10
© 2010 South-Western, a part of Cengage Learning
All rights reserved.
PowerPoint Presentation by Charlie Cook
The University of West Alabama
Chapter Objectives
After studying this chapter, you should be able to
Discuss the basic requirements for successful
implementation of incentive programs.
Identify the types of and reasons for
implementing individual incentive plans.
Explain why merit raises may fail to motivate
employees adequately and discuss ways to
increase their motivational value.
Indicate the advantage of each of the principal
methods used to compensate salespeople.
Differentiate how gains may be shared with
employees under the Scanlon and Improshare
gainsharing systems.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–2
Chapter Objectives (cont’d)
After studying this chapter, you should be able to
Differentiate between profit sharing plans and
explain advantages and disadvantages of these
programs.
Describe the main types of ESOP plans and
discuss the advantages of ESOP to employers
and employees.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–3
Strategic Reasons for Incentive Plans
• Variable Pay
 Tying pay to some measure of individual, group, or
organizational performance.
• Incentive Pay Programs
 Establish a performance “threshold” to qualify for
incentive payments.
 Emphasize a shared focus on organizational
objectives.
 Create shared commitment in that every individual
contributes to organizational performance and
success.
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10–4
FIGURE
10.1
Types of Incentive Plans
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10–5
Incentive Plans as Links to
Organizational 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.
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10–6
FIGURE
10.2
Advantages of Incentive Pay Programs
• Incentives focus employee efforts on specific performance targets. They
provide real motivation that produces important employee and organizational
gains.
• Incentive payouts are variable costs linked to the achievement of results.
Base salaries are fixed costs largely unrelated to output.
• Incentive compensation is directly related to operating performance. If
performance objectives (quantity and/or quality) are met, incentives are paid.
If objectives are not achieved, incentives are withheld.
• Incentives foster teamwork and unit cohesiveness when payments to
individuals are based on team results.
• Incentives are a way to distribute success among those responsible for
producing that success.
• Incentives are a means to reward or attract top performers when salary
budgets are low.
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10–7
Do Incentive Plans Work?
• Successful Plans
 Use important organizational metrics by which to
measure employee performance
 Find the right incentive payout. Payout formulas
should be simple and understandable.
 Are continuously communicated to employees to
establish a clear link between performance and
payout.
 Effectively measure employee output and reward
exceptional employee performance
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10–8
Do Incentive Plans Work?
• 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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–9
1
Setting Performance Measures—The Keys
Both large and small organizations have established performance
measures to improve operational success while rewarding employees for
their performance outcomes. Establishing meaningful performance
measures is one of the important and difficult challenges facing
management today. Before managers or supervisors develop and
implement organizational measures, they should consider the following
guidelines.
• Performance measures—at all organizational levels—must be
consistent with the strategic goals of the organization.
• Define the intent of performance measures and champion the cause
relentlessly.
• Involve employees.
• Consider the organization’s culture and workforce demographics when
designing performance measures.
• Widely communicate the importance of performance measures.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–10
Administering Incentive Plans
• Incentive systems are effective:
 When incentives are based on actual differences in
individual, team, or organizational performance and
not seen as entitlements.
 When annual incentive budgets are large enough to
reward and reinforce exceptional performance.
 When overhead costs associated with plan
implementation and administration are properly
considered beforehand and are controllable.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–11
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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–12
Successful Incentive Plans
• Employees have a desire for an incentive plan.
• Employees are encouraged to participate.
• Employees see a clear connection between the
incentive payments they receive and their job
performance.
• Employees are committed to meeting the standards.
• Standards are challenging but achievable.
• Payout formulas are simple and understandable.
• Payouts are a separate, distinct part of compensation.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–13
Effective Incentive Plan Administration
• Grant incentives based on individual
performance differences.
• Have the financial resources to reward
performance.
• Set clearly defined, accepted, and challenging
yet achievable performance standards.
• Use an easily understood payout formula
• Keep administrative costs reasonable.
• Do not “ratchet up” performance standards.
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10–14
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.
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10–15
Computing the Piece Rate
60 minutes (per hour)
12 minutes(standard time per unit)
$12.75 (hourly rate)
= 5 units per hour
= $2.55 per unit
5 units (per hour)
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–16
Piecework: The Drawbacks
• Problems with piecework systems:
 Is not always an effective motivator
 Piecework standards can be difficult to develop.
 Individual contributions can be difficult measure.
 Not easily applied to work that is highly mechanized
with little employee control over output.
 Piecework may conflict with organizational culture
(teamwork) and/or group norms (“rate busting”).
 When quality is more important than quantity.
 When technology changes are frequent.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–17
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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–18
Individual Incentive Plans (cont’d)
• 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.
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10–19
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.
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10–20
Problems with Merit Raises
1. 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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–21
Motivation Through Merit Raises
• Develop employee confidence and trust in
performance appraisal.
• Establish job-related performance criteria.
• Separate merit pay from regular pay.
• Distinguish merit raises from cost-of-living
raises.
• Withhold merit payments when performance
declines.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–22
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.

Provides a clear link between pay and performance.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–23
Incentive Awards and Recognition
• Awards
 Often used to recognize productivity gains, special
contributions or achievements, and service to the
organization.
 Employees feel appreciated when employers tie
awards to performance and deliver awards in a
timely, sincere and specific way.
• Noncash Incentive Awards
 Are most effective as motivators when the award is
combined with a meaningful employee recognition
program.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–24
2
Customize Your Noncash Incentive Awards
Compensation specialists recognize that a successful noncash incentive program will offer
employees a wide selection of awards—awards that appeal to a diverse workforce and the
uniqueness of individual employees. “One-size-fits-all” is not the approach to take. What
appeals to younger employees may not be attractive to older employees. For example, one
marketing firm characterizes recognition and rewards based on generations as follows:
Traditionalists (61+). These individuals are less likely to spend money on themselves.
Attractive awards include entertainment venues, vacations, and technology items. They
also appreciate health and wellness opportunities.
Boomers (41–60). Personal recognition is important. These individuals want to feel
appreciated for their work contributions and are likely to change jobs if they feel under
valued or go unrecognized. Boomers favor incentive rewards in the areas of travel, luxury
gifts, health and wellness options, and personalized plaques and awards.
Generation X (25–41). This group values a balanced lifestyle of work and play. Generation
X employees value gadgets and high-tech items along with flexible schedules and
discretionary time off. A flexible “day-off-work” would appeal to this group.
Generation Y (14–25). These employees desire immediate performance feedback.
Employee-of-the-Month programs appeal to these employees as do “spot” recognition
plans. Gift cards, gift certificates to “trendy” stores, and movie tickets are appropriate as
rewards for the immediate recognition of performance.
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10–25
Sales Incentives
Sales Incentive Plans
Straight Salary
Straight Commission
Salary and Commission
Combinations
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10–26
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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–27
Incentive Plans for Salespersons
• 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:

Emphasis is on sales volume rather than on profits.

Customer service after the sale is neglected.

Earnings tend to fluctuate widely between good and poor
periods of business.

Temptation to grant price concessions to get sales.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–28
Incentive Plans for Salespersons
• 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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–29
Incentives for Professional Employees
Managerial and Executive Incentives
Bonuses and merit increases
Double-track wage systems
Performance incentive bonuses
Profit sharing and stock ownership
Executive perquisites (perks)
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10–30
Executive Compensation
• The Executive Pay Package
 Base salary
 Short-term incentives or bonuses
 Long-term incentives or stock plans
 Benefits
 Perquisites (perks)
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10–31
Executive Compensation
• 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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–32
FIGURE
10.3
Types of Long-Term Incentive Plans
Stock options
Rights granted to executives to purchase shares of their organization’s stock at an
established price for a fixed period of time. Stock price is usually set at market value
at the time the option is granted.
Stock appreciation
rights (SARs)
Cash or stock award determined by increase in stock price during any time chosen
by the executive in the option period; does not require executive financing.
Stock purchase
Opportunities for executives to purchase shares of their organization’s stock valued
at full market or a discount price, often with the organization providing financial
assistance.
Phantom stock
Grant of units equal in value to the fair market value or book value of a share of
stock; on a specified date the executive will be paid the appreciation in the value of
the units up to that time.
Restricted stock
Grant of stock or stock units at a reduced price with the condition that the stock not
be transferred or sold (by risk of forfeiture) before a specified employment date.
Performance units
Grants analogous to annual bonuses except that the measurement period exceeds
one year. The value of the grant can be expressed as a flat dollar amount or
converted to a number of “units” of equivalent aggregate value.
Performance
shares
Grants of actual stock or phantom stock units. Value is contingent on both
predetermined performance objectives over a specified period of time and the stock
market.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–33
Executive Compensation:
Ethics and Accountability
• Incentive payments are excessive compared with return
to stockholders.
• Time periods for judging and rewarding performance
are too short.
• Quarterly earnings growth is emphasized at the
expense of research and development.
• Emphasis is placed upon equaling or exceeding
executive salary survey averages.
• Benefits do not relate closely to individual
performance.
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10–34
3
The “Sweetness” of Executive Perks
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10–35
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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–36
Executive Compensation Reform (cont’d)
• 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
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–37
Group 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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–38
4
Lessons Learned: Designing Effective Team Incentives
Will your team incentive program be successful? While there are no exact keys to success, team compensation specialists
cite the following as important components of a meaningful team incentive plan.
• Are organizational members—employees and managers—predisposed to a team incentive reward
system? Is there a “cultural readiness” for team compensation? If change is indicated, what information needs to be
given to all organizational employees?
• Enlist total employee and managerial support for the incentive effort. While top management support is
critical, without the encouragement of employees and middle- and lower-level managers (those directly involved in the
program implementation), team incentive programs invariably fail.
• When developing new programs, include representatives from all groups affected by the incentive
effort—labor, management, employees. Inclusion, not exclusion, serves to build trust and understanding of the
program’s intent and its overall importance to organizational success.
• Establish effective, fair, and precise measurement standards. Selected performance measures should be key
indicators of organizational success. Do not attempt to measure everything. Employees should be able to directly influence
the performance measures selected. Furthermore, performance measures should be challenging but realistic and
obtainable. Standards must encourage increased effort without becoming entitlements.
• Incentive payout formulas must be seen as fair, be easy for employees to calculate, offer payouts on a
frequent basis, and be large enough to encourage future employee effort. The goal is to create a pay-forperformance environment. When standards are not met, explain why the reward was not earned.
• Determine how incentive rewards will be distributed. Will team members receive equal dollar awards, or will team
members receive differential payments based on such factors as seniority, skill levels, rates of pay, member contributions,
and so forth?
• Communicate, communicate, communicate. Constantly champion the benefits of the incentive awards to
employees and their contribution to organizational success.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–39
Team Incentive Plans (cont’d)
• 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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–40
Team Incentive Plans (cont’d)
• 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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–41
Group Incentive Plans (cont’d)
• 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.
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10–42
Gainsharing Incentive Plans
Scanlon Plan
Rewards come from employee participation in
improving productivity and reducing costs.
Rucker Plan
(SOP)
Shared rewards come from the difference between
labor costs and sales value of production.
Improshare
Gainsharing based on increases in productivity of
the standard hour output of work teams.
Encourages employees to achieve higher output
Earnings-at-risk and quality standards by placing a portion of their
base salary at risk of loss.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–43
FIGURE
10.4
Scanlon Plan Suggestion Process
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10–44
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.
 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
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–45
Enterprise Incentive Plans (cont’d)
• 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.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–46
5
Employee Stock Option Plans
What Is a Stock Option?
A stock option gives an employee the right to buy a certain number of shares in the company at a
fixed price for a certain number of years. The price at which the option is provided is called the
“grant” price and is usually the market price at the time the options are granted. Employees who
have been granted stock options hope that the share price will go up and that they will be able to
“cash in” by exercising (purchasing) the stock at the lower grant price and then selling the stock at
the current market price.
How Stock Option Plans Work
Here is an example of a typical employee stock option plan. An employee is granted the option to
purchase 1,000 shares of the company’s stock at the current market price of $5 per share (the
“grant” price). The employee can exercise the option at $5 per share—typically the exercise price
will be equal to the price when the options are granted. Plans allow employees to exercise their
options after a certain number of years or when the company’s stock reaches a certain price. If
the price of the stock increases to $20 per share, for example, the employee may exercise his or
her options to buy 1,000 shares at $5 per share and then sell the stock at the current market price
of $20 per share.
Companies sometimes revalue the price at which the options can be exercised. This may happen,
for example, when a company’s stock price has fallen below the original exercise price.
Companies revalue the exercise price as a way to retain their employees.
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–47
Enterprise Incentive Plans (cont’d)
• 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.
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10–48
Employee Stock Ownership Plans
Rewards and Risks of ESOPS
Advantages
Disadvantages
Retirement benefits
Liquidity and value
Pride of ownership
Single funding basis
Deferred taxes
Not insured
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10–49
bonus
salary plus bonus plan
combined salary and commission plan
Scanlon Plan
differential piece rate
spot bonus
employee stock ownership plans (ESOPs)
standard hour plan
gainsharing plans
straight commission plan
Improshare
straight piecework
lump sum merit program
straight salary plan
merit guidelines
team incentive plan
perquisites
variable pay
profit sharing
© 2010 South-Western, a part of Cengage Learning. All rights reserved.
10–50