Variable Pay & Executive Compensation

MN 301 – Human Resource Management

Craig W. Fontaine, Ph.D.Pine Manor College

Fall 2014

Variable: Incentives for Performance

• Variable pay - Compensation tied to performance• Individual• Group/ team• Organizational

• Beneficial for both employees and employer• Employers - More output per employee• Employee - More pay

Why Use Variable Pay?

Variable Pay

Assumptions

Some people perform better and are more

productive than others

Better performing employees

should receive more

compensation

Some jobs contribute more

to organizational success than

others

Total compensation should be tied

directly to performance and

results

A Variety of Possible Incentives

Pay-for-Performance Plans

Reasons for Pay-for-

Performance Plans

Enhance results and reward employees financially

Link strategic goals and employee

performance

Reward and recognize employee

performance

Promote achievement of HR objectives

Factors for Successful Variable Pay Plans

Categories of Variable Pay

Individual Incentives

Individual Incentives• Piece-rate systems • Straight piece-rate system

• Wages are determined by multiplying the number of units produced by the piece rate for one unit

• Differential piece-rate system• Pays employees one piece-rate wage for units produced up to a

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

Individual Incentives• Bonus• One-time payment that does not become part of the employee’s

base pay• Massive kinked bonuses • Very large all or nothing bonus (example: golfer)

• Spot bonuses• Can be awarded at any time

Individual Incentives• Nonmonetary incentives• Performance awards

• Incentive rewards for performance• Recognition awards

• Recognizes individual employees for their work• Service awards

• Recognize service

Individual Incentives• Commissions• Percentage of the money taken in on sales• Often given on top of salary

Design of Group/Team Incentive Plans

Group/Team Incentives• Distributing rewards issue:• Same-size reward for each member• Different-size reward for each member

Group/Team Incentives• Challenges with group/team incentives• Rewards distributed in equal amounts to all members may be

perceived as unfair • Free riders - Member of the group who contributes little• Team size - Individual efforts of employees have little effect on

the total performance of the group in large groups

Conditions for Successful Group/Team Incentives

Types of Group/Team Incentives

• Group/team results• Group production

• Cost savings

• Quality improvement

• Gainsharing: Sharing with employees of greater-than-expected gains in productivity through increased discretionary efforts

Organizational Incentives

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

Profit Sharing

Framework Choices for a Profit-Sharing Plan

Employee Stock Plans• Stock option plan• Employees can buy fixed number of shares of company stock

• At a specified price for a limited period of time

• Employee stock ownership plan (ESOP)• Gives employees significant stock ownership in the organization

they work

Advantages and Disadvantages of ESOP

• Advantages• Favorable tax treatment for ESOP earnings• Employees motivated by their ownership stake in the firm

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

Metric Options for Variable Pay Plans

Types of Sales Compensation Plans

• Salary-only• All compensation is paid as a base wage with no incentives

• Straight commission• Compensation is computed as a percentage of sales in units or

dollars• Draw system makes advance payments against future

commissions to the salesperson• Salary-plus-commission or bonuses• Compensation is part salary for income stability and part

commission for incentive

Sales Metric Possibilities

Executive Compensation • Handled differently than other employees’ pay, why:

Legal Aspects of Executive Compensation

• Say on Pay• Publically listed companies must allow share holders to vote on

executive compensation• Clawbacks• Allows a company to recover any incentive based pay that was

paid out during the prior 3 years if it would not have been paid under restated financial statements

Executive Compensation Packages

Executive Compensation Consideration

sand

Concerns

Would another company hire this

person as an executive?

How does the executive’s

compensation compare with that for

executives in similar companies?

What would an investor pay for the level of performance

of the executive?

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

Reasonableness of Executive Compensation

Common Executive Compensation Criticisms

Executive Compensation and Boards of Directors

• In most organizations the board of directors is the major policy-setting entity• Must approve executive compensation packages

• Compensation committee : Subgroup of the board of directors that is composed of directors who are not officers of the firm