Copyright © 2008 by Nelson, a division of Thomson Canada Limited. 11–1 Part 4: Compensating Human...

Copyright © 2008 by Nelson, a division of Thomson Canada Limited. 11–1

Part 4: Compensating Human ResourcesPart 4: Compensating Human ResourcesPart 4: Compensating Human ResourcesPart 4: Compensating Human Resources

Chapter 11: Variable Pay and Executive Compensation

Prepared by Linda Eligh, University of Western Ontario


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

After you have read this chapter, you should be able to:

1. Define variable pay and identify three elements of successful pay-for-performance plans.

2. Discuss three types of individual incentives.

3. Explain three ways that sales employees are typically compensated.

4. Identify key concerns that must be addressed when designing group/team variable pay plans.

5. Discuss why profit sharing and employee stock ownership are common organizational incentive plans.

6. Identify the components of executive compensation and discuss criticisms of executive compensation levels.


Variable Pay: Incentives for PerformanceVariable Pay: Incentives for PerformanceVariable Pay: Incentives for PerformanceVariable Pay: Incentives for Performance

• Variable Pay Compensation linked to individual, group/team, and/or

organizational performance.

• Basic assumptions:Some jobs contribute more to organizational success

than others.Some people perform better and are more productive

than others.Employees who perform better should receive more

compensation.Some of employees’ total compensation should be

tied directly to performance.


Developing Successful Pay-for-Performance Plans

Developing Successful Pay-for-Performance Plans

• Reasons for Adopting Pay or Incentive Plans:Link more directly strategic business goals and

employee performance.

Enhance organizational results and reward employees financially for their contributions.

Reward employees to recognize different levels of employee performance.

Achieve HR objectives, such as increasing retention, reducing turnover, recognizing training, or rewarding safety and attendance.


Effective Incentive Plans Effective Incentive Plans Fig. 11-1Fig. 11-1Effective Incentive Plans Effective Incentive Plans Fig. 11-1Fig. 11-1


Metrics for Variable Pay Plans Metrics for Variable Pay Plans Fig. 11-2Fig. 11-2Metrics for Variable Pay Plans Metrics for Variable Pay Plans Fig. 11-2Fig. 11-2


Successes and Failures of Variable Pay Plans

Successes and Failures of Variable Pay Plans

• Successful incentive plans require:The development of clear, understandable plans that

are continually communicated.

The use of realistic performance measures.

Keeping plans current and linked to organizational objectives.

Strong links among performance results and payouts that truly recognize performance differences.

Clear identification of variable pay incentives separately from base pay.


Types of Variable Pay Plans Types of Variable Pay Plans Fig. 11-3 Fig. 11-3Types of Variable Pay Plans Types of Variable Pay Plans Fig. 11-3 Fig. 11-3


Individual IncentivesIndividual IncentivesIndividual IncentivesIndividual Incentives

IndividualismStressed in

OrganizationalCulture

IndividualismStressed in

OrganizationalCulture

Identification ofIndividual

Performance

Identification ofIndividual

Performance

IndependentWork

IndependentWork

IndividualCompetitiveness

Desired

IndividualCompetitiveness

Desired

Individual Individual Incentive Incentive SystemsSystems

Individual Individual Incentive Incentive SystemsSystems


Individual Incentives: Piece-Rate SystemsIndividual Incentives: Piece-Rate SystemsIndividual Incentives: Piece-Rate SystemsIndividual Incentives: Piece-Rate Systems

• Straight Piece-Rate SystemsWages are determined by multiplying the number of

pieces produced by the piece rate for one unit.

• Differential Piece-Rate SystemsEmployees are paid one piece-rate for units produced

up to a standard output and a higher piece-rate wage for units produced over the standard.


Individual Incentives: BonusesIndividual Incentives: BonusesIndividual Incentives: BonusesIndividual Incentives: Bonuses

• Bonus A one-time payment that does not become

part of the employee’s base pay.• Spot Bonus

A special type of bonus used is a “spot” bonus, so called because it can be awarded at any time.


Special Incentive ProgramsSpecial Incentive ProgramsSpecial Incentive ProgramsSpecial Incentive Programs

• Performance AwardsCash or merchandise used as an incentive reward.

• Recognition AwardsRecognition of individuals for their performance or

service to customers in areas targeted by the firm.

• Service AwardsRewards to employees for lengthy service with an

organization.


Purposes of Special Incentives Purposes of Special Incentives Fig. 11-4Fig. 11-4Purposes of Special Incentives Purposes of Special Incentives Fig. 11-4Fig. 11-4


Types of Sales Compensation PlansTypes of Sales Compensation PlansTypes of Sales Compensation PlansTypes of Sales Compensation Plans

• Salary-OnlyAll compensation is paid as a base wage with no

incentives.

• CommissionStraight Commission

Compensation is computed as a percentage of sales in units or dollars.

The draw system make advance payments against future commissions to salesperson.

Salary-Plus-Commission or Bonuses Compensation is part salary for income stability and part

commission for incentive.


Determining Sales Effectiveness Determining Sales Effectiveness Fig. 11-5Fig. 11-5Determining Sales Effectiveness Determining Sales Effectiveness Fig. 11-5Fig. 11-5


Why Organizations Establish Variable Pay Plans or Why Organizations Establish Variable Pay Plans or Groups/Teams Groups/Teams Fig. 11-6Fig. 11-6

Why Organizations Establish Variable Pay Plans or Why Organizations Establish Variable Pay Plans or Groups/Teams Groups/Teams Fig. 11-6Fig. 11-6


Group/Team IncentivesGroup/Team IncentivesGroup/Team IncentivesGroup/Team Incentives

Distribution of Distribution of Group/Team Group/Team IncentivesIncentives

Distribution of Distribution of Group/Team Group/Team IncentivesIncentives

Timing ofTiming ofGroup/Team Group/Team Incentives Incentives

Timing ofTiming ofGroup/Team Group/Team Incentives Incentives

Decision Making Decision Making About Group/Team About Group/Team

AmountsAmounts

Decision Making Decision Making About Group/Team About Group/Team

AmountsAmounts

Design of Design of Group/Team Group/Team

Incentive PlansIncentive Plans

Design of Design of Group/Team Group/Team

Incentive PlansIncentive Plans


Group/Team Incentives (cont’d)Group/Team Incentives (cont’d)Group/Team Incentives (cont’d)Group/Team Incentives (cont’d)

• Distributing RewardsSame-size reward for each member

Different-size reward for each member

• Problems with Group/Team IncentivesRewards in equal amounts may be perceived as

“unfair” by employees who work harder, have more capabilities, or perform more difficult jobs.

Group/team members may be unwilling to handle incentive decisions for co-workers.

Many employees still expect to be paid according to individual performance.


Conditions for Successful Conditions for Successful Group/Team Incentives Group/Team Incentives Fig. 11-7Fig. 11-7

Conditions for Successful Conditions for Successful Group/Team Incentives Group/Team Incentives Fig. 11-7Fig. 11-7


Types of Group/Team IncentivesTypes of Group/Team IncentivesTypes of Group/Team IncentivesTypes of Group/Team Incentives

• Group/Team Results “Self-funding” pay plans for groups/teams that reward through improved

organizational results on the basis of group output, cost savings, or quality improvement.

• Gainsharing (Teamsharing or Goal Sharing) The sharing with employees of greater-than-expected gains in

productivity through increased discretionary efforts.

Improshare, Scanlon Plan, Rucker

• Earnings-at Risk (EAR) Incentive plans designed to enhance performance by creating

enough dissatisfaction with base wages that employees become more interested in directing behaviours to what is rewarded with incentive pay.


GainsharingGainsharingGainsharingGainsharing

• Improshare “Improved productivity through sharing plan”Time studies determine how many hours it should

take to produce one unit of productWhen actual productivity is greater than the baseline,

a percentage of savings is shared with employeesEasiest of the gainsharing plans to understand and

installFocus is on quantity, not quality


Scanlon Plan Gains Example Scanlon Plan Gains Example Fig. 11-8Fig. 11-8Scanlon Plan Gains Example Scanlon Plan Gains Example Fig. 11-8Fig. 11-8


Rucker Plan Gains Example Rucker Plan Gains Example Fig. 11-9Fig. 11-9Rucker Plan Gains Example Rucker Plan Gains Example Fig. 11-9Fig. 11-9


Organizational IncentivesOrganizational IncentivesOrganizational IncentivesOrganizational Incentives

• Profit SharingA system to distribute a portion of the profits of the

organization to employees.Primary objectives:

Increase productivity and organizational performance Attract or retain employees Improve product/service quality Enhance employee morale

Drawbacks Disclosure of financial information Variability of profits from year to year Profit results not strongly tied to employee efforts


Framework Choices for a Framework Choices for a Profit-Sharing Plan Profit-Sharing Plan Fig. 11-10Fig. 11-10

Framework Choices for a Framework Choices for a Profit-Sharing Plan Profit-Sharing Plan Fig. 11-10Fig. 11-10


Employee Stock PlansEmployee Stock PlansEmployee Stock PlansEmployee Stock Plans

• Stock Option PlanA plan that gives employees the right to purchase a

fixed number of shares of company stock at a specified price for a limited period of time.

If market price of the stock is above the specified option price, employees can purchase the stock and sell it for a profit.

If the market price of the stock is below the specified option price, the stock option is “underwater” and is worthless to employees.


Employee Stock PlansEmployee Stock PlansEmployee Stock PlansEmployee Stock Plans

• Employee Stock Ownership Plan (ESOP)A plan whereby employees gain significant stock

ownership in the organization for which they work.

Advantages Favourable tax treatment for ESOP earnings

Employees motivated by their ownership stake in the firm

Disadvantages Retirement benefit is tied to the firm’s future performance

Management tool to fend off hostile takeover attempts


Components of Executive Components of Executive Compensation Packages Compensation Packages Fig. 11-11Fig. 11-11

Components of Executive Components of Executive Compensation Packages Compensation Packages Fig. 11-11Fig. 11-11


Performance Incentives: Long-Term vs. Short TermPerformance Incentives: Long-Term vs. Short TermPerformance Incentives: Long-Term vs. Short TermPerformance Incentives: Long-Term vs. Short Term

• Sarbanes-Oxley Act (SOX) U.S. Act containing numerous provisions that affect accounting

and financial reporting requirements of different types of executive compensation.

Mandates that CEOs and CFOs of companies listed on the U.S. stock exchanges must certify and sign off on interim and annual statements as well as their corporate governance framework.

Penalties can be swift and severe Delisting of stock, heavy fines, prosecution of top executives

• Bill C-198 Canada’s SOX equivalent


Executive CompensationExecutive CompensationExecutive CompensationExecutive Compensation

• “Reasonableness” of Executive CompensationWould another company hire this person as an

executive?

How does the executive’s compensation compare with that for executives in similar companies in the industry?

Is the executive’s pay consistent with pay for other employees within the company?

What would an investor pay for the level of performance of the executive?


Common Executive Compensation Issues Common Executive Compensation Issues Fig. 11-12Fig. 11-12Common Executive Compensation Issues Common Executive Compensation Issues Fig. 11-12Fig. 11-12


Executive CompensationExecutive CompensationExecutive CompensationExecutive Compensation

• Boards of DirectorsMajor policy setting entity that must approve

executive compensation packages

• Compensation CommitteesUsually a subgroup of the Board of DirectorsComposed of Directors who are not officers of the firmMake recommendations to the Board on

overall pay policies salaries for top officers supplemental compensation (stock options, bonuses) additional “perks” for executives


Compensation Committees Compensation Committees Compensation Committees Compensation Committees

• Criticisms Base pay and bonuses of CEOs is often set by members of

Board Compensation Committees who are themselves CEOs and who receive similar compensation packages in other companies.

Compensation consultants and advisers to CEOs often collect large fees which can distort objectivity of advice provided.

• Corrective Actions Change composition of Board compensation committees to

prohibit “insider” company officers from serving on them. Empower compensation committees to hire and pay

compensation consultants without involving executive management.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited. 11–1 Part 4: Compensating Human...

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