Chapter 10Pay-for-Performance:Incentive Rewards

Learning Outcomes

Implement a strategic incentive program

Detect when and what types of individual incentives are appropriate

Differentiate how gains may be shared with employees under different group incentive plans like the Scanlon and Improshare gainsharing systems

Learning Outcomes

Differentiate between profit sharing plans and explain advantages and disadvantages of these programs as an alternative to individual and group incentive systems

Understand how to apply different incentive systems designed for professionals and executives

Strategic Reasons for Incentive Plans

Variable pay: Tying pay to some measure of individual, group, or organizational performance

Attached to fixed costs allowing flexibility to increase, decrease, or maintain future payments to employees as business conditions warrant

Allows the organization to align its employees’ interests and outcomes with the organization

Strategic Reasons for Incentive Plans

Incentive pay plans

Establish a performance threshold for employees to qualify for incentive payments

Emphasize a shared focus on organizational objectives

By broadening the opportunities for incentives to employees

Creates an operating environment supporting shared commitment

Through belief that every individual contributes to organizational performance and success

Figure 10.1 – Types of Incentive Plans

Incentive Plans as Links to Organizational Objectives

Purpose of incentive plan

Encourages employees to assume ownership of their jobs, thereby improving effort and job performance

Motivates employees to expend more effort than under hourly and/or seniority-based compensation systems

Supports a compensation strategy to attract and retain top-performing employees

Advantages of Incentive Pay Programs

Focus employees on specific Performance targets

Incentive payouts are variable costs linked to the achievement of results

Base salaries are fixed costs unrelated to output

Directly related to operating performance

Encourage teamwork when payments are related to team results

Advantages of Incentive Pay Programs

Distribute success among those related to producing that success

Increase equity and justice

Means to reward or top performers when salary budgets are low

Requirements for a Successful Incentive Plan

Identify important organizational metrics encouraging employee behavior

Involve employees

Incentive programs should seem fair to employees

Find the right incentive payout

Payout formulas should be simple and understandable

Establish a clear link between performance and payout

Setting Performance Measures

Should distinguish between individual and group contributions

Should avoid biases based on likes and dislikes, different personalities, and political agendas

Should distinguish between one group’s contribution over another

Problems With Incentive Plan

Can be traced to the choice of performance measures

Overly quantitative, complex measures should be avoided

Selection of performance measure need to evaluate the extent to which employees involved can influence the measurement

Avoid intensifying performance goals continuously trying to exceed previous results

Leads to employee frustration and perception that the standards are unattainable

Figure 10.3 – Measurement DOs and DON’Ts

Administering Incentive Plans

Thorough planning must be combined with a cautious approach

Effective administration of incentive plans requires:

To motivate performance implying that poor performance must go unrewarded

Annual salary budgets to be large enough to reward and reinforce exceptional performance

Determination of overhead costs associated with plan implementation and administration

Individual Incentive Plans – Piecework

Straight piecework: Incentive plan under which employees receive a certain rate for each unit produced

Differential piece rate: Employees whose production exceeds the standard amount of output receive a higher rate for their work than the rate paid to those who do not exceed the standard amount

Individual Incentive Plans – Piecework

Benefits of piecework

Wage payment for each employee is simple to compute

Permits organizations to predict its labor costs with accuracy

Since the costs are the same for each unit of output

Computing the piece rate

Based on hourly wage rates that would otherwise be paid for the type of work being performed

Disadvantages of Piecework

Not an effective motivator

Desire for peer approval outweighs the desire for more money

Difficult to distinguish or measure individual contributions

Not applicable to highly mechanized work where employee has little control over output

Works against organizational culture as it can infringe on employee’s time, productivity, and total pay earned

Individual Incentive Plans – Standard Hour Plan

Sets rates based on the completion of a job in a predetermined standard time

Popular in service departments in automobile dealerships

Equipment maintenance and product quality can be at risk as employees strive to work faster to earn additional income

Individual Incentive Plans – Bonus

Supplemental to the base wage

Provides employees with more pay for exerting greater effort along with having the security of basic wage

Acts as tool to increase future performance

Spot bonus: Unplanned bonus given for employee effort unrelated to an established performance measure

Useful for retention and motivation of overburdened employees, during lean financial times

Individual Incentive Plans – Merit Pay

Links an increase in base pay to how successfully an employee performs his or her job

Becomes part of base pay once issued regardless of future performance

Serves as motivator to employees perceiving a raise to be related to the performance required to earn it

Merit guidelines: Used for awarding merit raises that are tied to performance objectives

Problems with Merit Raises

Money available for merit increases may be inadequate to satisfactorily raise all employees’ base pay

Managers may have no guidance in how to define and measure performance

Employees may not believe that compensation is tied to effort and performance

Unable to differentiate between merit pay and other types of pay increases

Problems with Merit Raises

Employees and managers may hold different views of the factors contributing to job success

Creates feelings of pay inequity

Individual Incentive Plans – Awards and Recognition

Awards

Used to recognize productivity gains, special contributions or achievements, and service to the organization

Tangible awards presented with the right message and style can make employees feel appreciated

Simultaneously underscoring a company

Recognition

Conduit that shows employees that the company appreciates their efforts, their unique gifts, and their contributions

Individual Incentive Plans – Sales Incentives

Unique needs of sales incentive plans

Performance standards for sales employees are difficult to develop because performance is affected by external factors

Sales volume may not be an accurate indicator of the effort salespeople have expended, hence salespeople are entitled to a degree of stability in their income

Types of Sales Incentive Plans

Permits salespeople to be paid for performing various duties that are not reflected immediately in their sales volume

Straight salary plan

Based on percentage of sales

Straight commission plan

Includes a straight salary and commission

Combination salary and commission plan

Pays a salary plus a bonus achieved by reaching targeted sales goals

Sales plus bonus plan

Group Incentive Plans – Team Compensation

Team incentive plans: All team members receive an incentive bonus payment when production or service standards are met or exceeded

Advantages

Establishes a psychological climate that fosters cooperation and a collective desire to fulfill organizational goals and objectives

Promotes a pay-for-performance philosophy

Group Incentive Plans – Team Compensation

Approaches in establishing team incentive payments

Set performance measures upon which incentive payments are based

Determine the size of the incentive bonus

Create a payout formula and should be explained to employees in detail

Group Incentive Plans – Team Compensation

Problems associated with team compensation

Individual team members may perceive that their efforts contribute little to team success or to the attainment of the incentive reward

Intergroup social problems

Complex payout formulas or insufficient payout reward

Group Incentive Plans – Gainsharing Incentive Plan

Programs under which both employees and the organization share financial gains by a predetermined formula

Reflects improved productivity and profitability

Increase in productivity is gained when:

Greater output is obtained with less or equal input

Equal production output is obtained with less input

Variations of Gainsharing Plans

Bonus incentive plan using employee and management committees to gain cost-reduction improvements

Scanlon plan

Gainsharing program where bonuses are based on the overall productivity of the work team

Improshare

Figure 10.4 – Scanlon Plan Suggestion Process

Enterprise Incentive Plan – Profit Sharing

Procedure by which an employer pays, or makes available to all regular employees, special current or deferred sums based on the organization’s profits

Advantages

Gives employees the opportunity to increase their earnings by contributing to the growth of the organization’s profits

Stimulates employees to think and feel like partners in the enterprise

Garners total commitment from employees rather than specific areas

Enterprise Incentive Plan – Profit Sharing

Disadvantages

Profits shared with employees may be the result of factors over which employees have no control

Decreased motivational value as profit sharing payments are made once a year or deferred until retirement may reduce their motivational value

If failed to pay off for several years in a row, has an adverse effect on productivity and employee morale

Enterprise Incentive Plan – Stock Options

Method of motivating and compensating hourly employees, salaried and executive personnel

Advantages

Implemented as part of an employee benefit plan or as part of a corporate culture

Links employee effort to stock performance

Boosts morale of disenfranchised employees in budget cuts and downsizing

Disadvantage

Extravagance of executive stock option plans and dubious corporate accounting procedures

Enterprise Incentive Plan – Employee Stock Ownership Plans (ESOPs)

Stock plans in which an organization contributes shares of its stock to an established trust for the purpose of stock purchases by its employees

Employer establishes an ESOP trust that qualifies as a tax-exempt employee trust under Section 401(a) of the Internal Revenue Code

Stock allocations are based on employee wages or seniority

Enterprise Incentive Plan – Employee Stock Ownership Plans (ESOPs)

Employees leaving or retiring can sell their stock back to the organization, or sell it on the open market if traded publicly

Advantages

Usage is encouraged by favorable federal income tax provisions

Provides retirement benefits for the employees

Employers can provide retirement benefits to the employees at relatively low cost

Increases employees’ pride of ownership in the organization

Enterprise Incentive Plan – Employee Stock Ownership Plans (ESOPs)

Disadvantages

Privately held companies are incapable to pay back the stock of employees when they retire

Pensioner becomes dependent on the price of company stock

Future retirees are vulnerable to stock market fluctuations and management mistakes

Not guaranteed by federally established Pension Benefit Guaranty Corporation

Incentives for Professional Employees

Professional employees

For many professions, the primary incentive system is based on an up or out model

Junior professionals are hired and are given a set amount of time to make valuable contributions to become a partner

Motivation is influenced by their increased mobility across companies

Can receive compensation beyond base pay

The Executive Pay Package

Components

Base salary

Short-term incentives or bonuses

Long-term incentives or stock plans

Benefits

Perks

The Executive Pay Package

Executive base salaries

Represents 30 or 40 percent of total annual compensation

Largest portion is received in long-term incentive rewards and bonuses

Influenced by levels of competitive salaries in the job market

The Executive Pay Package

Executive short-term incentives

Annual bonuses form the main element

Bonus payment in form of cash or stock and may be paid immediately, deferred for a short time, or deferred until retirement

Paid in cash, keeping with their pay-for-performance strategy

Based on:

Percentage of company’s total profits

The Executive Pay Package

Percentage of profits in excess of a specific return on stockholders’ investments

Annual profit plan where the amount is determined by the extent to which an agreed-upon profit level is exceeded

Executive long-term incentives

Offered in the form of stock options

Stock options serves to retain key executive personnel

Objected for the magnitude of rewards

The Executive Pay Package

Pay for performance option can be undermined when executives are granted additional options

Though company stock prices fall or performance indexes decline

Executive benefits

Benefits package offered to executives can be parallel to other groups of employees

Include programs for health insurance, life insurance, retirement plans, and vacations

Are broader in coverage and free of charge

The Executive Pay Package

Gives financial assistance in the form of trusts for estate planning, payment of mortgage interest, and legal help

Perks or perquisites: Special nonmonetary benefits given to executives

Means of demonstrating the executive’s importance to the organization

Cost is weighed against the added efficiency and managerial effectiveness generated as facilitates in company’s productivity

Executive Compensation: Ethics and Accountability

Justification of bonuses

Large financial incentives are a way to reward superior performance

Business competition is pressure-filled and demanding

Good executive talent is in great demand

Effective executives create shareholder value

Fact of business life, reflecting market compensation trends

Executive Compensation Reform

Internal Revenue Service (IRS) makes executive pay a part of every corporate audit

Securities and Exchange Commission issued pay disclosure rules requiring companies listed on the New York Stock Exchange and NASDAQ to disclose the true size of their top executive pay packages

Financial Accounting Standards Board (FASB) requires stock options to be recognized as an expense on income statements

Executive Compensation Reform

Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. 111-203) was signed into effect giving share holders say on pay

Voting shareholders of a company must ultimately approve of its executive salaries

PayforPerformance.pptx

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