Toward a Contingency Theory of Compensation Strategy

Author(s): David B. Balkin and Luis R. Gomez-Mejia

Source: Strategic Management Journal, Vol. 8, No. 2 (Mar. - Apr., 1987), pp. 169-182
Published by: Wiley
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Strategic Management Journal, Vol. 8, 169-182 (1987)

TOWARD A CONTINGENCY THEORY OF

COMPENSATION STRATEGY
DAVID B. BALKIN
Department of Management, Louisiana State University, Baton Rouge, Louisiana,
U.S.A.

LUIS R. GOMEZ-MEJIA
Graduate School of Business Administration, University of Colorado, Boulder,
Colorado, U.S.A.

This paper develops several propositions that link compensation strategy and the effectiveness
of the compensation systenm. The underlying argument is that effectiveness at realizing
intended pay strategies depends significantly on the existence of a match between compensation
strategies, organization and environment. These propositions are tested in a samiple of
33 high.tech and 72 non-high tech firms or business units in the Boston Route 128 area.
Respondents are nmanagers responsible for compensation policies in these firms or business
units. The relationships among compensation strategies, organization characteristics and
environment are explored. The findings nmay help researchers conceptualize, and practitioners
manage, the relationship between reward processes and strategy in organizations.

The consistency with which systematic relation-

level rests on two assumptions. First, this would

ships have been discovered between organiz-

require a smaller, less complex set of variables

ational characteristics and strategy at the overall

than would be the case if differences in organiz-

firm level would lead one to expect the existence

ation subunits (e.g. by function) are considered.

of a similar relationship with the organization's

Second, and equally important, it was believed

compensation system. To date, very little work

that over the long run a firm could not be

has been done in developing a contingency theory

successful in its compensation strategies as the

that ties the pay system to the organization's

subunit level unless these are designed to reinforce

operating objectives and strategies. This is surpris-

the strategies adopted by the entire organization.

ing in view of the fact that labor costs comprise

For example, a business firm may consist of a

more than half of total costs in most organizations,

young, high tech subunit that is rapidly growing

and that pay systems are pivotal in terms of the

and a mature, manufacturing subunit that is

motivation, attraction, and retention of human

profitable and slowly growing. The overall com-

resources (Lawler, 1981). As argued by Milkovich

pany strategy may involve using some of the

and Newman most compensation research tends

profits from the mature subunit to finance the

to emphasize techniques 'where the mechanics

research and development and expansion of the

become the focus, ends in themselves . . . the

high tech subunit. To support the strategy, each

purposes of the pay system are often forgot-

subunit may need to implement different forms

ten . . . to date we really do not know enough

of compensation packages.

to recommend [pay] policies under different

conditions' (1984: 11).

After a review of the relevant literature this

paper develops a set of propositions regarding

The purpose of this paper is to take some first

the choice and effectiveness of compensation

steps in the development of a contingency theory

strategies under various conditions. These prop-

of compensation strategy at the orgainizational

ositions are then tested in a sample of 33 high

level. The decision to concentrate on the macro-

tech and 72 non-high tech firms or business units

0143-2095/87/020169-14$07.00

(C 1987 by John Wiley & Sons, Ltd.

Received 4 February 1985

Revised 10 March 1986

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170 D. B. Balkin and L. R. Gomez-Mejia

in the Boston area. The article concludes with

the Japanese in a global marketplace, and the

an assessment of the potential significance of

changing world of a high-technology, service-

contingency theories of compensation and next

based economy have placed increased emphasis

steps involved in the development of such

on improved human resource management as a

theories.

means of restoring the competitive edge for U.S.

corporations (Miles and Snow, 1984). This
strategic human resource management perspective views people,-as much as capital, buildings

THEORETICAL FRAMEWORK AND

or equipment-as an important source of strategic

HYPOTHESIS

opportunities and constraints, and it recognizes

Perhaps the oldest line of inquiry focusing on

strengths and weaknesses that should be factored

that a firm's human resources have certain

the relationship between organizational strategies

into corporate strategies (Dyer, 1983). One of

and reward systems may be found in the executive

the weaknesses of human resources professionals

compensation literature (e.g. Baumol, 1959;

in some organizations is their focus on solving

McGuire, Chiu, and Elbing, 1962; Roberts,

operational, day-to-day problems and a lack of

1959). Economic research linking organization

understanding of broader, strategic business

performance with executive compensation has

issues that look at the long-run situation (Tichy,

led to mixed results (Fox, 1980; McEachern,

1983). Consequently, human resources depart-

1975; Rich and Larson, 1984). Many behavioral

ments in these organizations are reactive, fire-

scientists have contended that it is crucial for

fighting departments and are not as effective as

executives to be motivated by an appropriate

they could be.

reward package to further company goals (e.g.

Compensation is considered an important

Lawler, 1986; Salter, 1973). Unfortunately, com-

part of the strategic thrust of human resource

pensation packages intended to motivate execu-

management. In the recent work of Beer et al.

tives frequently fail (Patton, 1972; Pearce, 1986).

(1985) compensation (referred to as reward

Some of the reasons executives are not motivated

systems) is one of four major policy areas of

to perform in harmony with corporate objectives

human resources about which all general man-

are due to flaws in the design of the compensation

agers must become knowledgeable. The other

system or poor administration of the rewards. It

policy areas are employee influence, human

has been argued that certain conditions must be

resource flow and work systems.

taken into account when designing such a system.

Human resource management practices (includ-

For example, executive performance is more

ing compensation) may give a competitive advan-

effective when the reward package strikes a

tage to one corporation over its rivals (Schuler

balance between long-term and short-term goals

and MacMillan, 1984). For instance, People

(Rappaport, 1978); recognizes the executive who

Express and Lincoln Electric use compensation

takes risks (Salter, 1973); takes into consideration

practices to gain a cost-efficiency advantage over

executives' preferences for direct pay, deferred

their competitors. At Hewlett-Packard, on the

income and benefits (Lewellen and Lanser, 1973);

other hand, entrepreneurial behavior and inno-

and relates executive pay to meaningful financial

vation are stimulated by using incentive compen-

measures of corporate performance (Murthy and

sation policies that reward success (Schuler and

Salter, 1975).

MacMillan, 1984). In both of these situations the

A broader and more recent literature advocates

compensation policies help drive the overall

that human resource strategy (including pay)

business strategy, which may be dominated by

should be treated as an integral component of

cost-efficiency at Lincoln Electric or innovation

corporate strategy. Changes in the business

at Hewlett-Packard.

environment have made it necessary for top

For the most part, neither stream of research

executives to elevate the status of human resource

noted above focuses its attention on macro-

departments and include a human resource

organizational factors affecting pay strategies and

management perspective in the formulation of

how the interaction impacts the effectiveness of

corporate policies (Devanna, Fombrun, and

Tichy, 1981). The challenge of competing with

the compensation system. It is the authors'

contention, discussed throughout the rest of this

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Contingency Theory of Compensation Strategy 171

paper, that a contingency framework can deepen

normally led by entrepreneurs who set the tone

our understanding of this process.

for the organization. They are risking their capital

The conceptual root of the contingency perspec-

and assests in a fledgling business, and would

tive is that effectiveness at realizing intended

rather work with other individuals who are willing

strategies depends significantly on the existence

to trade off job security and immediate rewards

of a match among strategy, organization and

for the expected utility of anticipated growth.

environment. Originally advanced by Chandler

When firms enter the mature stage, leading

(1962), such a contingency approach has been

entrepreneurs tend to remove themselves from

extended and reinforced by such researchers as

the operational functions of the business and

Anderson and Zeithaml (1984), Fouraker and

Stopford (1968), Lawrence and Lorsch (1967),

develop a more routine administrative system.

Rumelt (1974), and Vancil (1980).

New products as a percentage of sales declines,

Of the contingency variables investigated to

allow professional managers to take over and

and product research and development expenses

date at the macro-level, most attention has been

as a percentage of revenues drop rapidly from

devoted to the product life cycle. Research in

growth to maturity (Anderson and Zeithaml,

marketing as well as in strategic management

1984). The task environment becomes more

indicates that stage in the product life cycle is a

predictable, market share is relatively stable,

fundamental variable affecting organizational

there are greater economies of scale, and the

strategy and its effectiveness (see Anderson and

rate of change in the state of the art is much

Zeithaml, 1984; Rink and Swan, 1979; and

lower (Hofer, 1975).

Day, 1981, for a comprehensive review of this

The stage in the life cycle is likely to be a key

literature). Hofer (1975) developed the most

determinant of compensation strategies and their

extensive theoretical profile of the product

effectiveness in achieving organizational goals.

life cycle as it affects business strategy. Two

One would expect those firms at the growth stage

propositions suggested by Hofer have received

to pay employees more in the form of an incentive

widespread empirical support:

basis and less in the form of salary and benefits.

The most fundamental variable in determin-

ing an appropriate business strategy is the

Such a policy would allow a growing business to

shift some of its compensation costs from a fixed
expense to a variable expense. The advantage of

stage in the product life cycle (1975: 798).

this strategy is that the firm receives float from

Major changes in business strategy are

employees and pays a portion of its compensation

usually required during three stages of the

product life cycle: introduction, maturity
and decline (1975: 795).
Organizations whose main products are at the

costs when it is in the best financial position to

do so. The incentives are paid to employees

when the financial or other strategic objectives

have been reached. As a result, the growing firm
can secure greater flexibility to invest heavily in

growth stage are faced with high rates of

research and development, new technology,

technological change (Hofer, 1975), suffer from

expansion of capacity, marketing and advertising

high mortality rates (Bell, 1982), are highly

(instead of additional compensation) to fuel

the growth. Employees, under an incentive

dependent on new product innovations to get

and more responsive to market trends and

compensation policy, are invited to be risk-takers

and share in the anticipated profits of future

shifts since fixed costs involving standardized

growth with the owners. Thus, incentive pay

established in particular industries (Tilles, 1966),

technology are relatively high as compared to

policies for firms in the growth stage of the

more mature firms (Morison, 1966). These firms

product life cycle function not only to finance

also face an uncertain environment requiring

future growth but also to motivate individual and

greater willingness to take risks and greater

tolerance for ambiguity (Gupta and Govindara-

group performance.

jan, 1984). In their socio-technical system, firms

at the growth stage are more likely to attract

Further, firms at the growth stage are expected

to find pay incentives to be more effective than
those at the mature stage of the product life

younger, more risk-taking managerial and techni-

cycle. Firms with mature products are more likely

cal personnel (Ettlie, 1983). These firms are

to be operating in more stable environments

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172 D. B. Balkin and L. R. Gomez-Mejia

where risk and anticipated growth are reduced.

centralization and standardization. With the

Mature firms are more apt to set up an

exception of top executives, each position in a

administrative structure for the compensation

larger company tends to be remunerated based

system which is less based on incentives and

on a fixed scale corresponding to its place in the

more mechanistic, emphasizing the fixed pay

job evaluation hierarchy. In terms of company

components (salary and benefits) established

culture, smaller firms are more entrepreneurial

through a formal job evaluation process. In other

and individuals less concerned with security

words, a greater reliance on incentives for

(Ettlie, 1983). Such an organizational climate is

growing firms should be more effective than in

more receptive to a reliance on variable rather

mature companies (whose markets and products

than a fixed compensation strategy. This is the

are stable) since an emphasis on unit and

rationale for propositions 3 and 4:

individual performance fits in with the organization's strategy and the risk taking nature of its

Proposition 3: The proportion of fixed com-

sociotechnical system. This is the rationale for

pensation costs in the total pay package will

propositions 1 and 2:

increase as a function of organizational size.

Propositioni 4: The effectiveness of an incent-

Proposition 1: Incentive pay as a proportion

ive-based reward strategy will be inversely

of the total compensation package will be

related to company size.

greater for firms at the growth stage of the

product life cycle.

Compensation strategies are likely to be influ-

Proposition 2: An incentive-based reward

enced not only by firm characteristics (e.g. stage

strategy will be more effective for firms at the

in life cycle and size) but also by industry traits.

growth stage of the product cycle.

One key industry factor is the extent to which

technological innovations and R&D success are

A second variable which is likely to affect

necessary for survival in a highly competitive

the choice and effectiveness of compensation

environment. In this paper we will focus our

strategies is the size of the firm. Financially,

attention on the high tech industries in relation

smaller firms are less able to afford fixed

to non-high tech industries, and develop a set of

cost expenditures. By providing a lower base

propositions based on characteristics of these two

compensation (which is a significant fixed cost in

different clusters of industries. High tech was

the short run) in exchange for an array of

selected because of its unique compensation

incentive pay programs, smaller companies can

practices (Balkin and Gomez-Mejia, 1985) and

buffer themselves against short-term financial

its human resource departments are involved in

pressures. Such a policy enables smaller firms to

the formulation of corporate strategy (Miles and

compete against larger firms in the product

Snow, 1984). High tech includes firms or business

market, without weakening their cash flow

units engaged in the production of computers,

position. Administratively smaller companies can

silicon chips, telecommunications, computer soft-

institute and manage incentive systems more

ware, artificial intelligence, technical instruments

efficiently than larger firms. For these smaller

and bioengineering products. The Boston Route

firms the number of positions are fewer, pay

128 area, where the data for this study were

comparisons are simpler, operations are normally

collected, has a heavy concentration of computer-

in a single plant or location, and performance

and electronics-related companies. Many of these

indicators easier to obtain. As the firm grows in

firms were started by former MIT students or

size it also becomes more complex in terms

faculty. The Massachusetts High Tech Council,

of salary grade levels, management structure,

an employers' association for many Boston high

product and market differentiation, and geo-

tech firms, defines high tech as a firm that spends

graphical dispersion, so that incentive systems

5 percent or more of its annual sales revenues

are more difficult to design, implement and

on R&D. While the decision to spend resources

control. Larger firms tend to develop bureaucratic

on R&D is a combination industry trait and

job evaluation schemes, where individual pay

decisions are made within a systematic and

strategic decision within the firm, the investigato

decided to use the Massachusetts High Tech

algorithmic framework emphasizing consistency,

Council method of identifying high tech due to

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Contingency Theory of Compensation Strategy 173

its simplicity and general acceptance within a

often insist that management adopt incentive-

significant portion of the high tech industries.

based compensation policies. They reason that

Also, this criterion led to meaningful results

their investments in the firm are less likely to go

when the empirical analysis was conducted (see

sour if persons with the skills critical to success

have a substantial upside potential if they stay

Results section).
High tech firms are characterized by (a) a high

with the firm, through an equity interest. Among

proportion of scientists and engineers in the work

a random sample of American firms, Gomez-

force; (b) geographic concentration in corridors

Mejia, Tosi, and Hinkin (1986) found that

such as Silicon Valley or Route 128 in Boston; (c)

externally controlled firms tend to pay managers

high expenditures on research and development

more on the basis of bonuses and long-term

focused at products at the cutting edge of

income rather than salary. Fourth, not only

technology; (d) rapid rates of technological

should pay programs be tailored to organization

change; (e) a very tight labor market for scientists

strategies and objectives, but they should also be

and engineers, with resulting high attrition rates

congruent with the organization's culture and

since there is little time for in-house training so

other firms. Geographic concentration adds to

values. In high tech, an entrepreneurial culture

nurtures the notion that rewards should be closely
tied to performance and that incentive attainments

this problem because relocation costs are minimal;

are a measure of personal achievement.

that these individuals must be attracted from

and (f) entrepreneurship, as many of these firrns

Thus, in addition to the main effects of stage in

are led by an entrepreneur who obtains financial

the life cycle and size on compensation strategies,

support from venture capitalists who usually

high tech firms will have their own unique

retain a piece of the company (Balkin and

stamp on pay policies. The above arguments are

Gomez-Mejia, 1985).

summarized in the following six propositions:

Incentive pay as a proportion of total compen-

more effective in this industry. First, most high

Proposition 5: The compensation mix in high

tech firms will contain a higher proportion of
incentive rewards anid a lower proportion of

tech entrepreneurs have already relinquished a

fixed pay.

substantial portion of the firm to the venture

place, of course, under very risky conditions to

Proposition 6: Considering all firms at the

growth stage of the product life cycle, those
that are high tech will have a pay mix with a
greater incentive component.
Proposition 7: Smaller high tech firms will
have a pay mix with a greater incentive
component than similar nion-high tech firms.
Proposition 8: An incentive-based compensation strategy will be more effective in high
tech firms than in non-high tech companies.
Proposition 9: For organizations at the growth
stage in the product life cycle, an incentivebased reward strategy will be most effective for

the employee because the mortality rate in the

high tech firms.

industry is exceedingly high.) Third, high tech

companies often rely on venture capital for

Proposition 10: For smaller companies, an

incentive-based reward strategy will be most

financing with an expected payback period of

effective for those which are high tech.

sation should be higher in high tech firms, and

the use of an incentive-based strategy should be

capitalist so that equity sharing is already an

established practice. It would be reasonable for

the owner to provide employees with some equity

in the new venture to compensate them for the

high risks they are assuming. Second, because of
the 'pirating' problem, high tech firms must

provide strong incentives to key contributors.

The lure of the 'brass ring' is used in the industry
to entice and retain scientists and engineers

through a pay system that promises extraordinary

financial benefits if the firm succeeds. (This takes

about 5 years, typically accompanied by an initial

public offering of company stock. Rapid growth
is anticipated during this period and pay incentives

are expected to play an important role in

motivating employees to achieve company objectives. The venture capitalists, in their role as
consultants with a vested interest in the company,

METHOD
Sample and data collection procedures

The sample of firms used in the study consists

of high tech and non-high tech companies from

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174 D. B. Balkin and L. R. Gomez-Mejia

the Route 128 'technology center', Boston,

sample and the Massachusetts High Tech Council

Massachusetts. Over 150 managers responsible

member list as both having around 60 percent

for compensation policies were interviewed in

electronics and instruments-producing firms as

person and by telephone to identify a representa-

evidence that our high tech sample is representa-

tive sample of companies in the area. The titles

tive of the types of firms that are in the Boston

of these managers ranged from compensation

Route 128 High Tech Center. While the study

manager and director of compensation in the

sample is representative of the high tech firms

larger firms to vice-president of human resources,

along Route 128, these firms are not necessarily

director of human resources and vice-president

representative of high tech firms nationwide. In

of finance in the smaller firms. The latter group

particular there is a very real possibility that

associated with the smaller firms did work in

pharmaceutical firms, which are heavily rep-

compensation along with a broader set of duties

resented in the Midwest, may well be under-

for their companies. Despite the broader set

represented along Route 128.

of demands placed on these individuals, a

The data collection tool used in the study was

representative sample of respondents from small

developed based on an extensive library search

firms participated in the survey. Two hundred

and in-plant inverviews with over 100 managers

and twenty-three firms or business units of larger

responsible for compensation policies in these

companies were chosen that met the following

companies. The survey was pre-tested with a

conditions: (a) scientists and engineers constitute

sample of these managers to ensure that it was

at least 3 percent of the employee population in

complete, easy to follow, and that the items were

each firm; (b) all firms were physically located

not ambiguous. The survey, conducted through

within a 70 mile radius to control for environmen-

the mail in August 1983, included questions

tal differences, e.g., cost of living, unemployment

pertaining to organizational characteristics, com-

rate, ease of mobility; (c) all firms had at

pensation strategies, and pay effectiveness. The

least one R&D unit; and (d) cross-sectional

questionnaires were completed by 105 respon-

representation in terms of stage, size, high tech

dents who were responsible for compensation

status, and main product lines.

Of the 223 firms or business units selected for

policies. The measures are described in more

detail below.

the study, 105 (47 percent) agreed to participate

in the project in exchange for a free copy of the

tech report. All participants were promised strict

Organizational characteristics

confidentiality of any information provided to

The organizational characteristics measured refer

the researchers. The resulting sample distribution

to the firm for single-business companies. For

consisted of 33 'high tech' and 72 'traditional'

diversified companies with multiple business

(non-high tech) firms or business units. This

units, the organizational characteristics measured

distinction was used to test those hypotheses

refer to the business unit. For example, stage in

pertaining to the unique effects of industry traits

product life cycle and sales revenues refer to the

on compensation strategies and their effectiveness.

participating firm if it is a one-business company,

The sample of 33 high tech companies was

but refer to the participating business unit if it

representative of the types of high tech product

belongs to a larger diversified company. In this

lines produced in the Boston Route 128 High

manner the corresponding measures for small

Tech Center. The high tech sample consisted of

organizations would be comparable to those of

64 percent firms whose product lines were in the

business units in larger, complex organizations.

electronics or technical instruments industries and

only 36 percent firms whose product lines were

drugs, chemicals or 'other'. An analysis of the
membership list of the Massachusetts High Tech
Council, an employer association that represents
all high tech industries in Massachusetts, revealed
that 62 percent of its members were producing

High tech vs. traditional firms

A company or business unit was defined as high

tech if its annual research and development
budget is 5 percent or more of its sales revenues.
This is the Massachusetts High Technology

either electronics or technical instrument prod-

Council definition of a high tech firm. This

ucts. We view the fact that the high tech

measure was treated as a 0/1 dummy variable.

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Contingency Theory of Compensation Strategy 175

Stage in product life cycle
This variable was defined in a manner similar to

that of Hambrick (1981, 1983) and Hofer (1975).

A company or business unit's stage was coded
into a dummy variable according to one of the
following categories (as designated by respondents):

1. Mature stage: products or services familiar

to vast majority of prospective users. Technology and competitive structure are reasonably stable.

2. Growth stage: sales growing at 20 percent

or more annually in real terms. Technology

and competitive structure are still changing.

over total compensation for each firm. This

operational definition was used by Gomez-Mejia,
Tosi, and Hinkin (1986) when analyzing the

effects of type of firm ownership on compensation

mix.

The pay policies in this study refer to the pay

of scientists and engineers in research and
development units. While the scientists and
engineers may be at different levels in the
organization (for example, associate engineer,
senior engineer, consulting engineer, etc.), the
engineers and scientists are usually treated as a
team with respect to compensation policies.
Interviews with high tech managers revealed that
scientists and engineers often work together as

a team on projects with senior and junior people

coordinating their efforts. A pay incentive that

is given only to senior people (such as a bonus)

would be demoralizing to junior-level contributors

Scale

Company or business unit size was measured as

annual sales revenues. It had a correlation of

0.21 with stage in the product life cycle (with no

significance at the 0.05 level). With a common
variance of only 0.04 we can assume these two
measures are fairly independent.

Profitability

and may lower the quality of team performance.

Therefore, most pay incentive policies in the

organizations in our sample allow all the scientists

and engineers in the R&D unit, regardless of
level, to participate in the incentive program.
The employee sample in the 'traditional' (nonhigh tech) firms refer to scientists and engineers
working in the smaller, less important R&D units
of these companies.

This measure was used as a control variable in

the study since it may affect the compensation

mix (Gomez-Mejia, Tosi, and Hinkin, 1986) or

Pay effectiveness

Pay effectiveness was conceptualized in terms of

the extent to which the compensation system
contributes to the achievement of organizational
goals. Important pay dimensions were first
to the lack of control for the amount of capital
identified through an extensive literature search
required to produce a given level of sales and
and interviews with managers responsible for
profits, the sample chosen for this study tends
compensation policies. Twenty-three items are
to minimize this problem. Many of the firms or
identified in this manner. Next, these managers
business units selected for this study are members
of the electronics industry and have similar capital were asked to evaluate the effectiveness of their
requirements. The more robust profitability meas- compensation system along each dimension, by
responding to the question 'How satisfied are
ure, return on assets, was not available for many
you with the way current pay practices in
of the business units in our sample.
your company contribute to the attainment of
organizational objectives'. The response format
Compensation strategies
consisted of the 1-5 Likert scale of the Minnesota
Satisfaction Questionnaire, ranging from (1)
Pay strategy was conceptualized in terms of pay
'extremely dissatisfied' to (5) 'extremely satisfied'.
mix or the relative importance of variable
The item responses of the 105 managers
(incentive) and fixed (salary, fringe benefits)
responsible
for compensation policies were factor
components of the compensation package. Pay
analyzed by the principal axis method with the
mix was measured as the average ratio of
squared multiple correlation as the estimate of
incentive payments, salary and fringe benefits
levels (Agarwal, 1981). It was defined as the

ratio of net income to sales. While it is recognized

that this measure of profitability is flawed due

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176 D. B. Balkin and L. R. Gomez-Mejia

communality. The resulting factor solution was
then rotated via the varimax criterion. Three

to the attraction of a sufficient number of

top-quality employees.

factors reached the standard criterion of an

Factor 3: pay as a motivationi tool. This factor

eigenvalue of 1.0 or greater. Table 1 shows the

measures the extent to which pay practices

items that loaded highly on each factor (defined

reward and induce higher productivity.

as 0.40 or higher). The three effectiveness

measures were tested for reliability and found to

Factor scores were then calculated by: (a)

be internally consistent with coefficient alphas of

selecting only the items with salient loadings on

0.95, 0.76, and 0.83 (Nunnally, 1967). The three

each factor and multiplying the salient factor

factors are as follows:

loadings by the standardized responses for those

itenms (this, in effect, weights the responses by

Factor 1: general pay effectiveness. This is a

the factor loadings); and (b) adding the weighted

global factor measuring the extent to which

responses into a total score. This approximation

current compensation practices contribute

procedure for computing factor scores is rec-

to organizational goals. It encompasses a

ommended by leading authorities in the field

broad spectrum of interrelated pay dimensionis such as pay level as compared to other

(Gorsuch, 1974; Schmidt, 1971; Wackwitz and

Horn, 1971). It tends to produce factor scores that

companies, frequency of pay increases, pay

intercorrelate, yet have stable interrelationships

as compared to the cost of living, pay as

across independent samples, whereas exact pro-

compared to that of newcomers into the

cedures (Gorsuch, 1974) tend to be less stable

company, and pay received as compared to

and generalizable across different samples.

employees' expectations.

Factor 2: pay as a recruitment tool. This is a

specific factor measuring the extent to which
current compensation practices conitribute

In addition to the three factors described

above, actual attrition data were used as a fourth

effectiveness measure. For most firms, retention
is an important criterion of success of a compen-

Table 1. Pay effectiveness factorsa

Loading Items

Factor 1: General Pay Effectiveness (ot = 0.95)

0.87 Pay as compared to employee's outcomes
0.78 Present pay levels

0.69 Pay as compared to newcomers' pay level

0.93 Pay levels as compared to other companies
0.79 Rapidity of pay raises
0.74 Size of pay increases
0.43 Benefits as compared to other companies

0.81 Pay compared to the cost of living

0.84 Pay for key scientists and engineers
0.86 Pay policies that retain employees

Factor 2: Pay as a recruitment tool (a = 0. 76)

0.63 Pay that attracts top-quality employees
0.47 Pay that attracts sufficient quantities of employees
Factor 3: Pay as a motivation tool (ot = 0.83)
0.73 Pay policies that motivate employees
0.74 Pay policies that reward high-quality contributions
0.50 Effectiveness of job evaluation system
0.36 Effectiveness of merit pay policy
a Obtained from principal axis method with squared multiple correlation as estimate
of communality and rotated via the varimax procedure.

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Contingency Theory of Compensation Strategy 177

sation system (Belcher, 1974; Milkovich and

effectiveness measure, because of the hetero-

Newman, 1984). This is particularly true for high

geneous mix of technology represented in the

tech firms since retaining high performers in

sample of firms. This measure would be more

R&D laboratories is critical to the firm's survival,

useful if the sample of firms all represented a

and replacement of these people (most of whom

common technology such as genetic engineering.

are performing tasks requiring extended project

It should be noted in passing that many

specific training) is both expensive and difficult.

compensation experts (e.g. Belcher, 1975; Milko-

Since attrition may have a curvilinear relationship

vich and Newman, 1984) have argued that in the

with performance (Jackofsy, 1984), a logarithmic

end the acceptability of the compensation system

transformation of this measure was used as a

as perceived by its users may be the best indicator

dependent variable.

of its utility and that more 'objective' indices

The pay effectiveness measures have some

(e.g. percentage of applicants accepting offers,

obvious limitations. The major limitation is, that

per capita productivity) are not necessarily cleaner

with the exception of the attrition rate, the other

Criterion measures. In fact, objective effectiveness

three indicators of pay effectiveness measure the

measures such as productivity or return on assets

attitudes of managers towards the pay policies

tend to be more contaminated and difficult to

they administer. Alternative measures of pay

interpret than subjective measures (Steers and

system effectiveness would be R&D unit perform-

Ungson, 1986; Deckop, 1986). Empirical support

ance measures such as commercial and technical

for the use of 'soft' pay effectiveness measures

success of the product, or meeting product

based on user reactions over 'hard' effectiveness

deadlines (Mansfield and Wagner, 1975; Katz

measures was documented in an extensive longi-

and Allen, 1985). However, the investigators'

tudinal study by Gomez-Mejia, Page and Tornow

choice to sample a broad cross-section of high

(1982). This suggests that while the pay effective-

tech firms and business units precluded the

ness scales used in this study have obvious

availability of these alternative effectiveness

limitations, they are perhaps no worse than would

measures. R&D performance data are proprietary

be the case if 'objective' measures were readily

information for many of these organizations.

available.

Most of the high tech firms are not willing to

share sensitive performance information with

outsiders, and have explicit policies that restrict

the kind of information available to outsiders.

Analysis

Multiple regression was used to test each of the

While our pay effectiveness measures are softer

10 hypotheses. The first set of equations was

than some of the alternative effectiveness meas-

calculated for each of the separate compensation

ures, they were the best data available that

components (incentive, salary and fringes) as a

managers in 105 organizations were willing to

percentage of the total pay package. This was

share with the investigators.

done in two steps. Step 1 tested for the main

Another possibility for an objective effective-

effects of stage (proposition 1), scale (proposition

ness measure is profitability. While we considered

profitability, we rejected it as an effectiveness

3), and high tech (proposition 5) on compensation

mix. Profitability was used as a control variable.

measure for this study because it would be biased

Step 2 tested for the interaction effects of stage!

high tech (proposition 6), and scale/high tech

(proposition 7) on pay mix.
that were not generating profits due to their lack
of maturity. New, high tech ventures may be
A second set of regressions was calculated with
against newer, entrepreneurial high tech firms

highly effective, yet unprofitable because all the

the four effectiveness measures as dependent

available resources are fueling research and

variables. This was done in three steps. Step 1

development, advertising and promotion and

tested for the main effect of high tech, incentives,

growth. Profits may not even be planned for the

base salary, and benefits on the four dependent

firm until growth goals are met.

variables. Step 2 tested the two-way interaction

One other possible measure of R&D unit

term for stage/incentive mix (proposition 2),

effectiveness is the number of patents granted

scale/incentive mix (proposition 4), and high tech/

(Keller and Holland, 1982; Packer, 1983). The

incentive mix (proposition 8) on the effectiveness

number of patents granted was not chosen as an

measure. Finally, step 3 tested the three-way

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178 D. B. Balkin and L. R. Gomez-Mejia

interaction term for high tech/stage/incentive mix

high tech and incentive pay show positive

(proposition 10) on pay effectiveness.

coefficients for all four effectiveness measures,

with base salary and benefits showing positive
coefficients for the first two factors. Step 2

RESULTS

supports propositions 2, 4, and 8, with the

exception of the attrition measure. In other

Table 2 summarizes the regression findings for

words, stage/incentive (proposition 2), scale/

the determinants of compensation strategies.

incentive (proposition 4), and high tech/incentive

Results in Step 1 show that stage and high tech

(proposition 8) exhibit significant relationships

are inversely related to salary and benefits as a

with the first three effectiveness measures. The

percentage of total compensation, and positively

results of the three-way interactions in Step 3 show

related to incentive mix. This supports prop-

that the high tech/stage/incentive (proposition 9)

ositions 1 and 5. Scale, on the other hand,

and high tech/scale/incentive (proposition 10)

behaves in an opposite manner with salary and

interaction terms are significant for the general

benefits having positive coefficients, and incentive

pay effectiveness factor.

mix having a negative coefficient. This supports

Descriptive data for each compensation mix

proposition 3. Profitability as a control variable

item, broken down by high tech and non-high

is positively related to salary and benefits, a

tech firms nested within stage and scale, are

finding congruent with previous research (Gomez-

shown in Table 4. The entries in the matrix

Mejia, Tosi, and Hinkin, 1986). Step 2 shows

refer to the average percentile score of each

that propositions 6 and 7 are supported for salary

compensation mix item corresponding to those

and incentive mix. The interaction terms stage/

firms in each cell. For example, a score of 70 in

high tech and scale/high tech show negative

the first cell indicates that, on the average, 70

coefficients for salary and positive coefficients

percent of all firms in the sample score lower on

for incentive mix.

incentive mix than high tech firms at the growth

Table 3 summarizes the regression results

stage of the life cycle. The pattern of scores in

with the effectiveness measures as dependent

the matrix shows that high tech firms rely on

variables. Step 2 depicts the main effects. Both

incentive compensation more than traditional

Table 2. Determinants of compensation strategies (N = 105 firms)

Compensation mix
(item . total compensation)
Independent variables Salaryt Benefits Incentives
Step 1
Stage

-0.340** -0.166** 0.159 *

(Proposition 1) (0.154) (0.075) (0.042)
Scale 0.336** 0.185** -0.143*
(Proposition 3) (0.131) (0.081) (0.072)

High tech -0.234** -0.171* 0.155**

(Proposition 5) (0.109) (0.083) (0.057)

Profitability 0.320* 0.174* 0.145
(Control) (0.165) (0.091) (0.094)

R2 = 0.32 R2 = 0.32 R2 = 0.34

Step 2

Stage x high tech -0.318* 0.196 0.140**

(Proposition 6) (0.162) (0.138) (0.061)

Scale x high tech -0.311* 0.184 0.1611*

(Proposition 7) (0.156) (0.121) (0.070)
R2 = 0.35 R2 = 0.33 R2 = 0.38

*p > 0.05; **p > 0.01; ***p < 0.001.

a Standard errors appear in parentheses.

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Contingency Theory of Compensation Strategy 179

Table 3. Determinants of pay effectiveness (N = 105 firms)
General pay

Independent variables effectiveness Recruitment Motivation Attrition

Step I

High

tech

0.623* 0.455* 0.813** 0.084*

(0.310)a (0.208) (0.285) (0.047)
Incentive 0.211** 0.155* 0.132** 0.034*
(0.083) (0.081) (0.052) (0.018)
Base salary 0.205 0.146 0.135 -0.042
(0.112) (0.136) (0.149) (0.053)
Benefits 0.186* 0.163* 0.145 -0.028
(0.087) (0.075) (0.139) (0.035)
R2 = 0.29 R2 = 0.36 R2 - 0.27 R2 = 0.28
Step 2

Stage x incentive 0.221* 0.153* 0.139* -0.027

(Proposition 2) (0.124) (0.081) (0.074) (0.029)
Scale x incentive 0.234* -0.168 0.152* -0.039
(Proposition

4)

(0.121)

(0.145)

(0.077)

(0.044)

High tech x incentive 0.192 0.174* 0.146** -0.033

(Proposition 8) (0.103) (0.082) (0.052) (0.202)
R2 = 0.35 R2 = 0.39 R2 = 0.38 R2 = 0.30
Step 3

Stage x high tech x incentive 0.025* 0.009 0.007 -0.002

(Proposition 9) (0.013) (0.008) (0.012) (0.003)

Scale x high tech x incentive 0.031* 0.018 0.011 -0.005

(Proposition

10)

(0.015) (0.015) (0.010) (0.004)

R2 = 0.43 R' = 0.40 R2 = 0.41 R2 = 0.32

*p - 0.05; **p : 0.01; *p '< 0.001.

\ Standard errors appear in parentheses.

Table 4. Average percentile scores for compensation mix items broken down by stage, scale, and high techW
(N = 105 firms)

Stage
Growth

Scale'

Mature

Small

Large

Compensation
items High tech Traditional High tech Traditional High tech Traditional High tech Traditional

Incentive 70 46 15 13 78 50 59
Salary
20
53
34
87
18
86
27
Benefits 24 64 65 77 03 28 55

06
73
93

Decimal points have been omitted.

b Firms below the median in annual sales are designated as 'small', those above the median are designated as 'la

firms, and that smaller firms at the growth stage

For the sake of simplicity, Table 5 summarizes

of the life cycle tend to rely less on fixed pay

the study's findings by proposition. It indicates

(salary and benefits) and more on variable pay

the text of each proposition and the extent to

(incentives).

which the data support the proposition.

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180 D. B. Balkin and L. R. Gomez-Mejia

Table 5. Summary of results by proposition
Propositions

Findings

1. Incentive pay as a proposition of the total compensation package will be greater for Strong support
firms at the growth stage of the product life cycle.
2. An incentive-based reward strategy will be more effective for firms at the growth Strong support
stage of the product cycle.
3. The proportion of fixed compensation costs in the total pay package will increase Strong support
as a function of organizational size.
4. The effectiveness of an incentive-based strategy will be inversely related to Moderate support
company size.

5. The- compensation mix in high tech firms will contain a higher proportion of Strong support
incentive rewards and a lower proportion of fixed pay.

6. Considering all firms at the growth stage of the product life cycle, those that are Strong support
high tech will have a pay mix with a greater incentive component.

7. Smaller high tech firms will have a pay mix with a greater incentive component Strong support
than similar non-high tech firms.
8. An incentive-based compensation strategy will be more effective in high tech firms Strong support
than in non-high tech companies.

9. For organizations at the growth stage in the product life cycle, an incentive-based Moderate suipport
reward Etrategy will be most effective for high tech firms.

10. For smaller companies, an incentive-based strategy will be most effective for those Moderate support
which are high tech.

CONCLUSION

proportion of R&D expenditures tend to rely on

If contingency theories of compensation strategy

incentive rewards, and this compensation strategy

makes a greater contribution to effectiveness for

can be successfully developed, their implications

are both obvious and important. At a minimum
they should help improve the effectiveness of
pay practices by imTiproving the compensation
strategy choices made by different organizations.

firms sharing those characteristics.

This, of course, should lead directly to greater

records. Because there were no exit interviews,

accomplishment of overall organization goals.

then it is impossible to determine whether a

The effectiveness variable that was most

difficult to predict is attrition. This may be in
part a function of the data-gathering procedures
since the information came directly from company

Such theories might also have a strorng impact

'leaver' quit because 'the grass was greener', or

on the entire field of compensation by ensuring

that job evaluation procedures and techniques
are designed to reinforce the strategies adopted

to avoid being terminated, or because a spouse

moved, or in response to a better pay package.
An obvious limitation of this study has been

by these organizations.

its exclusive reliance on self-report measures by

This article has developed a number of

managers responsible for compensation policies,

propositions about how compensation strategy

particularly those dealing with pay effectiveness.

and effectiveness vary as a function of stage in

The authors believe that the data-collection

the life cycle, scale of the firm, and industry

characteristics. The underlying argument is that
effectiveness at realizing intended pay strategies
depends significantly on the existence of a match
among compensation strategies, organization and

procedures and psychometric analysis discussed

environment.

earlier argue for sufficient confidence in these

measures, but that a similar study with multi-

method, multi-rater measurements and additional

objective data should yield more powerful results.
Arguably the most significant limitation of this

The study presented in this paper has lent

study has been its focus on only a few variables

empirical support to these normative expectations

along at least a few key dimensions. Its results

firm/industry characteristics. It may also be

can be summarized as follows. Small firms at the

difficult to generalize the results of this study

growth stage of the life cycle with a high

beyond the Route 128 population due to the

pertaining to both compensation strategy and

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Contingency Theory of Compensation Strategy 181

possible skewness of the high tech population

there. Many questions still remain unanswered

that should be dealt with in the future. For

example: What types of incentives (short- vs.

long-term, individual vs. group) are most effective
under different conditions? Do organizations
trying to achieve a low cost position require a

different compensation strategy as compared to

those whose primary concern is the upgrading of

product features/performance rather than cost

reduction? Do incentive-based rewards for scientists and engineers in high tech actually increase

the rate of innovation and profitability of the

firm? Do the compensation mix and the stage

in the life cycle affect each other? Which

environmental variables affecting compensation

strategies (e.g. labor market competition) are

most significant for each stage of the life cycle?
Are there any differences in the background,

personal characteristics, and quality of employees

who are attracted to organizations that rely

on incentive strategies? Obviously much work

remains to be done before a contingency theory

of compensation is fully developed. Future

research should include an extension of this study
to a different sample of firms. Efforts such as
these will take a number of years to complete.
However, the degree of success achieved in this

task will significantly impact the quality of the

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