Part 4: Compensating Human Resources
Chapter 11: Variable Pay and
Executive Compensation
Prepared by Linda Eligh, University of Western Ontario
Copyright © 2008 by Nelson, a division of Thomson Canada Limited.
11–1
Learning 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.
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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.
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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.
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Effective Incentive Plans
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Fig. 11-1
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Metrics for Variable Pay Plans
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Fig. 11-2
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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.
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Types of Variable Pay Plans
Copyright © 2008 by Nelson, a division of Thomson Canada Limited.
Fig. 11-3
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Individual Incentives
Identification of
Individual
Performance
Independent
Work
Individual
Incentive
Systems
Individualism
Stressed in
Organizational
Culture
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Individual
Competitiveness
Desired
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Individual Incentives: 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.
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11–10
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.
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11–11
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.
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Purposes of Special Incentives
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Fig. 11-4
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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.
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Determining Sales Effectiveness
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Fig. 11-5
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Why Organizations Establish Variable Pay Plans or
Groups/Teams Fig. 11-6
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Group/Team Incentives
Distribution of
Group/Team
Incentives
Timing of
Group/Team
Incentives
Design of
Group/Team
Incentive Plans
Decision Making
About Group/Team
Amounts
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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.
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Conditions for Successful
Group/Team Incentives Fig. 11-7
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Types 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.
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Gainsharing
• Improshare
 “Improved productivity through sharing plan”
 Time studies determine how many hours it should
take to produce one unit of product
 When actual productivity is greater than the baseline,
a percentage of savings is shared with employees
 Easiest of the gainsharing plans to understand and
install
 Focus is on quantity, not quality
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Scanlon Plan Gains Example
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Fig. 11-8
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Rucker Plan Gains Example
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Fig. 11-9
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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

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Framework Choices for a
Profit-Sharing Plan Fig. 11-10
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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.
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Employee 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
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Components of Executive
Compensation Packages Fig. 11-11
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Performance 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
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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?
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Common Executive Compensation Issues
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Fig. 11-12
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Executive Compensation
• Boards of Directors
 Major policy setting entity that must approve
executive compensation packages
• Compensation Committees
 Usually a subgroup of the Board of Directors
 Composed of Directors who are not officers of the firm
 Make recommendations to the Board on
overall pay policies
 salaries for top officers
 supplemental compensation (stock options, bonuses)
 additional “perks” for executives

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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.
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