include the following control variables: total number of employees, company age, thenumber of managers as a percentage of all employees, and current state of the market (profit-related payment); company age andcurrent state of the market (employee share-ownership scheme); total number of employees, company age, the number of

managers as a percentage of all employees, and current state of the market (group performance-related pay scheme). Theregressions for non-financial performance include the following control variables: total number of employees, company age, thenumber of managers as a percentage of all employees, and current state of the market (profit-related payment); total number ofemployees, company age and the number of managers as a percentage of all employees (employee share-ownership scheme);

total number of employees (group performance-related pay scheme).

The relationships between organizational performance and the effective use of reward andincentive compensation practices (H2)

The data used for the measures of the effectiveness of reward and incentive compensation

practices were drawn from employee opinion surveys in 16 companies. The descriptive statisticsand scale reliability of the dependent variables and independent variables are shown in Table 4.The scales all have Cronbachs Alphas above 0.7, except for one item, non-financialperformance, which is slightly below 0.7. The survey results show that employees were positivein their evaluation of reward and incentive compensation practices in their companies. Theyrecord a mean score of 3.93.

Table 4 Descriptive statistics and scale reliabilities for thedependent and independent variables

Scale namesNumber

of items

Cronbach

Alpha Mean s.d.

Financial performance 3 .78 3.61 .63Non-financial performance 3 .67 4.03 .70Reward and incentive compensation 8 .87 3.93 .63

Notes: The figures for dependent variables (financial performance and non-financial performance) are based on 16 senior

operations managers perceptions of company performance. The figure for independent variable (reward and incentive

compensation) is based on responses from 1,113 employees.

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To examine the association between organizational performance and individual-level assessmentof reward and incentive compensation practices, the ideal approach -- before analyzing the data -- is to aggregate individual-level data to the company level. However, there are two reasons whythis study does not follow this procedure. First, in our analysis of how individual characteristicsand company-level factors are associated with employees assessment of the effectiveness ofreward and incentive compensation practices, it was found that employees evaluation of theeffectiveness of the practices was affected not only by company-level factors such as companysize, but also by employees individual characteristics such as age and length of service. Thedivergent assessments within a company would make the aggregation approach unjustifiable. Ithas been suggested that a minimum degree of consensus among the respondents in the groupshould be ensured to perform aggregation (J ames, 1982; Joyce and Slocum, 1984). Secondly, asthe 1,129 returned, usable questionnaires were collected from only 16 companies, the statisticalsignificance may be less reflective of the real significance because of the small sample size (Hairet al., 1998). Due to the above considerations, cross-tabulation analysis rather than regression

was employed to analyze the data. The cross-tabulation analysis was combined with theSpearman R test to uncover the strength of association between dependent variables andindependent variables (Siegel and Castellan, 1988). It is to be noted that the question items foreach scale were transformed to a summary measure to suit cross-tabulation analysis.

The results of hypotheses testing are summarized and shown in Table 5. Of the two tests, apositive and significant correlation is found between financial performance and reward andincentive compensation (r = .165, p< .01). Based on the statistical result, partial support isprovided for Hypothesis H2, as the practices proposed in the hypothesis is correlated with onlyone dimension of organizational performance.

Table 5 The results of Spearman correlation tests on organizational performance andemployees evaluation of the effectiveness of reward and incentive compensation practices

Variables Spearman R Sig. Level

Financial performance/ Reward and incentive compensation .165 **Non-financial performance/ Reward and incentive compensation -.056

** Significant at the 0.01 level.* Significant at the 0.05 level.

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Discussion

This study tests two sets of hypotheses that propose a positive association between organisationalperformance and (1) the use of reward and incentive compensation practices; and (2) theeffective use of reward and incentive compensation practices. The results of the statisticalanalysis show that, in the context of the Taiwanese semiconductor design industry, the use of aprofit-related payment scheme is positively and significantly related to organizationalperformance; and that the effective use of reward and incentive compensation is positivelyrelated to financial performance. The results of the study indicate that companies using a profit-related payment scheme are more likely to perform better in terms of both financial and non-financial performance than companies that do not use such a scheme; and, that companies whichare effective in the use of reward and incentive compensation perform better than othercompanies. The research findings support the commonly held notion that the effective use ofreward practices has the potential to increase organizational performance; thus, it isrecommended that managers should give special attention to how best to employ such practicesto attract and retain talented individuals; and how to effectively incorporate performance-basedpayment into their reward system to strengthen the ties between pay and employeesperformance.

Nevertheless, some scholars suggest that performance-linked compensation practices have theirdrawbacks. The findings of Decis (1976) extensive experimental research on the associationbetween rewards and motivation show that monetary rewards do not always increase peoplesmotivation to perform. He indicates that contingent monetary payments are an extrinsic controlsystem that makes people less willing to perform in the absence of external rewards, as monetaryrewards have been perceived as the reason for performing tasks. By contrast, intrinsic rewards,

such as positive feedback, praise, interpersonal supportiveness, motivate people to performthrough ego-involvement and a desire to perform competently (Deci, 1976: 71). Lawler (1983)also indicates that performance-linked monetary rewards are based on extrinsic rather thanintrinsic rewards, which might have a negative impact on workforce stability and a companyslong-term development. Indeed, many HR managers indicated that a high employee turnover rateis a serious issue in the industry, as profitable firms are more likely than less profitable firms tooperate incentive compensation schemes that cater for the interests of employees. Therefore, it isrecommended that, in addition to rewarding employees with a good pay package, companiesshould also apply non-monetary rewards to recognize good performers in order to promoteemployees self-esteem and organizational commitment. Areas like achievement, recognition,responsibility, job discretion and personal growth are examples of non-financial rewards (De

Cenzo and Robbins, 1994; Lewis, 2001) that can provide employees with intrinsic rewards andcan have a profound impact on employee behaviour.

As with any empirical research, the present study has some limitations. We identify three mainlimitations and wish to propose some suggestions for future research. The first limitation of thisstudy is that causality cannot be definitively determined. Due to the cross-sectional researchdesign, the direction of the relationship between variables is uncertain. To gain a clearerunderstanding of the causal relationship between reward and incentive compensation practicesand organizational performance, a longitudinal design is ideally required for future research. The

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second limitation concerns the potential generalizability problems. Since the study investigatesonly a single sector, the findings may only reflect the sector under study and may only be validfor hi-tech economies. We suggest that similar research is needed for other industries in Taiwanand other countries, both hi-tech and non hi-tech, in order to extend the findings of this study. Afurther area of limitation concerns the measurement of the dependent variable. This study hasrelied on senior operations managers perceptions of organizational performance. Such asubjective measurement might suffer from potential response bias, although it did at least allowus to include companies where objective financial data were not available or accessible, and tomeasure not only the financial dimension of corporate performance but also non-financialperformance indicators including customer satisfaction, the development of new products orservices, and the quality of products or services. Future research should, where possible,incorporate both self-report data and objective financial data in order to make the measure oforganizational performance more comprehensive and reliable.

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