Sales Employees Compensation: An Optimal Balance between Fixed and Variable Pay

Abstract

This conceptual paper describes the pros and cons of fixed and variable pay in sales. It posits that agency theory can explain the variation across firms in respect to the compensation system used. A successful pay system communicates organizational priorities and goals and motivates salespeople to achieve higher performance. Variable pay can help firms align employee and organizational interests. However, a shift from fixed to variable pay results in an increase in variable costs along with an increase in fixed cost. Compensation strategy thus affects the firm’s cash flow, operating leverage, and breakeven points. The paper also posits that there is an optimal balance of variable versus fixed compensation costs that maximizes the economy value added (EVA) of the firm. When the variable pay component is small, increasing the variable component results in a higher EVA. At a higher level of variable pay, however, further increases in variable pay may reduce EVA due to losses associated with employee dissatisfaction, high stress, and higher turnover costs.

Keywords: Fixed pay, Variable pay, Agency theory, Compensation, EVA