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Compensation & Benefits Review
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DOI: 10.1177/0886368714541913
published online 4 July 2014Compensation & Benefits Review
Pankaj M. Madhani
Aligning Compensation Systems With Organization Culture
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Article
Introduction
The way organizations design their compensation plan
and pay their employees does not only depend on their
own preferences for the compensation plans but also
depends on the various extrinsic factors (nature of
industry in which they operate, the financial perfor-
mance of the organization, the size of the organization
and countercyclical hiring practices1 and various life
cycle stages such as business life cycle,2 organizational
life cycle,3 and product life cycle4 and intrinsic factors
(career life cycle stages of employees5 and organization
culture). Likewise, the behavior of employees toward
compensation plan depends on many factors such as the
perceived fairness of the compensation, the job respon-
sibility of employees and the culture of the organization.
Hence, culture is a common thread between employees
and organization. There are many kinds of organization
culture that affect individual and organizational
behavior.6
Organizational culture affects employee perceptions
as well as their behaviors in the workplace, and that con-
tributes to the success or failure of an organization. The
degree to which the values of employees are compatible
with the organization’s culture predicts his or her atti-
tudes toward the organization.7 Hence, culture determines
the organizational norms, and that influences how
employees should think and behave.
While organization culture receives considerably
more management attention today than in previous years,
research shows that fewer than 10% of organizations suc-
ceed at building high-performance cultures. According to
a global survey of more than 1,200 senior executives by
the management consulting firm Bain & Company, 91%
agree that “culture is as important as strategy for business
success.” Organizations can have a good strategy in
place, but if they don’t have the culture and the enabling
systems that allow them to successfully implement that
strategy, the culture of the organization will defeat the
strategy.8
A compensation system influences the behavior of
employees and is intended to align individual actions
with organizational goals. When compensation systems
are not consistent with the culture, it causes many unin-
tended consequences. This research focuses on the inter-
play of organization culture and compensation.
541913CBRXXX10.1177/0886368714541913Compensation & Benefits ReviewMadhani
research-article2014
Corresponding Author:
Pankaj M. Madhani, Associate Professor, ICFAI Business School (IBS),
IBS House, Opp. AUDA Lake, Near Science City, Off. SG Road,
Ahmedabad 380060, India.
Email: pmadhani@iit.edu
Aligning Compensation Systems
With Organization Culture
Pankaj M. Madhani, Associate Professor, ICFAI Business School (IBS), India
Abstract
Organization culture and compensation system design function as complementary elements in achieving the strategic
goals of the organization. When compensation systems are not aligned with organization culture, it causes many
unintended consequences. This research study looks at the impact of organization culture on compensation and vice
versa. Various frameworks provided in this article will help managers in effectively managing compensation costs as well
as enhancing performance of the organizations. The organization culture can be shaped by the type of compensation
system used and the kinds of behaviors and outcomes the organization chooses to reward and punish. When culture
and compensation structure (fixed pay vs. variable pay) are synchronized, the culture acts as an asset and generates
competitive advantage. Depending on how compensation system is designed, developed, communicated and managed,
it can positively or negatively influence an organization’s culture. This research identifies compensation strategies for
various types of organization culture and suggests the best-case scenario for optimal performance.
Keywords
organization culture, positive culture, negative culture, compensation, fixed pay, variable pay, operating leverage
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2 Compensation & Benefits Review
The Interdependence of Culture and
Compensation
Organization culture and compensation system design
should function as complementary elements in directing
employees toward achieving the strategic goals of the
organization. Compensation and the way rewards are
managed represent a powerful tool for influencing cul-
ture. As culture is also concerned with influencing
employee behaviors and attitudes, the design and man-
agement of compensation provide a primary method of
achieving control.
The compensation system specifies the terms of
exchange between the organization and the individual
employee and the organization and thereby defines the
employment relationship. In its design and management,
it expresses the values and norms to which members of
the organization must conform and specifies the contribu-
tions expected from them as well as the rewards they can
expect to receive as a result of their performance. The
compensation system is a reflection of the organization’s
values and beliefs, and hence its design is very critical. It
must communicate values and goals accurately to encour-
age appropriate employee behavior. Thus, compensation
systems reflect and reinforce the culture (Figure 1).
As such, the compensation system is key to under-
standing culture and plays a critical role in defining and
shaping organizational culture.9 Large organizations
with several different business units often have multiple
compensation systems. Although they may share some
fundamental philosophies and values, they may also
differ according to the particular business setting and
competitive environment. Thus, multiple compensation
systems can support multiple cultures (or subcultures)
within one organization.
Organization culture has the function of influencing
employee behavior. An organization must understand,
develop and communicate its values and beliefs effec-
tively. It must also rely on these values and beliefs as the
foundation for hiring, managing and shaping the behavior
of employees. Once the desired culture of an organization
is defined, compensation system can support and reinforce
the culture. A key guiding principle for communicating an
organization’s values and beliefs to employees is the com-
pensation program. Hence, the culture directly affects and
influences the compensation system (Figure 1).
Compensation systems may also act as a signaling
device to potential applicants, providing information
about less visible attributes of an organization such as its
culture. Although there are other HR policies and prac-
tices that shape the culture, the compensation system is a
very important organizational dimension that applicants
are likely to be aware of at the time they apply. While
applicants can acquire information about an organiza-
tion’s culture through different sources such as job inter-
viewers or websites, these sources of information may be
inconsistent and variable. Compensation policies, on the
other hand, are often observable to applicants and repre-
sent relatively stable sources of information reflecting
organizational culture. Compensation systems convey
important messages about an organization’s values and
practices to current employees as well as potential hires.
Compensation systems are capable of attracting (or repel-
ling) the right kinds of people because they communicate
so much about an organization’s philosophy, values and
practices.10
Compensation systems promote the behavior that ulti-
mately becomes dominant in the organization. Such
behavior influences employees’ perceptions and beliefs
about the value systems of the organization. Hence, com-
pensation systems offer one direct measure of organiza-
tions’ fundamental assumptions, values and expectations.
As compensation systems are important in defining an
organization’s culture, they are useful for employees for
comparison with their needs and values. It is important to
align the compensation strategy to support the culture.
The compensation plan will influence behavior best if it
is consistent with the beliefs and expectations of the
organization.
Organization Culture: A
Cross-Sectional Perspective
As shown in the Figure 2, organization culture includes
several levels, with a varying degree of awareness on the
part of an organization’s members. The core and most fun-
damental level consist of patterns of basic assumptions that
Figure 1. The interdependence of culture and compensation.
Source. Model developed by author.
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Madhani 3
employees take for granted without being aware of them.
Assumptions are not directly observable and instead must
be inferred from what can be seen and heard in organiza-
tions. At the surface level there are artifacts and espoused
values that represent the visible and audible patterns of the
culture.
Artifacts include the visible and physical patterns,
such as dress codes, physical settings (architecture and
offices), newsletters, signs and banners. Espoused values
are audible and spoken, such as goals, philosophies, slo-
gans and strategies and are included in stories of organi-
zational heroes, legends, myths, acronyms and greetings.
Artifacts and espoused values are usually congruent with,
or reflective of, the basic underlying assumptions. The
intermediate level covers values and beliefs, concerning
what ought to be done. This research focuses on the inter-
mediate level of values and identifies the compensation
strategy aligned with various types of organization cul-
ture. Values and beliefs consist of symbols, communica-
tions scripts, events, myths and ways of doing things.
These underlying values have an influence on the behav-
ior of employees, as they rely on these values to guide
their decisions and behavior. These levels of organization
culture are shown in Figure 2.
Hence, organization culture consists of some combi-
nation of artifacts, values and beliefs and underlying
assumptions that organizational members share about
appropriate behavior.11
As culture consists of “values,” “beliefs” and “norms,”
these are the three key elements that influence the
thoughts and actions (behavior) of people in organiza-
tions. Values are the factors an organization considers
most significant with respect to its business operations,
its employees and its customers. These are the things an
organization strives for and wants to protect at all costs.
Beliefs are assumptions individuals hold about them-
selves and their organization. Norms are unwritten rules
of behavior in the organization and help “operationalize”
actions that are consistent with values and beliefs, for
example, as how employees should dress and interact.
Organizational culture can be construed to cover
almost everything in an organization: basic assumptions
and beliefs, expectations, values, models of behavior,
rituals, norms, practices, attitudes, shared philosophies,
symbols, heroes and artifacts that knit an organization
together.12 Organizational culture is the pattern of basic
assumptions that a given group has invented, discovered
or developed in learning to cope with its problems of
external adaptation and integral integration.13
The organizational culture can also be divided into
two layers according to inherent characteristics: a visible
layer and an invisible layer. The visible layer consists of
buildings, clothing, behavior modes, regulations, stories,
myths, languages and rites. The invisible layer consists of
common values, norms, faith and assumptions of organi-
zation members.14
Culture and Performance
Individuals tend to become more aware of their organi-
zation’s culture when they have the opportunity to feel,
realize and compare it with culture of other organiza-
tions. Culture has been described as the “personality of
the organization,” and just as no two personalities are
the same, no two organizational cultures are identical.
Organization culture is a key driver in enhancing the
performance of the organization and is an explanatory
variable that distinguishes one organization from
another. There is a relationship between organization
culture and its performance, with respect to success
financial indicators.15
Organizational culture plays a role of a backbone in
any organization and has significant effects on the morale
and motivation of employees. It is a more effective mech-
anism for controlling and managing employee behavior
than organizational rules and regulations.
Culture has two major attributes: content, which signi-
fies the types of values and behaviors held by members of
an organization, and strength or the depth and breadth of
those behaviors embedded among its members. Both
content and strength of culture are important for achiev-
ing a high level of organizational performance.16
Organization culture can be “strong” or “weak” and is
best tested by how clearly it is understood by the lowest
level employees.17 Similarly, culture can be “positive” or
“negative” based on the nature of content.
Strong Versus Weak Culture
A “strong” culture is one that is shared by employees and
demonstrated by their consensus regarding the values of
the organization. The stronger a culture, the more likely it
is to influence the way employees think and behave in the
organization. Organizations with strong cultures are more
likely to achieve their goals than those with relatively
“weak” cultures. Hence, strong culture organizations
have a higher degree of organizational success (measured
Artifacts and
Espoused
Values
Values and
Beliefs
Assumptions
Figure 2. Organization culture: A cross-sectional
perspective.
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4 Compensation & Benefits Review
by financial measures) that is attributable to a higher level
of employee motivation.
A strong culture may act as an asset or a liability for
the organization, depending on the types of values that
are shared. In an organization with a culture that is
strongly outcome oriented, the organization may perform
well, if this value system matches the organizational
environment and employees behave ethically. However, a
strong outcome-oriented culture coupled with unethical
behaviors and more inclination for quantitative perfor-
mance indicators may be detrimental to an organization’s
effectiveness and acts as a liability. Years ago Enron
exemplified this dysfunctional type of a strong culture.
A strong culture produces harmony in employees’ per-
ception and way of thinking, regulates their behavior and
provides for the sharing of common values and objectives.
However, the employees in organizations with a strong
culture are often preoccupied with past success, are unable
to react effectively to signals from the environment and
are also unable to consider alternatives to sustain success.
Therefore, a strong culture makes change difficult.
In an organization with a strong culture, where values
are widely shared, if the organization decides to adopt a
different set of values, unlearning the old values and
learning the new ones will be a challenge because
employees will need to adopt new ways of thinking and
behaving. For example, Home Depot had a decentralized,
autonomous culture where many business decisions were
made using “gut feeling” while ignoring the available
data. When Robert Nardelli became CEO of the company
in 2000, he decided to change its culture, starting with
centralizing many of the decisions that were previously
left to individual stores. This initiative met with substan-
tial resistance, and many high-level employees left dur-
ing Nardelli’s first year.18
Positive Versus Negative Culture
An organization’s culture may be one of its strongest
assets or its biggest liability. “Positive” organization cul-
ture provides competitive advantages for the organiza-
tion, while “negative” culture may lead to performance
deterioration. Culture is an intangible but very real “eco-
nomic asset” of business enterprises. For companies that
possess a strong positive culture, like Starbucks,
Southwest Airlines, Wal-Mart or Google, it is a true “eco-
nomic asset” meaning that it leads to quantifiable higher
profitability. If a positive culture exists, it functions as an
intangible asset.
Organizations with dysfunctional cultures hurt perfor-
mance as their culture acts as an economic “liability.”
Their earnings are “less than” what they might otherwise
be, thereby incurring real opportunity costs. Starbucks is
a classic success story with a strong positive culture that
is an economic asset, while K-Mart (filed bankruptcy on
January 22, 2002), AIG (prevented from bankruptcy by
being “too big to fail”) and GM (pre 2010) are classic
cases of a dysfunctional corporate culture that led an
organization to a steep decline in profitability.19
Categorizing Organizational
Cultures
The most detailed and frequently cited model that
describes contents and strengths of corporate cultures is
the competing values model (CVM), which incorporates
the extent of the organization’s (external or internal) ori-
entation and also the degree of freedom (flexibility or
control) to the requirements of the environment.20 The
purpose of a control system is to guarantee that the orga-
nization achieves its objectives while also ensuring that
its members behave in the appropriate way.
The CVM model builds on two underlying dimensions
to explore organizational cultures: one dimension reflects
the extent to which an organization is focused on its inter-
nal or external functioning; the other reflects the extent to
which an organization has an orientation of control or
flexibility. Hence, the first dimension has an internal,
person-oriented emphasis characterized by integrating
and maintaining activities versus an external, organiza-
tion-oriented emphasis characterized by differentiation
and competitiveness. The second dimension has an
emphasis on stability and control and is characterized by
mechanistic processes versus an emphasis on flexibility
and change, with organic processes.
The two axes form a four-quadrant typology of organi-
zational cultures. Four quadrants, reflecting four cultural
types, are created at the point of intersection of these axes
(Figure 3). The four dominant types of cultures—(a) hier-
archy, (b) clan, (c) adhocracy and (d) market—emerge
from the framework. Each of the four types of cultures
has a different focus and orientation:
Hierarchy culture: internal focus + control
Clan culture: internal focus + flexibility
Adhocracy culture: external focus + flexibility
Market culture: external focus + control
Each culture type is characterized by a particular set of
shared beliefs, style of leadership and set of shared values
that act as a bond or glue for members. The four types of
cultures are ideal types in the sense that an organization is
unlikely to reflect only one type, and large organizations
tend to develop a number of subcultures instead of a sin-
gle homogeneous culture.
Most organizations develop a dominant cultural style.
More than 80% of the several thousand organizations
studied by researchers have been characterized by one or
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Madhani 5
more of the culture types identified by the competing val-
ues framework. Those that do not have a dominant cul-
tural type may be unclear about their culture or may have
a mix of different cultural types.6 These four organization
cultures based on competing values framework are
explained below along with their characteristics.
Hierarchy Culture
The hierarchy culture focuses on maintaining a smooth-
running organization and is characterized by a formal-
ized, centralized and structured workplace. Formal
policies, procedures and processes hold the organization
together. Through effective communication, coordination
and information management, organizations with hierar-
chy culture seek to establish uniformity, stability and con-
trol (Figure 4).
There is a significant negative relationship between
centralized decision making and customer-oriented sell-
ing as centralization acts as a barrier to market orienta-
tion.21 A strong internal orientation along with
centralization of a hierarchical culture make it more dif-
ficult to develop customer orientation at both individual
and organizational levels.
Due to its internal orientation, the hierarchical culture
may help the organization be effective only when the
environment is stable and certain as it prevents quick
action and thus may be a misfit in an uncertain and
dynamic environment. A hierarchical culture is rule
based, bureaucratic and system oriented and has a high
level of formal controls (Figure 5). A bureaucratic system
represents a high level of formal controls combined with
a low level of informal controls (e.g., professional and
cultural control) in the organization. Its rigid structure
hinders flexibility and discretion, and hence it has a low
degree of innovativeness.
Formal controls are written, management-initiated
mechanisms while informal controls, in contrast, are
unwritten, typically staff-initiated mechanisms. Though
formal controls are clearly designed by the organization,
they can also play a role in shaping the informal control.
Professional control is exercised when the organizational
unit that establishes certain standards monitors confor-
mity and takes action when social deviations occur. In
contrast, cultural control refers to the pattern of shared
values and beliefs that guide norms of behavior within the
organization.22
The emphasis on formal controls is due to their rela-
tive observability and ease of assessment in comparison
with informal controls of the organization. Ford, GM,
Flexibility
Clan
Culture
Adhocracy
Culture
External Focus
Internal Focus
Hierarchical
Culture
Market
Culture
Control
Figure 3. The competing values framework.
Source. Adopted from Cameron and Quinn (1999).
Peopl
eP
roduct Innovaon
Process Product
Clan
Culture
Hierarchical
Culture
Key Focus
ControlCompete
Orientaon
Adhocracy
Culture
Key Focus
Orientaon
Collaborate Create
Market
Culture
Figure 4. Culture types: Relationship between key focus and
orientation.
Source. Matrix developed by author.
Empowermen
tE
ntrepreneurial
System Sales
Clan
Culture
Hierarchical
Culture
Internal Orientaon
High Moderate
Formal Control
Adhocracy
Culture
External Orientaon
Informal Control
High Moderate
Market
Culture
Figure 5. Internal versus external orientation and control
types.
Source. Matrix developed by author.
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6 Compensation & Benefits Review
McDonalds, UPS, NASA, Johnson & Johnson, Kraft
Foods, Dell Computer and Exelon, the No. 1 U.S. nuclear
power generator, are examples of organizations with a
hierarchical culture.
Clan Culture
Clan culture is a warm and friendly workplace where
employees collaborate with coworkers and are empowered
to share with each other like an extended family (Figure 4).
Because of its similarity to a family-type organization, it is
called a clan. William Ouchi has used the term clan to
describe a control system based on socialization and inter-
nalized values and norms. As such, a clan culture represents
a high level of informal controls (professional and cultural
control) with a low level of formal controls to achieve its
objectives (Figure 5). In this culture, strong fraternal rela-
tionships among organizational members exert strong peer
pressure to adhere to organizational norms. A clan culture
comprises a set of values and norms that are highly consis-
tent with the requirement of a steady state strategy.
A clan culture is characterized by loyalty, teamwork,
employee involvement, personal commitment and self-
management. This culture has a long and thorough social-
ization process to develop long-term corporate
commitment so that the employee contribution exceeds
contractual agreements. The socialization process results
in strong identification among members of organization
along with a strong sense of interdependence. This type
of culture is likely to perform better than the hierarchical
culture.23 However, due to its strong internal focus and a
high level of centralization, this culture serves as an
impediment to customer orientation.
The clan culture has collectivistic cultures and focuses
on shared goals where employees are rewarded based on
group or organizational accomplishments. The loyalty in
terms of long-term commitment of individuals in the orga-
nization is rewarded in the form of job security. Clan culture
emphasizes shared values, participation and cooperation.
The organization is held together by consensus, loyalty and
tradition. The clan culture is people oriented as it empha-
sizes individual development with high cohesion and high
morale of employees (Figure 4). In the clan culture, the
organization member is aware of its unique history, shares a
sense of pride in fraternity and in membership and often
documents its origins and celebrates its traditions in various
ceremonies. Nokia, Toyota, Emirates Airlines, Pixar, Valero
Energy Corp, Southwest Airlines and Nukor are examples
of organizations with clan culture.
Adhocracy Culture
The derivation of the word adhocracy is based on the
word ad hoc—meaning a temporary, specialized and
dynamic unit. Adhocracy culture is an entrepreneurial,
future-oriented and innovative workplace that encour-
ages individual initiative and adaptability (Figure 4). As
the adhocracy culture has less centralization and formal-
ization, it represents a relatively low level of formal con-
trols to achieve its objectives (Figure 5). As such,
employees in this culture are more likely to be customer
oriented. The adhocracy culture is flexible in its approach
but with an external focus and hence reacts quickly to
changes and reconfigures itself rapidly to new
circumstances.
Adhocracy cultures are well suited for organizations
operating in dynamic contexts such as high-tech start-up
organizations working to establish themselves in the mar-
ket as well as mature firms that are in need of innovation
to enhance growth. These organizations are characterized
by a flat hierarchy and perform better than the clan cul-
ture. Examples of organizations with an adhocracy cul-
ture are Apple Computer, Intel, Texas Instruments, HP,
3M, Home Depot, AstraZeneca, W. L. Gore, Genentech
and Google.
Market Culture
The market culture is oriented toward the external envi-
ronment instead of internal focus. A market culture is a
workplace with a hard-driving work culture and contrac-
tual relationship between individual and organization.
Market culture focuses on efficiency and goal achieve-
ment. With its outward focus, best practices and bench-
marking are used to develop policy and practices. The
core values that dominate market culture are productivity
and competitiveness (Figure 5). The market culture gen-
erates personal initiative, a strong sense of ownership and
an entrepreneurial approach.
A market culture has a product focus while a hierarchy
culture has a process focus (Figure 4). The “product”
focus is defined as physical goods to customers (who are
external), while “process” in a hierarchy culture is defined
as production or operations that produces the products.
An external customer is typically interested in the prod-
uct offering itself, not the internal processes the organiza-
tion deploys to make the product available in the market.
Hence, as the emphasis on the product serves the cus-
tomer needs, it has to carry an external orientation, while
processes, which occur inside the organization, often
without contact with the customer, are more internally
oriented.
The market culture is not designed to generate loyalty,
cooperation or a sense of belonging to a social system.
Members do not feel constrained by norms, values or alle-
giance to an accepted way of doing and thinking. Hence, a
market culture does not exert a great deal of normative
pressure on employees as there is little pressure from peers
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Madhani 7
to conform to specific behavior or attitudes. Likewise,
superiors are less effective as role models or mentors and
have limited influence on subordinate rewards. Hence, this
culture exerts less degree of informal control compared to
formal control (Figure 5). Profitability, consistency,
strength in market niches, sales growth and secure cus-
tomer bases are primary objectives of the market culture
organization. This is the best performing culture.
Market culture is adopted by organizations when the
external environment is hostile and consumers are choosy
and value oriented; the organization then focuses on
enhancing competitive position, productivity, sales and
profits. It has mechanistic processes and values profits
over employee satisfaction. A strong external orientation
of a market culture makes it compatible with the cus-
tomer-oriented values. Former CEO Jack Welch of
General Electric famously announced that if businesses
divisions were not first or second in their markets, then,
simply, they would be sold. GE has a highly competitive
culture where performance results speak louder than pro-
cess. Hence, it is a good example of market culture.
Similarly, Merrill Lynch, Best Buy and direct-selling
firms such as Amway and Avon products are examples of
organizations with a market culture.
Operating Leverage and
Compensation Structure
Operating leverage generally refers to the organization’s
incurrence of fixed operating costs and is determined by
the cost structure of the firm (higher fixed costs relative
to sales increases operating leverage). The degree of
operating leverage (DOL) is a function of the organiza-
tion’s cost structure in terms of the relationship between
fixed costs and total costs. An organization that has high
operating leverage (high fixed costs relative to total costs)
will also have higher variability in earnings than a similar
organization with low operating leverage. The more the
operating leverage (fixed costs/total costs), the more
profits will vary with changing sales revenue. Operating
leverage acts as a multiplier and amplifies the impact of
sales on earnings before interest and tax (EBIT) and pro-
duces a larger change in it than the corresponding changes
in sales. Hence, when operating leverage is high, a small
percentage increase in sales can produce a much larger
percentage increase in EBIT.24
A positive DOL indicates that as sales revenue
increases, operating profits will increase (and vice versa).
If DOL is +3.0, for example, this would indicate that a
1% increase in revenue would result in a 3% increase in
EBIT. The benefits of high operating leverage can be
immense for the organization, particularly during period
of high predictability and low uncertainty. During the
period of stability, a higher proportion of fixed pay in the
compensation structure and, hence, high operating lever-
age will help the firm in magnifying operating income
sharply during the period of higher revenue growth.
Similarly, during the period of uncertainty and volatility,
a higher proportion of variable pay in the compensation
structure and, hence, low operating leverage will help the
firm in managing environmental shocks. The best of all
strategies with regard to operating leverage where com-
pensation policy is concerned is to maintain operating
leverage according to specific types of organization
culture.
Compensation Structure and
Organization Culture
An organization’s approach to developing, maintaining
and managing compensation systems can influence the
degree to which employees view an organization’s cul-
ture as having an HR-oriented (clan), innovation-oriented
(adhocracy), process-oriented (hierarchical) or result-
oriented (market) culture. These classifications can also
differentiate one organization’s culture from that of other
organizations. Culture has been regarded as part of the
organization, implying that no organization can survive
without its culture.
The organization culture can be shaped by the type of
compensation systems (fixed pay vs. variable pay) used
in the organization and the kinds of behaviors and out-
comes it chooses to reward and punish. Employees who
work within a specific type of culture will expect a com-
pensation system that is distinctive and compatible within
that culture. In a salary-friendly culture, employees
expect a higher proportion of fixed pay in pay mix design
while in an incentive-friendly culture employees will
expect a higher proportion of variable pay (Figure 6).
When culture and pay mix are synchronized, it will
result into synergy and the culture will act as an asset and
generate competitive advantage. However, any mismatch
between culture and pay mix will result in competitive
disadvantage as the culture will then be a liability and
hinder organization performance.
Employees belonging to cultures where uncertainty
avoidance is high are likely to prefer compensation plans
that reduce ambiguity and therefore prefer a higher pro-
portion of fixed salary such as in hierarchical culture and
clan culture. Similarly, in an adhocracy or market culture,
where employees are externally oriented and the empha-
sis is on individual results, variable pay should account
for a higher percentage of the total. As shown in Figure 6,
the hierarchy culture and clan culture are salary friendly
while adhocracy and market cultures are incentive
friendly.
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8 Compensation & Benefits Review
There are cultural differences in organizations where
the emphasis is on variable, incentive pay and those where
the emphasis is on base salary, and the people who can suc-
ceed in the two cultures are also different. Compensation
systems will influence the degree to which employees
view culture as salary friendly (hierarchical and clan cul-
ture) or incentive friendly (adhocracy and market culture).
Culture is considered to be an intangible organiza-
tional asset. As such, the compensation system is strate-
gic when it specifies what employers want from their
employees and what they should be motivated to accom-
plish in order to serve organizational interests.25 Different
organization cultures produce different management
styles, structures, procedures as well as compensation
systems. In some cultures, certain specific forms of com-
pensation are more appropriate than in others. The links
between compensation and culture have been very lightly
researched hitherto, hence this research focus on this rela-
tively unexplored area.
Relying on Compensation Strategy
to Shape Culture
Compensation systems can shape organization culture as
they have a major effect on employees’ motivation, satis-
faction and sense of membership. Culture can influence
compensation system directly or indirectly through a
mediating HR philosophy. Since culture relates to the
basic values, beliefs and assumptions of its members, it
significantly influences the type of compensation and its
underlying conditions that can be most effective.
Similarly, the compensation system also influences cul-
ture directly by selectively reinforcing certain beliefs and
values (Figure 1). Once values, business objectives and
desired behaviors are determined, then compensation
plans can and should support the culture. For example, if
the business objective is innovation and the desired
behavior is risk taking, then the compensation strategy
should have higher proportion of variable pay.
Compensation should be aligned with the organiza-
tion’s desired culture. Compensation governs who gets
rewarded and why and thus is a reflection of the organiza-
tion’s values and beliefs. While culture is about people’s
behaviors—that is to say, how goals are accomplished—
the goal should be to establish a culture that drives com-
pany success and, more specifically, to link compensation
rewards to behaviors.
The clan culture may be ineffective in an environment
that requires innovation, entrepreneurship, quick change
and a strong desire for individual achievement. Similarly,
the aggressiveness, autonomy and short-term focus of the
market culture may be ineffective in mature, monopoly
capital-intensive industries, where system wide integra-
tion is critical. Compensation systems are, in effect, pow-
erful mechanisms that can be used by organizations to
communicate desired attitudes and behaviors to employ-
ees. A compensation system that reveals what is expected
from employees is essential for overall performance. The
planning of compensation strategy to fit the desired cul-
ture is discussed below.
Hierarchy Culture
The compensation system in a hierarchy culture must rein-
force and respect the hierarchy and the need for a predict-
able and secure environment where individual needs are
subordinated to the organization’s goal of smooth-function-
ing operations, systems and processes. A hierarchy culture
requires a compensation system that encourages stability
and a long-term system-wide perspective from its employ-
ees. The focus is on coordination and control rather than on
aggressiveness and entrepreneurship. More emphasis on
fixed pay and on reinforcing the hierarchy provides this
kind of support. However, guaranteed jobs and a higher
proportion of fixed pay encourage employees to “free-ride”
on the efforts of others, because doing so has not much
effect on their reward as long as their coworkers work hard.
Hence, in this culture, compensation structure features
subjective and qualitative attributes for the inclusion of
long-term performance criteria that would be difficult to
quantify, and hence focus is on behavior control (Figure 7).
One relevant element of the compensation system is
whether the organization rewards behaviors or results.
Behavior-based control means that organizations are, to a
great extent, involved in the monitoring, directing, evaluat-
ing and rewarding of their employees.
In hierarchy culture, promotions are relatively fre-
quent and often motivated more by the individual’s need
Variable Pay
Pay Mix Design
Synergy
(Hierarchical
& Clan Culture)
Fixed Pay
Incenve
Friendly
Salary
Friendly Culture
Compeve
Disadvantage
(Sub-Opmal)
Compeve
Disadvantage
(Sub-Opmal)
Synergy
(Adhocracy &
Market Culture)
Figure 6. Relationship of salary/bonus mix and culture.
Source. Matrix developed by author.
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Madhani 9
for development than by the organization’s need to fill a
vacancy. The long-term concerns of a hierarchical culture
are conformity and efficiency to promote reliable and
predictable output, stability in relationships and employ-
ment security. Hence, it involves promotion and/or trans-
fer on a regular basis across divisions or functional
boundaries. Such practices communicate concern for the
lifetime career of employees and contribute to a tight,
homogeneous organization with common language,
experience and values. Promotion is often based on the
length of service as employees must pass through a series
of job in the hierarchy before reaching a senior position.
Frequent contact between superiors and subordinates
encourages the mentor–mentee relationship and concen-
trates more on controlling behavior. The compensation
system focuses on loyalty, consistency and efficiency and
hence involves higher fixed pay in pay mix (Figure 7).
Clan Culture
A clan culture is characterized by organizational collec-
tivism, shared decision making and the perception that
the organization takes care of employees. In a clan cul-
ture, bonuses are based on team or organizational perfor-
mance; hence the organization is perceived as having a
more collectivist culture. The culture supports flexibility,
but it is internally oriented and does not usually generate
risk-taking behavior or innovation and hence is not con-
ducive to entrepreneurial activity (Figure 7). Accordingly,
a clan culture also has higher proportion of fixed pay in
pay structure of employees. Incentive awards are based
on group performance as the system rewards the team,
not individuals. This provides support for cooperative
rather than competitive behavior. The importance of
long-term commitment by employees (promotion is
based on tenure) and conformity to its norms are key fea-
tures of a clan culture. Variable pay is a relatively small
proportion of total compensation, although salary is not
as significant as in a hierarchical culture (Figure 7).
In times of relative predictability or certainty, organi-
zations attempt to build leverage by rebalancing compen-
sation costs with relatively higher fixed commitments in
the pay mix, that is, a higher fixed pay proportion is
favored over variable pay. This increase in operating
leverage will mean greater profitability during the period
of rising revenue. In hierarchy and clan culture, where the
orientation of the firm is internal and has more certainty
in terms of system stability and performance of organiza-
tion members, higher proportion of fixed pay in pay is
preferred. As organizations with hierarchy culture and
clan culture prefer a high degree of base pay, typically
they have high operating leverage. Hence, for hierarchy
culture and clan culture, a higher proportion of fixed pay
provides the best fit of pay structure and culture and gen-
erates competitive advantage (Figure 8).
Adhocracy Culture
An adhocracy culture organization reacts quickly to
change, since it encourages and rewards individual initia-
tive, flexibility and freedom to promote growth. An adhoc-
racy culture is characterized by high flexibility, with
external focus, does not have centralized power or author-
ity relationship and emphasizes risk taking and risk antici-
pation. Firms operating in a dynamic environment adopt
adhocracy culture. It emphasizes a relatively high propor-
tion of variable pay for goals that have to be accomplished.
In this culture, compensation systems are oriented to the
need for attracting, motivating and retaining creative
Internal External
Moderate Moderate
High High
Variable Pay/Total Pay
Adhocracy
Culture
Market
Culture
Clan
Culture
Hierarchy
Culture
Fixed Pay/Total Pay
BehaviouralOutcome
Control
Flexibility
Figure 7. Compensation strategy across various cultures.
Source. Matrix developed by author.
Low
High
Misfit of Operang Leverage
and Culture
Low High
Fit of Pay Structure and Culture
Compeve
Advantage
(Opmal)
Fixed Pay and
Operang Leverage-
High
Compeve
Disadvantage
(Sub-Opmal)
Fixed Pay and
Operang Leverage-
Low
Figure 8. Relationship of misfit of operating leverage and culture
with fit of pay structure and culture (hierarchy and clan cultures).
Source. Matrix developed by author.
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10 Compensation & Benefits Review
employees who satisfy the organization’s need to be inno-
vative. Skill-based pay is a logical fit due to its emphasis
on rewarding each employee’s unique abilities and skills,
rather than a rigidly defined job. Hence, this culture under-
lines relatively higher proportion of variable pay in com-
pensation structure (Figure 7).
Market Culture
In this culture, compensation systems are driven by the
organization’s main operating assumptions that it must
retain/gain market share to survive and prosper. A great
deal of emphasis is placed on individual performance.
Market culture is characterized by achievement of mea-
surable tasks and demanding agreed-on goals. Therefore,
the formal control orientation is quite stable and focuses
on outcome control (Figure 7). In contrast to behavioral
control, an outcome-based control system objectively
defines performance, measures it and explicitly links
rewards to performance. Outcome-based control sup-
poses greater interest in the consequences of behaviors
than in the behaviors themselves. As the focus is on out-
come and not on behavior, nonquantifiable aspects of
performance are generally not evaluated.
Because of the quantitative emphasis, performance
evaluation necessarily is focused on the immediate time
frame with little consideration of long-term conse-
quences. Market cultures hold employees accountable for
goal achievement and hence use compensation systems
that reward employee output. Accountability is primarily
for results and not for the methods by which results were
achieved. As there is a focus on measuring only the results
without much regard to the process, it may lead to
unhealthy practices where individuals see their peers as
rivals and focus on short-term results only.
Informal interactions between superior and subordi-
nate are infrequent in the market culture. Feedback is ori-
ented more toward evaluation than toward employee
development. In the market culture, the low level of supe-
rior–subordinate interaction and the assessment, as
opposed to developmental, approach to feedback empha-
sizes autonomy. Concern is not expressed for subordinate
development or long-term career progress. The reward
system is neither conducive to building a mentor–mentee
relationship nor likely to contribute to the transmission of
subtle norms and values. Socialization is not an important
function of this system.
The market culture relies on a contractual relationship
between the employee and the organization where
increased levels of performance from the employee are
rewarded through increased financial rewards. As a mar-
ket culture emphasizes individualism, it is less likely to
use teamwork to get jobs done and hence fosters employ-
ees who interact less with their coworkers.
With its focus on being competitive in the marketplace,
skill-based or competency-based pay, rather than a job-
based pay system, makes the most sense since performance
and financial results drive this culture. The focus on the
individual recognizes the value of unique abilities and
skills rather than with job responsibilities. A higher propor-
tion of variable pay is advocated to reward the high
demands placed on employees and to achieve aggressive
goals (Figure 9). In this culture, rewards are tied to perfor-
mance indicators as opposed to seniority or loyalty. In this
culture, the organization does not promise (or imply) secu-
rity; the individual does not promise (or imply) loyalty.
The low operating leverage of organization means less
variability of operating income resulting from changes in
revenue. In the adhocracy and market cultures, where ori-
entation of the organization is external and faces uncer-
tainty in terms of new product development and market
share, low operating leverage (higher variable cost rela-
tive to total cost) is preferred. In these cultures, lower
base pay and a higher proportion of variable pay is advo-
cated. A higher proportion of variable pay provides best
fit of pay structure and culture and generates competitive
advantage (Figure 9).
Illustration
To illustrate the impact of culture on compensation, con-
sider the four different cultures—hierarchy, clan, adhoc-
racy and market—as shown in Table 1.
Organization “A” is a large-scale, mature manu-
facturing company producing denim. The organi-
zation is a capital-intensive unit in the textile-
manufacturing sector with economy of scale.
Low
High
Misfit of Operang Leverage
and Culture
Low High
Fit of Pay Structure and Culture
Compeve
Advantage
(Opmal)
High Variable Pay and
Low Operang
Leverage
Compeve
Disadvantage
(Sub-Opmal)
Low Variable Pay and
High Operang
Leverage
Figure 9. Relationship of misfit of variable pay and culture
with fit of pay structure and culture (adhocracy and market
cultures).
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Madhani 11
It has a hierarchy culture and hence favors high
fixed pay (80%) in its compensation structure
(Table 1).
Organization “B” is an established company in the
field of iron ore processing. This company has a
team-oriented culture with the management
focused on training and long-term career develop-
ment of employees. In this clan culture, fixed pay
is still a higher proportion (70%) of the pay mix
(Table 1).
Organization “C” is a start-up company manufac-
turing and marketing the optical lens for surgical
robots used in precision heart surgery. The com-
pany is an innovative, high-tech unit in the field of
medical science. As it is an externally oriented,
research-driven firm with an adhocracy culture, its
pay structure has a higher proportion of variable
pay (60%) for employees (Table 1).
Organization “D” is a retail sales firm, handling
electronic consumer products such as optical storage
devices. The business is externally oriented and
focuses on product sales and market share. Culture
in this organization is high risk and performance ori-
ented. Hence, given its market culture, a very high
proportion of variable pay (80%) in compensation
structure is advocated (Table 1).
Figure 8 shows that hierarchy and clan cultures advo-
cate higher proportion of fixed pay in compensation
structure and high operating leverage. Similarly, the
matrix of Figure 9 shows that adhocracy and market cul-
tures favor higher proportion of variable pay in pay struc-
ture and low operating leverage. Findings of these
matrices are supported by Table 1. As calculated in Table
1, hierarchy and clan cultures have higher proportion of
fixed pay (80% and 70%, respectively) in pay mix and
hence shows higher operating leverage (1.93 and 1.66
respectively) as well as higher break-even point (no
profit–no loss situation); whereas adhocracy and market
cultures have higher proportion of variable pay (60% and
Table 1. Compensation Structure and Culture: An Illustration.
Culture type
No. Item details, calculation Hierarchical Clan Adhocracy Market
1 Organization name “A” “B” “C” “D”
2 Focus Internal External
3 Organization profile Production Processing Start-up Retail sales
4 Aggregate performance, units 70,000 70,000 70,000 70,000
5 Unit price, $ 7.50 7.50 7.50 7.50
6 Revenue = (4) × (5), $ 525,000 525,000 525,000 525,000
7 Threshold value, units 50,000 50,000 50,000 50,000
8 Unit variable cost, $ 3.50 3.50 3.50 3.50
9 Incentives, % 6.67 10.00 20.00 26.67
10 Variable pay = ([4] − [7]) × (5) × (9), $ 10,000.35 15,000.00 30000.00 40,000.35
11 Fixed pay, $ 40,000 35,000 20,000 10,000
12 Total pay = (10) + (11), $ 50,000 50,000 50,000 50,000
13 Variable pay/unit = (10)/(4), $ 0.14 0.21 0.43 0.57
14 Total variable cost/unit = (8) + (13), $ 3.64 3.71 3.93 4.07
15 Unit contribution margin = (5) − (14), $ 3.86 3.79 3.57 3.43
16 Contribution margin = (4) × (15), $ 270,000 265,000 250,000 240,000
17 Fixed cost (overhead), $ 90,000 70000 50,000 30,000
18 Total fixed cost = (11) + (17), $ 130,000 105,000 70,000 40,000
19 Total variable cost = (4) × (14), $ 255,000 260,000 275,000 285,000
20 Total cost = (18) + (19), $ 385,000 365,000 345,000 325,000
21 EBIT (earnings before interest and taxes) = (6) − (20), $ 140,000 160,000 180,000 200,000
22 BEP (break-even point) (units) = (18)/(15) 33,704 27,736 19,600 11,667
23 Fixed pay/total pay = (11)/(12), % 80 70 40 20
24 Variable pay/total pay = (10)/(12), % 20 30 60 80
25 Fixed cost/sales revenue = (18)/(6), (%) 24.76 20.00 13.33 7.62
26 Operating leverage = (16)/(21) 1.93 1.66 1.39 1.20
27 Increase in profitability due to 10% increase in
production/sales = 0.1 × (26), %
19.29 16.56 13.89 12.00
Source. Calculated by author.
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12 Compensation & Benefits Review
80% respectively) in pay mix and hence show lower
operating leverage (1.39 and 1.20, respectively) as well
as lower break-even point.
Conclusion
Culture has been identified as a subtle, intangible phe-
nomenon—pervasive but difficult to manage or influ-
ence. Many organizations today are focusing on their
company’s culture, including deciding what it should be,
aligning culture with strategic goals, business strategy
and compensation design and transitioning to the desired
culture. Culture is important because it reinforces the val-
ues in the organization, which in turn shapes employee
behavior. Culture can significantly affect employee work
experience and ultimately organizational performance.
A key contributor to culture is the compensation sys-
tem, which reflects the values of the organization, desired
actions and emphasis placed on desired results. The com-
pensation system is an important characteristic of an
organization and contributes to its culture. Depending on
how the system is designed, installed, communicated and
managed, it can support, hamper or change the direction
of an organization’s culture. Organizations have not thor-
oughly studied and linked organization culture and com-
pensation system as the culture frequently is not defined
and discussed, and often organizations are unsure of the
messages that specific compensation design alternatives
convey to employees. This research identifies compensa-
tion strategies for various types of organization culture
and suggests appropriate compensation structure for each
type of culture.
Declaration of Conflicting Interests
The author declared no potential conflicts of interest with respect
to the research, authorship, and/or publication of this article.
Funding
The author received no financial support for the research,
authorship, and/or publication of this article.
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Author Biography
Pankaj M. Madhani earned a master’s degree in business
administration from Northern Illinois University, a master’s
degree in computer science from Illinois Institute of Technology
in Chicago and a PhD in strategic management from CEPT
University. He has more than 27 years of corporate and aca-
demic experience in India and the United States. During his ten-
ure with corporate experience, he was recognized with the
Outstanding Young Managers Award. He is now working as an
associate professor at ICFAI Business School (IBS) where he
received the Best Teacher Award from IBS Alumni Federation.
He is also the recipient of the Best Mentor Award. He has pub-
lished various management books and more than 200 book
chapters and research articles in several academic and practitio-
ner journals such as WorldatWork Journal and The European
Business Review. He is a frequent contributor to Compensation
& Benefits Review and has published 12 articles on sales com-
pensation. His main research interests include sales force com-
pensation, corporate governance and business strategy.
by guest on July 6, 2014cbr.sagepub.comDownloaded from
