Lecture 10 (Chapter 11)
Rewarding Performance
Lecture Objectives: To discuss pay-for-performance plans especially their benefits and
drawbacks.
I. Pay for Performance Challenges
Pay for performance plans reward employees’ performance because employees vary in how well
they do their jobs.
A. The “Do Only What You Get Paid For” Syndrome
The closer an employee’s pay is tied to particular performance indicators, the more s/he
will focus on those indicators and neglect other important components that are not being
measured. It is nearly impossible to measure every important outcome or activity of any
job.
B. Unethical Behaviors
Employees deceive, misinform and engage in other unethical and illegal behaviors and
excuse such behavior by saying that their organizations led them to do it because of pay
policies. See Manager’s Notebook on pages 339-340.
C. Negative Effects on Cooperation
In order to try to get rated higher, employees may sabotage their fellow employees or at
minimum, not offer help. If employees are required to work together, individual rewards
can lead to poor overall group performance.
D. Lack of Control
Many factors other than individual effort and skill can affect performance such as quality
of materials, working conditions, support from management, competitors’ innovation etc.
Jobs and situations vary considerably in the amount of control employees have over their
performance.
E. Difficulties in Measuring Performance
Accurate measurement of employee or group performance is not easily achieved.
F. Psychological “Contracts”
These “contracts” are sets of expectations based on prior experience and are resistant to
change. Altering pay for performance plans can cause very negative employee reactions.
G. The Credibility Gap
Employees often feel their employer’s pay for performance plans are flawed and do not
reward superior performance.
H. Job Dissatisfaction & Stress
Although pay for performance plans can lead to higher productivity, they often lead to
lower job satisfaction.
I. Potential Reduction of Intrinsic Drives
By concentrating employees’ attention on money, employees may fail to engage in any
activity that does not have specific rewards attached to it despite how interesting or
fulfilling such activities are for employees.
II. Meeting the Challenges of Pay-for-Performance Systems
Pay policies can give an employer ways of aligning employees’ interests with those of the
organization.
A. Link Pay & Performance Appropriately
Piece-rate plans result in employees being paid on the basis of units produced or
processed. These plans work best when employees have complete control over the speed
and quality of their work.
B. Use Pay for Performance as Part of a Broader HRM System
Unless other HR policies like selection criteria, performance appraisals, and training are
consistent with encouraging high performance standards, pay plans will not be sufficient
to create outstanding performance.
C. Build Employee Trust
Cutthroat cultures and lack of trust in management lead employees to focus more on
impression management than working hard.
D. Promote the Belief that Performance Makes a Difference
If employees believe that their performance will not be rewarded, they will not try to
perform at high levels.
E. Use Multiple Layers of Rewards
Because all types of pay plans have weaknesses, use of several at the same time (like
individual, plant-wide and corporate plans being all part of a group of employees’
compensation) may work best to motivate employees to achieve organizational goals.
F. Increase Employee Involvement
Employees’ acceptability of their employer’s pay plans is critical if the plans are to be
effective. One way to gain employee acceptance is to have them participate in the design
of those plans. It may lead to greater understanding of the plans, greater commitment to
them and a better match between the plans and the employees’ needs. Dispensing
rewards is best done by only top managers. As part of input designing pay systems, ask
employees to consider how to have the system encourage ethical behavior.
G. Use Motivation & Non-financial Incentives
Non-financial rewards include public & private praise, honorary titles, expanded job
responsibilities, challenging work and other rewards that cost only token amounts.
III. Types of Pay-for-Performance Plans
They vary by organizational level, ranging from individual, group to plant and corporate.
A. Individual-Based Plans are the most widely used type of pay-for-performance plan
and merit pay is the most common type of individual-based plan.
1. Merit pay consists of an increase in base pay, typically given once a year and
varies by position in salary range and performance appraisal rating.
2. Bonus program or lump-sum payments do not raise an employee’s base pay,
and can fall outside the regular annual performance review cycle when some
milestone is achieved.
3. Awards are one-time rewards of tangibles (something one can touch).
4. Advantages of individual-based plans
a. Performance that is rewarded is likely to be repeated and increase
employee motivation over time.
b. Can shape an individual’s goals over time to align them with the
organization’s goals.
c. High performers are more likely to stay with the org. and continue to be
high performers.
d. Fits employees’ expectations given our individualistic national culture.
5. Disadvantages of individual-based plans
a. Tying pay to goals may promote single-mindedness and neglect of
either important tasks or risky goals.
b. Many employees reject merit pay as really merited and thus are not
motivated by such plans because of lack of significant differences in
increases due to higher performance and acceptance of position in range
factor.
c. May work against achieving quality-based goals as individual rewards
do not reward unmeasurable quality factors nor facilitate cross-functional
coordination required for quality products.
d. Tends to promote authoritarian organizational structures and uncreative
performance.
6. Conditions under which individual-based plans are most likely to succeed
a. When contributions of individual employees can be accurately isolated.
b. When jobs demand autonomy.
c. When cooperation is less critical to successful performance or when
competition is to be encouraged.
B. Team-Based Plans assist organizations in increasing the flexibility with which they
can deploy their employees. These plans typically reward all team members equally
based on group outcomes.
1. Advantages of team-based plans
a. foster group cohesiveness
b. make it easier for managers to measure performance accurately
2. Disadvantages of team-based plans
a. may not work with individualistically oriented employees.
b. may create free riders
c. can discourage high performance if groups develop norms of “ease”
d. if various work groups are interdependent, identification of appropriate
groups can be difficult.
e. may create inter-group competition that is counterproductive in meeting
customers’ needs.
3. Conditions under which team-based plans are most likely to succeed
a. when work tasks are so intertwined that it is difficult to single out who
did what within a group of employees.
b. when org. structure is supportive by consisting of few levels,
decentralized authority, intrinsically motivated employees, and culture of
group goals.
c. when org. promotes intrapreneuring self-managed work groups.
C. Plant-wide Plans (Gainsharing plans are facility-based pay plans in which a portion of
firm’s cost savings is returned to employees, usually in the form of lump-sum bonuses.)
1. Scanlon Plan relies on complex set of committees of employees and managers
to generate and evaluate labor cost-saving suggestions. 75% of annual savings go
back to employees.
2. Rucker Plan uses a simpler set of committees than Scanlon Plans but passes
along savings regarding any aspect of production costs (material and labor). Has
complex formulas for determining bonuses for employees.
3. Improshare plans involve: after a standard that identifies the expected number
of labor hours required to produce an acceptable level of output is set, future
production in less hours results in bonuses for employees.
4. Advantages of plantwide plans
a. All employees are encouraged to use their talents to better plant
operations.
b. Employee input is used to improve the production process.
c. Common goal promotes cooperation.
d. Are fewer measurement difficulties than individual- or work-group
plans
5. Disadvantages of plantwide plans
a. Can have many free riders
b. When changes are needed in bonus formulas, employees resist change
unless they will be paid more after the change.
c. When demand for product falls, these plans can result in no bonuses
regardless of how clever or hard-working employees are. Hence they are
not motivating when product demand slips.
6. Conditions favoring plantwide plans
a. when a plant has only a few hundred employees.
b. when technology improvements can lead to ever increasing efficiencies
of operation.
c. when historical data on the firm’s various plants are used to reward the
most efficient plants regardless of percentage gains because some plants
may have been less efficient in the past.
d. when a plant’s culture lends itself to participative management
e. when a plant’s product-market is stable
D. Corporate-wide Plans are based on a firm’s overall profitability.
1. Profit-sharing uses a formula to allocate a portion of declared profits to
employees, usually in the form of money contributed to retirement plans.
Involves no tie to improved employee productivity.
2. Employee stock ownership plans (ESOPs) are based on the firm’s performance
as measured by its stock price. Employees can receive company stock at or below
market value or it can be deferred for retirement. Employees lose money if their
firm’s stock price drops.
3. Advantages of corporate-wide plans
a. The cost to the firm is automatically adjusted downward during
economic downturns.
b. May increase employee commitment although your instructor knows of
no research that supports this thesis.
c. Offers a firm tax advantages and may make hostile takeovers more
difficult.
4. Disadvantages of corporate-wide plans
a. Puts employees’ retirement at risk if all retirement is tied into employer
b. Not likely to lead to higher individual employee performance.
c. Creates future financial obligations for firms that can cause financial
distress at a later time if this benefit is too generous, given the firm’s longterm performance.
5. Conditions favoring corporate-wide plans
a. Fits large firms.
b. Fits firms with interdependent business units when identification of
relative contributions of units to overall firm performance is difficult.
c. Fits cyclical industries.
d. When used consistently with other types of incentives to encourage
employee trust in top management.
IV. Designing Pay-for-Performance Plans for Executives & Salespersons
Incentives are a greater percentage of total income for executives and salespersons than for other
types of employees.
A. Executive Compensation Plans
1. Salary & Short-term incentives averaged less than half of total executive
compensation during the 1990s. The amount of salary is directly related to firm
size. Annual bonuses are the rule and are not usually adversely affected by poor
firm performance.
2. Long-term incentives are either in the form of stock plans or a combination of
cash awards and stock. Various long-term executive incentives include: stock
options - time frame & price (often below market) are stipulated, stock purchase
plans - can purchase stock at or below fair market value during a given month or
so (can be offered to all employees), restricted stock plans - execs are obligated to
remain with firm for x years in order to receive stock at minimal cost to
themselves, stock awards - signing bonus, formula-based stock plans - execs can
redeem (cash out) this type of stock at value based on book value or other basis
not actual market value of stock, junior stock is priced below common stock but
can be converted to common stock by execs if pre-set goals are achieved,
nonqualified stock options are not a business expense for tax purposes so
guidelines are wide open, phantom stock - pays execs a bonus proportional to
change in stock price over time, SARs.- right to cash or stock equal to difference
between value of stock at time of grant and its value when right is exercised,
performance plan units - value of shares given to execs is tied to some measure of
performance like increase in EPS.
These plans may not be linked to executive’s performance because they are often
not linked with the firm’s long-term strategic objectives. However, they make up
the greatest portion of executive compensation and are constantly changing as
CEOs game the current rules to enhance themselves financially. Currently
backdating of option dates is an issue as the practice saves execs the 15% capital
gains tax.
3. Perks are non-cash incentives given to executives such as company car, club
memberships, company plane, financial counseling, personal liability insurance,
chauffer service, home security system, & loans.
4. Directors as equity partners: boards of directors are now paid in stock or stock
options so the fox is watching the hen house.
B. Salespeople
1. Reasons for setting salespeople’s comp. up differently: their range in
performance (sales, for example) tends to vary much more than for other types of
employees, they experience little supervision if they do external sales, and their
commissions are largely known only to themselves.
2. Straight salary advantages: best when goal is to maintain good customer
relations and service existing accounts for highly technical products; encourages
non-selling activities, little paperwork for pay purposes, will not push unwanted
goods on customers, low resistance to changes in territories, and can make for a
secure feeling, and loyal professional sales force.
Disadvantages include: low motivation, difficult to attract sales stars, & more
sales managers are needed.
3. Straight commission advantages: best when trying to generate high sales
volumes through new accounts; highly motivated to sell, attracts stars, few
managers needed, selling costs are efficiently controlled, and simple to administer
plan.
Disadvantages: sales over profits emphasized, customer service not a priority,
may overstock customer, & resistance to changes in sales territories.
4. Salary/commission advantages: combines advantages of both salary and
commission and is most prevalent approach to sales persons’ pay as it recognizes
both selling and non-selling activities, supports a wider range of marketing goals.
Disadvantages: complicated pay plans, unwanted effects can surprise managers,
and costly to administer.
C. Rewarding Excellence in Customer Service
1. Common measures of customer satisfaction are surveys, records of on-time
delivery and number of complaints. Bonuses can be tied to these results.