Variable Pay and
Executive Compensation
Module 4
CEO Pay
 Made in America—My Story
 Sam Walton and John Huey (1993)
 “A lot of what goes on these days with high-flying
companies and these overpaid CEO’s who’re really
looting from the top and aren’t watching out for
anyone but themselves, really upsets me.”
 CEO Pay
Variable 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.
Effective Incentive Plans
Boeing, Nordstrom, Wal-Mart, Safeway
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.
 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
Piece-Rate Systems
 Straight Piece-Rate Systems
 Wages are determined by multiplying the number of
pieces produced by the piece rate for one unit.
 Differential Piece-Rate Systems
 Employees 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: 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 Programs
 Performance Awards
 Cash or merchandise used as an incentive reward.
 Recognition Awards
 Recognition of individuals for their performance or service to
customers in areas targeted by the firm.
 Service Awards
 Rewards to employees for
lengthy service with an organization.
Types of Sales Compensation Plans
 Salary-Only
 All compensation is paid as a base wage with no
incentives.
 Commission
 Straight 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
Group/Team Incentives (cont’d)
 Distributing Rewards
 Same-size reward for each member
 Different-size reward for each member
 Problems with Group/Team Incentives
 Rewards 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.
 Social Loafing
 The folly of rewarding A and hoping for B
Conditions for Successful Group/Team Incentives
Organizational Incentives
 Profit Sharing
 A 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 Profit-Sharing Plan
Employee Stock Plans
 Stock Option Plan
 A 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 Plans
 Employee Stock Ownership Plan (ESOP)
 A plan whereby employees gain significant stock
ownership in the organization for which they work.
 Advantages

Favorable 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
Compensation Packages
Executive Compensation
 “Reasonableness” of Executive Compensation
 Would 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?

Investors are owners

We as managers are stewards (agency theory)
Common Executive Compensation Issues