Pay-for-Performance: Incentive Rewards

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Pay-for-Performance:Incentive Rewards

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The Challenges of Human Resources Management

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2 of 36© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2 of 49

Linking Pay to Performance

Performance Pay Motivation Improved Performance


Pay for Performance

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How Incentives Sometimes “Work”


Employee Opposition to Incentive Plans

• Production standards are set unfairly. • Incentive plans are really “work speedup.”• Incentive plans create competition among

workers.• Increased earnings result in tougher standards.• Payout formulas are complex and difficult to

understand.• Incentive plans cause friction between

employees and management.


Incentive Plans as Links toOrganizational Objectives

• Incentive Plan Purposes Encourage employees to assume “ownership” of their jobs,

thereby improving effort and job performance.

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

Support a compensation strategy to attract and retain top-performing employees.

• Incentive Plan Effectiveness There is evidence of a relationship between incentive plans

and improved organizational performance.


Requirements for a Successful Plan Identify important organizational metrics that

encourage 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.


Why Incentive Plans Fail

They fail to meet employee expectations for pay gains.

There is confusion about incentive payment calculations due to poor design and implementation of the plan.

Employees do not have the capability to change their performance levels.

The organization environment does not support plan.


Incentive Plans as Links to Organizational Objectives

Contemporary arguments for incentive plans focus on linking compensation rewards, both individual and group, to organizational goals.


Individual Incentive Plans• Straight Piecework

An incentive plan under which employees receive a certain rate for each unit produced.

• Differential Piece Rate A compensation rate under which employees

whose production exceeds the standard amount of output receive a higher rate for all of their work than the rate paid to those who do not exceed the standard amount.


Computing the Piece Rate

hourper units 5 unit)per time(standard minutes 12

hour)(per minutes 60=

unitper $2.55 hour)(per units 5

rate)(hourly $12.75 =

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Pros and Cons of Piecework• Easily understandable, equitable, and

powerful incentives• Employee resistance to changes

in standards or work processes affecting output

• Quality problems caused by an overriding output focus

• Possibility of violating minimum wage standards

• Employee dissatisfaction when incentives either cannot be earned or are withdrawn

• May conflict with organizational culture and/or group norms


Norms: A Group’s Unspoken Rules


Individual Incentive Plans (cont’d.)

• Standard Hour Plan An incentive plan that sets pay rates

based on the completion of a job in a predetermined “standard time.”

If employees finish the work in less than the expected time, their pay is still based on the standard time for the job multiplied by their hourly rate.


Individual Incentive Plans (cont.)

• Bonus Incentive payment that is supplemental to the

base wage for cost reduction, quality improvement, or other performance criteria.

• Spot bonus Unplanned bonus given for employee effort

unrelated to an established performance measure.


Merit Pay

• Merit Pay Program (Merit Raise) Links an increase in base pay to how

successfully an employee achieved some objective performance standard.

• Merit Guidelines Guidelines for awarding merit raises that

are tied to performance objectives.


Merit Pay and Motivation

• Evidence suggests that merit raises of 10-15% motivate changes in behavior.

• Typical merit raises range from 2-6%• Rewards are more motivating if:

– They are timely– They are public rather than secret– They are scarce rather than common


Example of Merit Increase Grid


Lump-Sum Merit Pay• Lump-Sum Merit Program

– Program under which employees receive a year-end merit payment, which is not added to base pay.

– Advantages:• Provides financial control by maintaining annual

salary expenses and not escalating base salary levels.

• Contains employee benefit costs for levels of benefits normally calculated from current salary levels.


Problems with Merit Raises1. Money for merit increases may be inadequate to satisfactorily

raise all employees’ base pay.

2. Managers may have no guidance in how to define and measure performance; there may be vagueness regarding merit award criteria.

3. Employees may not believe that their compensation is tied to effort and performance; they may be unable to differentiate between merit pay and other types of pay increases.

4. Employees and their managers may hold different views of the factors that contribute to job success.

5. Merit pay plans may create feelings of pay inequity.


Sales Incentives

Straight Commission

Straight Salary

Salary and CommissionCombinations

Sales Incentive Plans


Incentive Plans for Salespersons

• Straight Salary Plan Compensation plan that permits salespeople to be paid

for performing various duties that are not reflected immediately in their sales volume.

Advantages:– Encourages building customer relationships.– Provides compensation during periods of poor sales.

Disadvantage:– May not provide sufficient motivation for maximizing sales

volume.


Incentive Plans for Salespersons (cont.)

• Straight Commission Plan Compensation plan based upon a percentage of sales.

– Draw is a cash advance that must be paid back as commissions are earned.

Disadvantages:– Salespeople will stress high-priced products.– Customer service after the sale is likely to be neglected.– Earnings tend to fluctuate widely between good and poor

periods of business, an turnover of trained sales employees tends to increase in poor periods.

– Salespeople are tempted to grant price concessions.


Incentive Plans for Salespersons (cont.)

• Combined Salary and Commission Plan A compensation plan that includes a straight salary

and a commission component (“leverage”). Advantages:

– Combines the advantages of straight salary and straight commission forms of compensation.

– Offers greater design flexibility

– Can be used to develop the most favorable ratio of selling expense to sales.

– Motivates sales force to achieve specific company marketing objectives in addition to sales volume.


Group/Team Incentive Plans

• Team Incentive Plans Compensation plans where all team members

receive an incentive bonus payment when production or service standards are met or exceeded.

• 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 fully explain to

employees how payouts will be distributed.


Team Incentive Plans• Advantages

Team incentives support group planning and problem solving, thereby building a team culture.

The contributions of individual employees depend on group cooperation.

Team incentives can broaden the scope of the contribution that employees are motivated to make.

Team bonuses tend to reduce employee jealousies and complaints over “tight” or “loose” individual standards.

Team incentives encourage cross-training and the acquiring of new interpersonal competencies.


Team Incentive Plans (cont.)

• Disadvantages Individual team members may perceive that “their” efforts

contribute little to team success or to the attainment of the incentive bonus.

Intergroup social problems—pressure to limit performance and the “free-ride” effect may arise.

Complex payout formulas can be difficult for team members to understand.


Team Incentive Plans (cont.)

• Gainsharing Plans Programs under which both employees and the

organization share the financial gains according to a predetermined formula that 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.


Gainsharing Incentive Plans

Scanlon Plan Rewards come from employee participation in improving productivity and reducing costs.

Improshare Gainsharing based on increases in productivity of the standard hour output of work teams.


Gainsharing Plans

Philosophy of

cooperationInvolvemen

t systemIdentity

Scanlon Plan Components

Competence

Benefits sharing formula


Scanlon Plan Suggestion Process


Improved Productivity through Sharing (Improshare): An Example

• A standard of the number of person-hours required to produce an expected level of output is developed

• 5000 hours of labor to produce 1000 units each week (5 hours per unit)

• In a given week 5000 labor hours produced 1300 units

• 1500 hours have been saved (300 x 5)• 50-50 split between firm and employees;

employees get 750 hour bonus• 750/5000 = 15% bonus• Employees receive a 15% bonus for the week


Enterprise Incentive Plans• Profit Sharing

Any procedure by which an employer pays, or makes available to all regular employees, in addition to their base pay, current or deferred sums based upon the profits of the enterprise.

Deferred profit-sharing plans– A predetermined portion of profits based on the

employee’s contribution to the firm’s profits is placed in each employee’s retirement account under a trustee’s supervision.

– Employees’ income taxes on the distributions are deferred, often until the employee retires.


Enterprise Incentive PlansProfit Sharing Challenges

• Agreement over the percentages of shared of profits and the forms of distribution (cash or deferred) of profits between company and employees

• Annual variations and possibility of no payout due to financial condition of company

• Maintaining motivational connection of profit-sharing to performance of employees


Enterprise Incentive Plans (cont.)

• Stock Options Granting employees the right to purchase a

specific number of shares of the company’s stock at a guaranteed price (the option price) during a designated time period.

The value of an option is subject to stock market conditions at the time that option is exercised.



• 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.

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

– Stock bonus plans are funded by direct employer contributions of its stock or cash to purchase its stock.

– Leveraged plans are funded by employer borrowing to purchase its stock for the ESOP.



Rewards and Risks of ESOPS

Advantages Disadvantages

Liquidity and value

Pride of ownership

Deferred taxes

Single funding basis

Not insured

Retirement benefits

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Advantages of ESOPs• For the Company

Can take a tax deduction equal to the fair market value of the shares transferred to the ESOP trustee

Gets an income tax deduction for dividends paid on ESOP-owned stock

Can borrow against ESOP in trust and then repay the loan in pretax rather than after-tax dollars

• For the Employees Develop a sense of ownership in and commitment to the firm. Do not pay taxes on ESOP earnings until they receive

a distribution.• For the Shareholders of Closely-Held Corporations

Can place assets into an ESOP trust which will allow them to purchase other marketable securities to diversify their holdings


Incentives for Executives (cont.)

• Justifications Large financial incentives reward superior

performance. Business competition is pressure-filled and

demanding. Good executive talent is in great demand. Effective executives create shareholder

value.


Incentives for Executives• The Executive Pay Package

Base salary Short-term incentives or bonuses Long-term incentives or stock plans Benefits Perquisites (perks)


Types of Long-Term Incentive Plans


The “Sweetness” of Executive Perks


Executive Compensation Reform

• Current Reform Measures The Internal Revenue Service (IRS) is looking for tax-

code violations in executive pay packages and will make executive pay a part of corporate audits.

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

The Financial Accounting Standards Board (FASB) now requires that stock options be recognized as an expense on income statements.


Executive Compensation Reform (cont.)

• Other Reform Measures: The adoption of performance formulas that peg

executive compensation to organizational benchmarks other than stock price

Shareholder resolutions that allow shareholders the right to vote on executive pay packages

Greater accountability by compensation committees to justify large executive pay awards or severance or retirement packages


Pay for Performance???

• Give Me a Break: Big Bucks for Execs as Companies Flounder

• Nardelli out at Home Depot

http://abcnews.go.com/2020/story?id=123916

http://abcnews.go.com/2020/story?id=123916

http://money.cnn.com/2007/01/03/news/companies/home_depot/

http://money.cnn.com/2007/01/03/news/companies/home_depot/


Nonfinancial and Recognition Awards

• Effects of Recognition-Based Awards– Recognition has a positive impact on performance,

either alone or in conjunction with financial rewards.– Day-to-day recognition from supervisors, peers, and

team members is important.

• Ways to Use Recognition– Social recognition– Performance-based recognition– Performance feedback


1501 Ways to Reward Employees (2012)


Social Recognition and Related Positive Reinforcement Managers Can Use

• Challenging work assignments• Freedom to choose own work

activity• Having fun built into work• More of preferred task• Role as boss’s stand-in when he

or she is away• Role in presentations to top

management• Job rotation• Encouragement of learning and

continuous improvement

• Being provided with ample encouragement

• Being allowed to set own goals• Compliments• Expression of appreciation in

front of others• Note of thanks• Employee-of-the-month award• Special commendation• Bigger desk• Bigger office or cubicle


Customize Your Noncash Incentive Awards


Punished by Rewards (1999)

• Punished by Rewards

• Intrinsic v. extrinsic motivation

http://psychology.about.com/od/motivation/f/difference-between-extrinsic-and-intrinsic-motivation.htm


Intrinsic Motivation and Creativity

• The issue of whether reward decreases or increases intrinsic interest and creativity is relevant to organizations because creative contributions help organizations become more efficient, adapt to change, and develop new products and services

• http://www.psychology.uh.edu/faculty/Eisenberger/IMC.html

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http://www.psychology.uh.edu/faculty/Eisenberger/IMC.html




Pay-for-Performance: Incentive Rewards

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