Pay-for-Performance: An International Comparison - Bachelor of Science Business Administration Thesis

Pay-for-Performance: An International Comparison - Bachelor of Science Business Administration Thesis

Table of Contents
Table of Contents II
List of Abbreviations III
List of Figures IV
List of Tables V
1 Introduction 1
2 Pay-for-Performance: an Overview 2
2.1 Pay-for-Performance and Variable Compensation Defined 2
2.2 Types of Pay-for-Performance 3
2.3 Pay-for-Performance: Controversies 5
3 Theoretical Framework 7
3.1 Introduction to G. Hofstede’s cultural dimensions 7
3.2 Propositions of R. S. Schuler and N. Rogovsky 9
4 Pay-for-Performance in Germany 9
4.1 The German Culture: Description 9
4.2 Description of Pay-for-Performance in Germany 10
5 Pay-for-Performance in the USA 13
5.1 The Culture of the USA: Description 13
5.2 Description of Pay-for-Performance in the USA 14
6 Pay-for-Performance in China 17
6.1 The Chinese Culture: Description 17
6.2 Description of Pay-for-Performance in China 19
7 Conclusion 22
References VII

List of Abbreviations
e. g. exempli gratia
ed. editor
eds. editors
et al. et alii
etc. et cetera
i.e. id est
Iss. issue
p. page
pp. pages
URL Uniform Resource Locator
Vol. volume

1 Introduction
Employee remuneration is probably one of the most important aspects of Human Resource Management. An effective and efficient compensation system is vital for a company aiming at achieving a sustainable competitive advantage. The design of a compensation system becomes even more difficult once a company operates in more than one country, e.g. in case of multinational corporations, as the compensation system appropriate for employees in one country might not be appropriate for employees in another one. Therefore, it is important to be aware of the country-specific differences in the compensation practices.
The aim of this scientific work is to provide an international comparison of pay-for-performance compensation, since it occupies an important place in contemporary employee remuneration. The focus of this paper is on white-collar employees and executives. Moreover, only cultural aspects influencing pay-for-performance in a specified country are considered. Thus, the legal, natural, political and economic environments are not taken into account.
In the second section of this work a brief overview of pay-for-performance is provided. First of all, the basic definitions of pay-for-performance and variable pay are to be clarified as they are often confused. Secondly, the types of pay-for-performance compensation plans are described. Thirdly, the controversial issues around pay-for-performance are presented.
The third part will provide an introduction to the theoretical framework on the basis of which the usage of pay-for-performance in different countries in the sections four, five and six will be analyzed. The theoretical framework is built on three cultural dimensions of G. Hofstede and on the propositions of R. S. Schuler and N. Rogovsky.
Furthermore, in the fourth, fifth and sixth sections the data on pay-for-performance compensation in Germany, the USA and China will be examined, since these countries play an important role in global economy and the cultural differences between them are significant.
In the end, the seventh section will provide a brief summary of the most important aspects of this scientific work and discuss its limitations.
2 Pay-for-Performance: an Overview
2.1 Pay-for-Performance and Variable Compensation Defined
There are many definitions of pay-for-performance and variable compensation in the scientific literature. Thus, there is no consensus on what exactly is meant by both of these terms in the management science, which may cause confusion. For example, in German literature on employee compensation basically two kinds of terms can be found: ‘leistungsorientierte Vergütung’ and ‘ergebnisorientierte/erfolgsorientierte’ Vergütung. ‘Leistungsorientierte Vergütung’ is based on individual or collective work effort, whereas the latter one is based on figures that are influenced by external factors and thus cannot be directly attributed to an individual employee performance, e.g. an overall result of a department or of the whole enterprise, although the English term pay-for-performance, as it will be described in section 2.2, covers both of these aspects.
In this scientific work, the following definition of pay-for-performance will be assumed: pay-for-performance compensation programs are aimed at an accurate measurement of employee performance on an ongoing basis in order to secure that their pay varies in accordance with their performance. One of the main purposes of pay-for-performance is to motivate staff to perform well. It is based on the microeconomic Principal-Agent theory, according to which employees, ’agents’, are self-interested and try to keep their work efforts as low as possible. Therefore, to make sure that ‘agents’ do what is good for the company and thus for the ‘principals’, who are considered to be company’s representatives, compensation should reflect the employee’s performance.
All types of continuous cash compensation other than the base pay are regarded as variable pay. Usually, an employee is entitled to the variable compensation after having achieved specific goals, which should be measurable according to the Management by Objectives (MbO) approach in the best case.
Two main aims of variable pay are employee motivation and labour cost flexibility: both the profit-related situation of a company and each employee’s contribution to the success of the enterprise are reflected in the variable part of labour compensation.
Although pay-for-performance and variable compensation are often considered synonyms, they are not fully identical: whereas pay-for-performance compensation is always variable, not every variable compensation is performance-related, e.g. in case of hourly wages of blue-collar employees. Since the focus of this scientific work is on white-collar employees and executives, all the four terms pay-for-performance, performance-related pay, variable compensation and variable pay will be considered as synonyms.
2.2 Types of Pay-for-Performance
There are many different types of variable pay because a variable pay plan which perfectly suits for a specific organization might not be necessarily suitable for another. Generally, the following seven types of variable compensation plans can be distinguished:
• Business incentive plans evaluate and reward the performance in different layers such as company, business unit, department, plant and individual level based on financial and operating measures.
• Cash profit sharing plans put emphasis on company’s profitability as a measure of success. A fixed amount or a percentage of base pay is paid out to employees if they meet a profitability target defined before, e.g. net income. Due to the fact that cash profit sharing plans are easy to administer they are used in many companies.
• Individual performance plans. Payouts from these plans depend on individual performance, therefore they differ among employees. Most of them include provisions that comprise corporate and group objectives.
• Gain sharing or productivity plans. Employees share a percentage of cost savings achieved by a group, business unit, or organization. Gain sharing plans, which usually are self-funded, are common in production environments. The motivational effects of gain sharing plans are lower than those of the individual performance plans but higher than the motivational effects of corporate-level plans, e.g. cash profit sharing.
• Team awards. Their aim is to provide incentives to individuals working together in team or working on one project.
• Special recognition plans reward excellent individual or group performance.
• Stock option plans, which can be granted either to all employees or only to executives, allow employees to purchase company stock at a specific price during a specific period of time. If the stock value increases within this specific period, the employee has the possibility to buy the stock at the price below its market price. There are many forms of stock options and their modifications available, e.g. nonqualified stock options, incentive stock options, stock appreciation rights, restricted stocks, phantom stocks etc.
Variable pay type can be regarded as a short-term incentive or a long-term incentive according to its time horizon. The short-term incentive pay rewards performance which is measured after a period of one year or less, whereas the long-term incentive pay is oriented towards achievement of a sustainable business success. A typical example for long-term incentives are stock options.
2.3 Pay-for-Performance: Controversies
One of the main aims of variable compensation, as mentioned above, is an increase in employee motivation. According to this view, organizational members will be motivated to increase their efforts if the following conditions are fulfilled:
1. Employees understand how their actions impact the overall success of the organization.
2. Employees understand how their performance impacts their pay.
3. Employees perceive performance expectations as realistic and the reward for their efforts as material (at least as high as employee’s one month’s salary).
However, it is claimed that under certain circumstances pay-for-performance can cause an adverse effect, in particular demotivate employees and thus decrease their performance.
In order to understand the latter opinion, it is necessary to distinguish between two types of motivation: extrinsic and intrinsic.
Extrinsic motivation. If an activity is performed for the purpose of attaining a specific result other than the activity itself, it is an extrinsically motivated activity. According to the already mentioned Principal-Agent Theory as well as the Skinner’s Behaviourism Theory and the traditional economics theory individuals are extrinsically motivated, therefore money incentives, which are regarded as external incentives, can boost employee performance.
Intrinsic motivation. The activity of a person is viewed as intrinsically motivated if it is done for its own sake. An individual performs such an activity in order to feel competent and self-determining in respect to it. The reward a person receives is of internal character.
Basically, there are three reasons why an individual might perform an intrinsically motivated behaviour:
1. An activity itself is connected with pleasure for a person. An example for this would be the joy one has while reading an interesting book.
2. A feeling of happiness one has after achievement of targets a person has set himself or herself (in this case the process of achievement of an aim is not enjoyed).
3. Adherence to norms for its own sake, e.g. ethical norms or professional codes of conduct.
One of the motivational theories which places strong emphasis on intrinsic motivation is Herzberg’s motivation-hygiene theory, according to which only intrinsically motivated employees are willing to increase their performance.
Numerous laboratory experiments and field research have shown that external incentives, e.g. money incentives, may crowd out intrinsic motivation. This phenomenon is called the crowding-out effect.
It has three sub-effects:
1. Overjustification effect. Employees are not able to enjoy their work process because they think that they have less autonomy. The level of their performance might decrease if the loss of intrinsic motivation is not compensated for by external incentives.
2. Spill-over effect. Intrinsic motivation is lost not only with regards to the actual task but also with regards to other domains.
3. Multitasking effect. The employees concentrate on goals which are easily measurable and pay less attention to the fulfilment of those which are important but cannot be easily measured.
According to Frey, variable pay can be suitable for extrinsically-motivated employees only, in particular for the so-called income maximizers and status-oriented. An income maximizer aims at maximizing his or her monetary income which helps him to satisfy his needs by means of consumption of goods and services. Work itself is not connected with pleasure for an income maximizer; his efforts are only aimed at earning money. If a relationship between performance of an income maximizer and his pay is clear-cut for him, which is possible only in case of simple activities, variable pay will increase his performance. A status-oriented employee compares himself to other employees. His aim is to contrast favorably with his colleagues. A status-oriented person will be motivated by variable pay to perform better if it positively influences his status. However, he can also be motivated by non-monetary incentives.
Variable pay is regarded as not suitable for intrinsically-motivated employees: the loyals (perceive organizational aims as their own), the formalists (the correctness of the work process is very important for them), and the self-determined (concentrate themselves on their personal immaterial aims) due to the fact that it might crowd out their intrinsic motivation.
Although the impact of variable pay on employee performance is a highly controversial topic and it is not perfectly clear now whether variable pay increases or decreases a person’s motivation, it has become quite popular in recent years. However, there are dramatic differences between variable compensation practices across different countries. Pay-for-performance compensation practices in Germany, the USA and China will be examined in the following sections on the basis of the cultural dimensions of G. Hofstede and propositions of R.S. Schuler and N. Rogovsky.
3 Theoretical Framework
3.1 Introduction to G. Hofstede’s cultural dimensions
National culture has an important impact on the design of pay-for-performance compensation system of a particular country. Geert Hofstede, a prominent psychologist, developed a framework for analysis of cultural differences on the basis of data on employee values and norms. The data were collected from more than 100,000 IBM employees in 64 countries. Hofstede defined 5 cultural dimensions according to which countries can be compared: power distance, uncertainty avoidance, individualism versus collectivism, masculinity versus femininity and long-term versus short-term orientation. This thesis focuses on three of them: power distance, uncertainty avoidance and individualism versus collectivism.
Power distance measures a degree of inequality in power or influence between people, particularly a boss and a subordinate, perceived by the one who has less power compared to the other. In high-power-distance cultures the gap between rich and poor is large, whereas in low-power distance cultures differences between different societal classes are not that huge, since the government implements social welfare programs in order to reduce inequality between the members of the society. Power distance index values vary from 11 (very low power distance, Austria) to 104 (very large power distance, Malaysia).
Uncertainty avoidance indicates a degree to which people feel threatened by uncertain and risky situations. Members of societies that show a low degree of uncertainty-avoidance are easygoing and open for different beliefs and opinions. Managers in such societies are risk-taking, make decisions fast and possess an entrepreneurial spirit. Societies scoring high on uncertainty avoidance try to minimize ambiguity by laying down detailed rules; managers may be slow at decision-making. People in such societies are less tolerant to beliefs that differ from the norms of their society. The uncertainty avoidance index ranges from 8 (lowest uncertainty avoidance, Singapore) to 112 (highest uncertainty avoidance, Greece).
Individualism versus collectivism. Individualism is a tendency of people to act primarily as individuals and not as part of a group. In individualistic societies, people are more concerned with their personal success and the success of their immediate families than with the needs of the society. Contrary to that, members of collectivistic societies are committed to the goals of the group; they have a strong attachment to it. People in such societies consider their life as a cooperative experience; group harmony is of high importance for them.
3.2 Propositions of R. S. Schuler and N. Rogovsky
R. S. Schuler and N. Rogovsky developed a concept that explains how national culture influences the compensation practices in a specific country. Their propositions are based on Hofstede’s dimensions introduced above. In this scientific work, the following propositions of R. S. Schuler and N. Rogovsky will be examined:
Proposition 1. A seniority-based (depending on the time worked) or a skill-based compensation system can be typically found in countries of high uncertainty avoidance because such practices are predictable and certain from the point of view of the employees. As a consequence, pay-for-performance compensation is not widespread in such countries.
Proposition 2. Pay-for-performance compensation, especially individual incentive plans rather than team awards, are more likely to be found in individualistic cultures.
Proposition 3. Stock options and their modifications e.g. employee stock ownership plans will be available for employees in countries with relatively low power distance and uncertainty avoidance, and high individualism.
Variable compensation practices in Germany, the USA and China will be described in the following sections on the basis of Hofstede’s cultural dimensions and the three Propositions.
4 Pay-for-Performance in Germany
4.1 The German Culture: Description
The German culture is many-sided and has many subcultures: there are significant differences between the East and West Germans. In this thesis it is assumed that the characteristics of German culture described by means of Hofstede’s dimensions can be viewed as more or less typical for all Germans.
Power distance. Germany has a score of 35 in power distance dimension, which is low. This means that the subordinate can contradict his boss and it is not perceived as impolite in German companies; the leadership style is participative and spans of control are wide.
Uncertainty avoidance. Germany’s score on uncertainty avoidance is 65. Although the uncertainty avoidance index ranges from 8 to 112 and it might seem that Germany has a moderate score, Hofstede describes the German culture as a culture with strong uncertainty avoidance. Therefore, the Germans perceive clear and unambiguous principles as an important part of their life because it provides them with a sense of security they need. Moreover, they place a strong emphasis on both formal and informal rules, e.g. dress codes and the use of titles and last names.
Individualism versus collectivism. German culture scores 67 on individualism versus collectivism dimension, which indicates that German culture is neither fully individualistic nor collectivistic. Hence, the Germans strive to achieve not only their personal goals but also the goals of the group they belong to. For example, German managers are usually quite loyal to the companies their work for.
4.2 Description of Pay-for-Performance in Germany
According to the Proposition 1, pay-for-performance compensation is not likely to be found in countries scored high in uncertainty avoidance. As the score of German culture in this dimension is relatively high, it might be assumed that variable compensation is not widespread in Germany. Knebel and Femppel/Boehm support this by claiming that labor costs in German companies are more of fixed than of variable character. Contrary to their opinion, Lurse/Stockhausen and Kramarsch argue that the German compensation practices are changing dramatically and there is a strong tendency towards the use of pay-for-performance. The empirical study of Wagner et al., conducted with 500 largest German companies in the year 2001, supports the latter view. According to it, approximately 97% of enterprises have pay-for-performance compensation practices at their disposal. Variable pay accounts for 3-30% of the total compensation package; this percentage depends on the role of an employee in the enterprise and his or her ability to influence the company’s success: executives usually have a higher percentage of variable compensation in relation to their total remuneration compared to other employees (see Figure 1). As reported in the compensation survey of the Klaus Lurse Personalberatung which dates back to the year 1998, the variable part amounts to 25-40% of the managing director’s compensation, to 25-35% of the executive’s compensation and only to 10-15% of the total remuneration package of tariff-employees.

Figure 1: Share of the variable pay in the total compensation (in %).
Source: based on Wagner et al., p. 161.
Therefore, although the German culture scores relatively high in uncertainty avoidance, pay-for-performance compensation practices are quite widespread among the German enterprises. However, they might be widely used only among the largest German companies which participated in the empirical studies described above. In summary, although skill-based remuneration (reflected in the base salary whose amount is determined based on the job requirements) plays an important role in Germany, variable compensation practices are very likely to be found in German enterprises. There is almost no seniority-based pay since the principle ‘the same compensation for the same job’ is followed. This is partially contradicting Proposition 1.
As stated in Proposition 2, high individualism signalizes that pay-for-performance and especially incentives with focus on individual performance are very popular in a specified country. Germany’s score in this dimension is moderate. Hence, it might be assumed that variable compensation practices are used in German enterprises but are not that widespread as in countries with higher individualism e.g. the USA (see sections 6.1 and 6.2). Furthermore, the amount of team awards and individual performance incentives used should be nearly the same.
As described above, the pay-for-performance practices are quite popular in Germany. Moreover, there is a continual trend towards an increase in use of variable pay. It gets more and more accepted by employees. Variable compensation based on group performance is used rarer than individual performance plans (see Figure 2). Both of these findings contradict Proposition 2.

Figure 2: Percentage of individual incentive plans and team awards available.
Source: based on Wagner et al. (2005), p. 160.
Based on Proposition 3 one can conclude that stock options and their modifications are not widely used in Germany since the Germans are characterized by strong uncertainty avoidance and a moderate level of individualism. Other authors, e.g. Pennings and Clarc/Philippatos also claim that the Germans might be reluctant to use long-term incentives such as stock options or employee ownership plans because they do not tolerate uncertainty and need a sense of security.
Even in the 1990s, employee stock ownership plans and share-based remuneration of executives were not widely implemented in German companies, although there was a steady increase in the use of employee stock ownership plans since the 1970s. Whereas all the 500 largest US companies had long-term incentives at their disposal in the year 2000, less than half of German DAX enterprises used it. According to Kramarsch, the use of long-term incentives in German companies will continue to increase but it will never achieve the scope of the US companies due to a lack of acceptance in the society; variable compensation in Germany has rather a short-term orientation.
These findings support Proposition 3: stock options and their modifications are used in Germany, but they are not very widespread due to little tolerance of ambiguity which is typical for Germans.
The crowding-out effect can occur with German employees as many of them are intrinsically motivated. As a consequence, the possible adverse effects of variable pay should be considered.
5 Pay-for-Performance in the USA
5.1 The Culture of the USA: Description
Despite the fact that the US culture can be considered as a rich mix of many other cultures, it is unique and distinct.
The United States have a score of 40 in power distance dimension, which is below the world average score of 55. This indicates that equality between different societal levels exists; the US cultural values make the cooperation across different power levels possible. Organizational structures are flat; managers think that ‘subordinates are people like me’ and vice versa. There are relatively small differences in income between the members of the US society.
The US culture scores 46 on uncertainty avoidance. This score is significantly lower than the world average of 64, which indicates that the US society has fewer rules and is open to new ideas and beliefs. Changes can be implemented more easily in such a culture. US people are willing to take risks and feel comfortable in ambiguous or chaotic situations.
The US society holds the first rank in individualism versus collectivism dimension. Therefore, the US culture is extremely oriented towards individualism. As a consequence of this, the bonds between members of the US society are loose. Employees do not feel that their company is responsible for them, they are sure that everything is in their own hands. They are direct, self-confident and have a strong desire for personal success. Americans emphasize their own careers; the welfare of the organization or group is not that important for them. As a result, the members of the US society tend to be not loyal to their organizations.
5.2 Description of Pay-for-Performance in the USA
According to Proposition 1, in countries with weak uncertainty avoidance, variable compensation practices rather than seniority-based or skill-based practices tend to be employed. As described above, the US culture is characterized by a very low uncertainty avoidance index. Therefore, variable pay should be widespread in the USA.
As Packwood reports, the use of variable compensation in the US companies has significantly increased in recent years. In the early 1990s, 51% of the US enterprises implemented a variable pay plan; variable part accounted for only 3.8% of the salaried employee’s total compensation package reflecting 43% of the overall pay increase opportunity. Today, more than 80% of enterprises located in the US use pay-for-performance; the variable pay budget averages 11.1% of the overall salaried employee pay representing approximately 79% of the payroll increase opportunity. Hence, the conclusion drawn from Proposition 1 is supported: variable compensation is widely practiced in the US companies.
As stated in Proposition 2, variable pay and especially individual incentives tend to be found in the individualistic countries rather than in collectivistic ones. US culture is regarded as the most individualistic culture in the world. Consequently, variable pay and focus on individual performance in particular rather than the group or organizational performance should be widespread in the USA.
As mentioned above, pay-for-performance has become a common compensation practice in the US companies recently. The usage of variable pay components based on individual performance is also increasing: it rose by approximately 94% during the years 1996-2005 and its prevalence in the year 2005 was 33%, whereas the prevalence of awards allocated on the basis of team performance was only 9% (see Table 1 on the next page). Moreover, according to the survey of Le Blanc/Mulvey, the US employees prefer variable pay that is dependent upon their individual performance rather than the team or group performance. It shows that individual incentives are much more valued in the US culture than the collective ones. Therefore, Proposition 2 is also supported by empirical evidence.
Stock Option/
Ownership Individual Incentive
Plans Team Awards
Prevalence in 2005 37% 33% 9%
Change during 1996-2005 +76% +94% -31%

Table 1: Prevalence of pay-for-performance plan types in the US..
Source: based on Hewitt 1996-2005 Variable Compensation Measurement Survey, quoted in Abosch (2008), p. 233.
The US culture is characterized by low power distance and uncertainty avoidance, and a high degree of individualism. Hence, according to Proposition 3, stock options and other types of long-term incentives should be available for many US employees.
According to Kramarsch, long-term variable compensation components are considered as very important for the improvement of the company’s strategic situation in the USA. As reflected in Table 1, the prevalence of stock option and stock ownership plans increased by 76% during the years 1996-2005, now their prevalence in the overall variable compensation is at about 37%, which is even higher than the prevalence of the individual incentives. The 500 largest US companies listed in the S&P Index offer long-term incentives to their employees. Moreover, stock options and stock ownership plans accounted for 56% of their CEOs overall compensation in the year 1999, although they only accounted for 30% in the year 1992. According to another source, long-term incentives built up to 300% of the base salary of the US CEOs in the year 1998. However, significant variations between companies of different size and sector are possible. The most popular long-term incentives for CEOs in the US enterprises listed in the S&P Index are stock options (87% of companies use it).
Although it might seem that long-term incentives are primarily used in the compensation packages of top executives, they play an important role for middle-managers and other salaried employees as well. For example, long-term incentives of a Director of Human Resources in US companies sum up to 125,000, which is extremely high compared to the base salary of approximately 175,000. Moreover, employee stock ownership plans with 12 to 14 million employee covered in the year 1994 are also quite widespread in the US enterprises.
On the basis of this data can be concluded that long-term incentives, especially stock options, are very likely to be found in the US enterprises, which is in accordance with Proposition 3.
As in the case of Germany, some of the US employees tend to be intrinsically motivated, therefore the probability of the crowding out effect should be taken into account when designing a compensation system appropriate for the USA.

6 Pay-for-Performance in China
6.1 The Chinese Culture: Description
The Chinese culture differs substantially from cultures in other parts of the world. According to the G. Hofstede’s cultural dimensions, it can be viewed as an opposite to Western cultures.
Power distance. China scores 80 points on the power distance scale, which is very high compared to the world average of 55. This means that there are huge inequalities in power within the Chinese society, which have been legitimated by its members. Due to the impact of Confucianism this culture can be characterized by a rigid social hierarchy, i.e. high position persons have to be treated with respect; it is not polite to contradict a person if he or she has a higher position in the society. Organizational structures are hierarchical and authority is centralized, which leads to bureaucracy and a lack of efficient vertical communication.
Uncertainty avoidance. Chinese culture has a score of 40 in the uncertainty avoidance dimension. Although it may seem that China is a country with a relatively low uncertainty avoidance index, it is not that straightforward. According to Hofstede/Bond, this dimension is more applicable to the Western cultures, as the Chinese do not consider it as an important issue. Uncertainty avoidance in China can be both high and low depending on the circumstances. On the one hand, the Chinese are risk-averse and are reluctant to change; nonetheless, they are able to accept ambiguities and tolerate contradictions. Members of the Chinese society follow informal rules and try to compromise on the formal ones.
Individualism versus collectivism. China has a very low individualism score of 20 points; therefore Chinese society is considered to be highly collectivistic (communist societies are collectivistic in most cases). It means that Chinese people are more concerned with their group goals rather than their individual interests; collectivism is perceived as a citizen’s social responsibility and individualism is seen as egoism. For example, the Chinese do not use the pronoun ‘I’, a subordinate would not say ‘I think that...’ when expressing his thoughts to his superior, he or she would say ‘Your subordinate thinks that…’ as an emphasis is put on the relationship between the two. However, an individual’s own views are rarely represented. Even during the decision making in business context collective consensus is sought, as the Chinese tend to emphasize harmony in the group.
Social relationships and loyalties are of high importance for members of the Chinese society. In most interpersonal relationships, face-saving (mianzi) is the main aim. The widespread interpersonal connections of the Chinese society are called guanxi. The connection’s position is often used to get some personal benefits.
Although even Chinese sayings e.g. ‘the tree growing high above the others will be blown down by the wind’ indicate that Chinese society is very collectivistic, there is an opinion that modern Chinese society is both individualistic and collectivistic. This may be caused by the fact that since China opened up to the Western world, Chinese collectivism was influenced by the Western individualism. Another reason for the tendency towards individualism could be an improved standard of living.
6.2 Description of Pay-for-Performance in China
According to Proposition 1, high uncertainty avoidance is an indicator for the prevalence of a seniority-based or skill-based compensation system in a given country. As described in section 6.1, the Chinese can score both high and low on uncertainty avoidance dimension depending on the situation. Therefore, it is not possible to say that either seniority-based or variable compensation practices prevail in the Chinese society as both of them can be found in China.
Before the implementation of labour market reforms in the mid-1980s, work rewards were linked with the ‘iron rice bowl’ concept. ‘Iron rice bowl’ (in Chinese: Tiefanwan) is lifelong guaranteed employment, i.e. employees received pay and benefits on the basis of their tenure, their performance level was not taken into account. Tiefanwan compensation stems from Confucian philosophy that emphasizes age and seniority. The Chinese respect elder people (changbei) because they are supposed to be wiser because of their life experience. During the personnel reforms of the 1990s employee remuneration based on performance criteria was introduced, also in the public sector. Nowadays, the ‘iron rice bowl’ is fading away, not only because of economic reforms but also due to the fact that Western management philosophy influences Chinese compensation practices. For example, in the year 2002 Chiu, Wai-Mei Luk, and Li-Ping Tang reported that variable pay amounted to approximately 40% of the total pay of urban Chinese employees. However, according to Goodall and Warner, seniority-based wages, which were common in pre-reform state-owned companies, are still in use in some Chinese joint venture firms. Therefore, both seniority-based and variable compensation practices exist in enterprises located in China, which is in accordance with Proposition 1.
As stated above, although China is one of the most collectivistic countries of the world, modern Chinese society shows an increasing tendency towards individualism. Therefore, on the basis of Proposition 2, it can be predicted that variable compensation practices as well as focus on individual performance are both present in modern China as its cultural values are changing.

Compensation practices in China prior to the economic reform of the year 1978 emphasized economic equality due to the influence of socialism. According to the Communist Party ideology, large wage differences would lead to inequality within the society. Egalitarian wage policy was in place. The aim of it was to reduce the probability that an employee who has not realized his or her full potential will be discouraged from providing high efforts since it was believed that all people have the same potentiality. Thus, variable compensation was not practiced.
After 1978, wage policy was changed under the slogan ‘to each according to his work’: job level and wage category determined the basic wage, and, additionally, a bonus was introduced for the first time and thus variable compensation. However, the bonus was not based on the individual performance; it was linked to the overall performance of the enterprise. Especially in the public sector, managers resisted to implement the variable compensation policies. In many companies, all employees received equal bonuses or bonuses were issued on a rotating basis. Even when bonuses were eventually allocated, some employees rewarded for their excellent performance were not willing to take the bonuses because they feared that it may worsen the relationship between them and their fellow workers. Therefore, collectivism still influenced the employees and thus the compensation system to a high degree.
Nowadays, there is a clear tendency towards individualism in the Chinese society. As a result, variable compensation and particularly variable compensation components based on the individual performance have become more widespread. As Du/Choi and Chiu/ Wai-Mei Luk/Li-Ping Tang report, variable pay practices have been widely introduced to Chinese employees; fixed wages tend to be replaced. According to the results of an empirical study of Zheng/Morrison/O’Neil (conducted in 2001), performance-linked payment can be found in approximately 70% of small and medium-sized enterprises in China; there are significant differences in this percentage between enterprises depending on its ownership (see Table 1).
As stated in Proposition 3, stock options are more likely to be found in countries with low power distance and uncertainty avoidance, and high individualism. As described above, it is not possible to make clear statements about the degree of uncertainty avoidance and individualism in the Chinese society. However, there is no ambiguity concerning power distance dimension. China scores very high on it.
Enterprise Ownership
State related Foreign related Collective related Domestic private owned Total percentage of firms
60% 63% 64% 91% 70%

Table 2: Enterprises with the usage of pay-for-performance (in%).
Source: Based on Zheng/Morrison/ O’Neil (2001), p. 1798.
Therefore, stock options should not be widespread in China, which is supported by the fact that no listed firms in China offered stock options to their executives at the end of the year 2002. The maximum amount of stock which can be held by executives and employees is limited to 0.017% of company’s stock. However, from the year 2008, Procter & Gambles provides its employees with an opportunity to buy shares of the company. Nevertheless, it is rather an exception: long-term incentives are still not widely used in China.
The crowding-out effect is not very likely to occur with the Chinese employees since they are regarded as extremely extrinsically motivated and having the cash mentality. From this perspective, pay-for-performance is an appropriate compensation practice in China.
7 Conclusion
The scale of use of pay-for-performance compensation practices differs substantially across Germany, the USA and China due to the differences in cultural values of those countries. Nevertheless, these countries show an identical trend towards the continuous increase in the use of variable compensation. Moreover, individual performance plans seem to be very popular among the employees in all three countries, which is surprising since cultures of Germany, the USA and China are very different.
The statistical data were not supporting the propositions of N. Schuler and R. S. Rogovsky in all cases. This might be due to the fact that they were not tested empirically. Another reason could be the drawbacks of the G. Hofstede’s theory. First of all, his survey is based on employee responses from only one company, namely the IBM, which raises a question about the representativeness of it. Secondly, his study does not take into account the cultural differences existing within one country. Thirdly, since the research of G. Hofstede dates back to the 1960s, it might be assumed that the cultural values of societies have changed, e.g. as described in section 6.1 China has become more individualistic.
The propositions of N. Schuler and R. S. Rogovsky are based on the assumption that only culture impacts the pay-for-performance practices in a specified country. However, it is also impacted by economic and political environment as well as legal and other issues. For example, tariff regulations impact the use of pay-for-performance in Germany significantly. Still, these propositions together with the G. Hofstede’s cultural dimensions can be a useful tool for managers trying to design a compensation system which will be well-accepted in a specified country.

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