PART FOUR
COMPENSATION
C H A P T E R
T
Pay for Performance
And Financial
Incentives
T w e l v e
12
Lecture Outline
Strategic Overview
Money and Motivation: An Introduction
Performance and Pay
Individual Differences
Psychological Needs and Intrinsic vs. Extrinsic
Motivation
Instrumentality and Rewards: Vroom’s Theory
Types of Incentive Plans
Individual Employee Incentives and Recognition
Piecework Plans
Merit Pay as an Incentive
Merit Pay Options
Incentives for Professional Employees
Recognition—based Awards
On-line Award Programs
Incentives for Salespeople
Salary Plan
Commission Plan
Combination Plan
Setting Sales Quotas
Strategic Sales Incentives
Team or Group Variable Pay Incentive Plans
How to Design Team Incentives
Pros and Cons of Team Incentives
Organization-wide Variable Pay Plans
Profit-Sharing Plans
Employee Stock Ownership Plan (ESOP)
Scanlon and Other Gainsharing Plans
At-Risk Variable Pay Plans
Incentives for Managers and Executives
Short-Term Incentives: The Annual Bonus
Long-Term Incentives
Other Executive Incentives
Strategy and Executive Compensation
Designing and Executing Effective Incentive Plans
Why Incentive Plans Fail
How to Implement Incentive Plans
Incentive Plans in Practice
In Brief: This chapter gives an
overview of money and motivation,
and then outlines different incentive
programs that are used for different
types of employees. It also discusses
organization-wide incentive plans.
Interesting Issues: There is tension
between the concept of providing
employees with a secure, stable
income (which some feel allows
them the ability to be entrepreneurial
and take appropriate risks for the
company), and the idea of linking
pay directly to performance. A good
discussion may be developed from
this tension as students grapple with
their own resolution of this issue.
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ANNOTATED OUTLINE
I.
Money and Motivation: An Introduction
A. Performance and Pay – Compensation, shareholder value, and turbulence are
factors that characterize business today, and they have produced a renaissance
for financial incentive/pay-for-performance plans.
B. Individual Differences – the law of individual differences. This means that people
differ in personality, abilities, values, and needs.
C. Psychological Needs and Intrinsic versus Extrinsic Motivation
1. Abraham Maslow – argued that people have a hierarchy of five increasingly
higher-level needs, which he called physiological, security, social, selfesteem, and self-actualization.
2. Frederick Herzberg - hygiene—motivator theory of motivation similarly divides Maslow’s
hierarchy into lower level (physiological, safety, social) and higher-level (achievement,
self-actualization) needs.
3. Edward Deci – found that extrinsic rewards could at times actually detract from the
person’s intrinsic motivation.
D. Instrumentality and Rewards: Vroom’s Theory – says a person’s motivation to exert some
level of effort is a function of three things: the person’s expectancy (in terms of probability)
that his or her effort will lead to performance;14 instrumentality, or the perceived connection
(if any) between successful performance and actually obtaining the rewards; and valence,
which represents the perceived value the person attaches to the reward.
E. Types of Incentive Plans include: individual incentive programs; group incentive
programs; and profit-sharing plans. Variable pay generally refers to a group
incentive plan that ties pay to some measure of the firm’s (or facility’s) overall
profitability.
Know Your Employment Law: Incentives – the employer must
comply with the overtime provisions of the Fair Labor Standards Act
when designing and administering its incentive plans. Certain
bonuses are excludable from overtime pay calculations. The
problem is that many other types of incentive pay must be included.
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II.
NOTES
Educational Materials to Use
Individual Employee Incentive and Recognition Programs
A. Piecework Plans – Piecework is where you pay the worker a sum (piece rate) for
each unit he/she produces. Straight piecework entails a strict proportionality
between results and rewards regardless of output. With a standard hour plan,
the worker gets a premium equal to the percent by which his/her performance
exceeds the standard.
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B. Merit Pay As An Incentive – Merit pay or raise is any salary increase the firm
awards to an employee based on his/her individual performance. It is different
from a bonus in that it usually becomes part of the employee’s base salary,
whereas a bonus is a one-time payment.
C. Merit Pay Options – Traditional merit pay plans have two basic characteristics: (1)
merit increases are usually granted to employees at a designated time of the
year in the form of a higher base salary, and (2) the merit raise is usually based
exclusively on individual performance. Two adaptations of merit pay plans are:
(1) one awards merit raises in one lump sum once a year and (2) merit awards
are tied to both individual and organizational performance (see Table 12-2).
D. Incentives for Professional Employees – Professional employees are those
whose work involves the application of learned knowledge to the solution of the
employer’s problems, such as lawyers, doctors, economists, and engineers.
Making incentive pay decisions for professional employees can be challenging
because they’re usually paid well anyway.
E. Recognition-Based Awards – Studies show that recognition has a positive impact
on performance, either alone or in conjunction with financial rewards.
F. Online Award Programs – There are many reasons to use internet sites like
these to manage your awards program. The sites can offer a much broader
range of products than most employers could catalog and offer themselves. And
perhaps most important, the whole process is expedited—it’s much easier to
bestow and deliver the awards.
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III.
NOTES
Educational Materials to Use
Incentives for Salespeople
A. Salary Plan – offered by some firms. Straight salary makes it simple to switch
territories or to reassign salespeople, and it can foster loyalty among the sales
staff. A disadvantage is that it can constrict sales and de-motivate potentially
high-performing salespeople.
B. Commission Plan – pays salespeople for results, and only for results; thus, they
tend to attract high-performing sales people who see that effort clearly leads to
rewards. But it may cause them to neglect non-selling duties like servicing small
accounts, cultivating dedicated customers, and pushing hard-to-sell items.
C. Combination Plan – Most companies pay salespeople a combination of salary
and commissions, usually with a sizable salary component. Combination plans
give salespeople a floor to their earnings, and still provide an incentive for
superior performance. But they can become complicated, and misunderstandings
can result.
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D. Setting Sales Quotas – Setting effective quotas is an art. In today’s fast-changing
business scene, sales quotas must become more flexible than they have been in
the past.
1.
An Example: Auto Dealers – Compensation for car salespeople ranges from
a high of 100 percent commission to a small base salary with commission
accounting for most of total compensation.
E. Strategic Sales Incentives – Sales commissions remain popular, but employers
increasingly link them to non-volume-based measures.
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IV.
NOTES
Educational Materials to Use
Team or Group Variable Pay Incentive Plans
A. How to Design Team Incentives – There are three approaches:
1. Members are paid based on one of three formulas – all members receive the
pay (a) earned by the highest producer, (b) earned by the lowest producer, or
(c) equal to the average pay earned by the group.
2. Set a production standard based on the final output of the group as a whole.
3. Tie rewards to goals based on some overall standard of group performance.
B. Pros and Cons of Team Incentives – A lot of our work today is organized around
teams, so team incentives make sense to encourage cooperation and training.
But exceptionally hard working employees do not get paid according to their
efforts, which may reduce motivation.
When You’re On Your Own, HR for Line Managers and
Entrepreneurs: Incentives Supervisors Can Use – Most supervisors
would not want to rely simply on the employer’s incentive plans to
motivate his or her employees. There are a wide variety of things
that a supervisor can do. A few are listed in the textbook.
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V.
NOTES
Educational Materials to Use
Organization-Wide Variable Pay Plans
A. Profit-Sharing Plans involves employees receiving a share of the company’s
annual profits. There are several types of profit-sharing plans: cash plans,
Lincoln Incentive system, and deferred profit-sharing plans.
B. Employee Stock Ownership Plans (ESOP) are company-wide plans in which a
firm contributes shares of its own stock or cash to purchase the stock to a trust
established to purchase shares of the firm’s stock for employees.
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C. Scanlon and Other Gainsharing Plans
1. Scanlon Plan – is an incentive plan developed in 1937 by Joseph Scanlon.
The basic features of the plan include: philosophy of cooperation, identity,
competence, involvement system, and sharing of benefits formula.
2. Gainsharing Plans are incentive plans that engage many or all employees in
a common effort to achieve a company’s productivity objectives, with any
resulting cost-savings gains shared among employees and the company.
Implementing a Plan – The basic eight steps are: 1) establish general plan
objectives; 2) define specific performance measures; 3) decide on a funding
formula; 4) decide on a method for dividing and distributing the employees’
share of the gains; 5) make the disbursement significant enough to get
participants’ attention and to motivate their behavior; 6) choose the form of
payment; 7) decide how often bonuses are to be paid; and 8) develop the
involvement system.
D. At-Risk Variable Pay Plans are plans that put some portion of the employee’s
weekly pay at risk, subject to the firm meeting its financial goals.
1.
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VI.
NOTES
Strategic HR – AmeriSteel’s HR-based incentive plan, called Partners in
Performance, helped it achieve its strategic aims of increasing productivity
and being competitive.
Educational Materials to Use
Incentives for Managers and Executives
A. Short-Term Incentives: The Annual Bonus – is aimed at motivating the short-term
performance of managers and executives.
1.
Eligibility usually includes both top and lower level managers.
2.
Fund Size refers to the total amount of bonus money the firm makes
available. A nondeductible formula is where they use a straight percentage
(usually of the company’s net income) to create the short-term incentive fund.
A deductible formula assumes that the fund should start to accumulate only
after the firm has met a specified level of earnings.
3.
Individual Awards – Typically, a target bonus (as well as maximum amount)
is set for each eligible position, and the actual award reflects the person’s
performance.
The HR Scorecard, Strategy and Results: The New Incentive Plan
– The Hotel Paris did not have an incentive pay program at all. Lisa
Cruz set about creating and implementing an incentive plan that
uses many of the concepts listed in this book.
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B. Long-Term Incentives are used to inject a long-term perspective into their
executives’ decisions.
1.
Stock Options account for over half of executives’ compensation. A stock
option is the right to purchase a specific number of shares of company stock
at a specific price during a specific period of time; the executive thus hopes
to profit by exercising his/her option to buy the shares in the future but at
today’s price.
2.
Other Stock Option Plans – More companies are implementing broad-based
stock option plans in which the potential appreciation is relatively modest, but
in which all or most employees can participate.
3.
Other Plans – Stock appreciation rights permit the recipient to exercise the
stock option (by buying the stock) or to take any appreciation in the stock
price in cash, stock, or some combination of these. A performance
achievement plan awards shares of stock for the achievement of
predetermined financial targets. A restricted stock plan is where shares are
usually awarded without cost to the executive, but restricted from selling the
stock for a specified time period.
4.
Performance Plans are designed so that executives don’t prosper unless the
company does; thus, payment is contingent on achievement of
predetermined objectives.
C. Other Executive Incentives – Companies provide various incentives to persuade
executives to remain with the firm such as golden parachutes and loans.
D. Strategy and Executive Compensation – Few HR practices have as profound or
obvious an impact on strategic success as the company’s long-term incentives.
In creating the compensation package you should: 1) define the strategic context
for the executive compensation program, including the internal and external
issues that face the company, and the firm’s business objectives; 2) shape each
component of the executive compensation package based on your strategic
aims, and then group the components into a balanced plan that makes sense in
terms of these aims; 3) create a stock option plan that gives the executive
compensation package the special character it needs to meet the unique needs
of the executives and the company, and its strategy; 4) check the executive
compensation plan for compliance with all legal and regulatory requirements and
for tax effectiveness; and 5) install a process for reviewing and evaluating the
executive compensation plan whenever a major business change occurs.
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VII.
NOTES
Educational Materials to Use
Designing and Executing Effective Incentive Plans
A. Why Incentive Plans Fail – Some explanations include: performance pay can’t
replace good management; you get what you pay for; “pay is not a motivator;”
rewards punish; rewards rupture relationships; rewards can unduly restrict
performance; rewards may undermine responsiveness; rewards undermine
intrinsic motivation; and people work for more than money.
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B. How to Implement Effective Incentive Plans – Some guidelines to follow to make
your plan more effective: use common sense; link the incentive with your
strategy; make sure effort and rewards are directly related; make the plan easy
for employees to understand; set effective standards; view the standard as a
contract with your employees; get employees’ support for the plan; use good
measurement systems; emphasize long-term as well as short-term success; take
the corporate culture into consideration; and adopt a comprehensive,
commitment-oriented approach.
C. Incentive Plans in Practice – Most companies have several incentive plans.
Figure 12-3 summarizes the percentage of companies using each of several
selected plans.
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