Mgmt 383 Chapter 13 Variable Pay Executive Compensation
Mgmt 383 Chapter 13 Variable Pay & Executive Compensation Spring 2009
Variable Pay • Variable Pay – compensation linked to individual, group or organizational performance. • The emphasis is on the linking of rewards with performance • The philosophical argument is between merit-based compensation and senioritybased compensation.
Basic Assumptions of Variable Pay • Some people do better work than others. • Employees who do more for the organization should receive more. • A portion of certain employees’ total compensation should be predicated on rewarding above-satisfactory performance. • Some jobs contribute more to organizational success than others. • New venture team v. custodial department.
Reasons for Incentives • Link strategic goals and employee performance. • Achieve HR objectives such as increasing retention, reducing turnover, recognizing training success, or reward safety. • Reward employees financially for their contribution to organizational results. • Recognize different levels of employee performance and reward employees.
The Golden Rule of Variable Pay The most important factor in the success of any incentive program is that it must be consistent with both the culture and the financial resources of the organization.
Rewards • Remember behavior modification. • It is important to make sure that what is being rewarded is really what is needed, because people tend to produce what is measured and rewarded. • Never assume that everyone wants the same type of incentive rewards.
Types of Variable Pay • Incentives - compensation offered as reward for efforts (results) beyond normal performance expectations. • Individual Incentives - do not require (or encourage) cooperation among individuals. • Group/Team Incentives - requires entire group to cooperate to attain reward (may cause intragroup conflict). • Organizational Incentives the entire organization is rewarded.
Individual Incentives • Conditions/criteria: • Individual performance must be isolated and identifiable. • Independent work must be performed. Results must not be too interdependent with other workers. • Individual competitiveness must be desired. • The organizational culture must emphasize individual achievement.
Individual Incentives • Types of individual incentives: • Straight Piece-Rate - number of units produced. • Differential Piece-Rate - rate increases with higher levels of production. • Bonuses – one-time, lump sum, payment that does not become part of the employees base pay. • • • Attendance Certifications Production quotas • Commissions/sales compensation
Individual Incentives: Sales Compensation • Sales Compensation – the three most common approaches: • Salary Only • Straight Commission - set percentage of sales • Salary-Plus Commission or Bonus • Sales Performance Metrics - Establishing clear performance measures: • • Sales to quota Sales relative to other sales staff Sales from new customers New product sales Control of sales expenses Account retention Customer satisfaction
Individual Incentives: Special Incentive Programs • Performance Awards [nonmonetary] – incentives for significant performance. • Travel • Merchandise • Gift certificates • Recognition Awards – given to acknowledge specific efforts or activities (customer service, e. g. ) • Employee of the Year • Service Awards - length of service
Practical Advice Keep it simple! • A variable pay program will NOT accomplish its intended purpose if it is too complicated or complex to be understood by employees
Group/Team Incentives • Conditions/criteria: • Significant interdependence exists; team work and cooperation are essential. • Cannot readily identify exactly who is responsible for differing level of performance. • Management wants to create or reinforce teamwork and cooperation.
Design of Group/Team Incentives • Distribution of Group/Team Incentives : • Same size for all (76%) • Different size for each team member (24%) • Timing of Group/Team Incentives : • • Monthly (2%) Quarterly (25%) Biannually (17%) Annually (56%)
Design of Group/Team Incentives • Decision Making about Amount of Group/Team Incentives • Specific dollar amount, lump sum (56%) • Percentage of base pay (44%)
Group/Team Incentives • Problems with Group/Team Incentives: • Internal equity problems. • • Equal amounts perceived as “unfair” by hard workers. Free riders. • Poor performing individual can preclude the group from gaining the reward. • Group resistance (group dynamics). • Goal displacement (marketing wanting more features to increase sales, production wanting simpler designs to reduce costs).
Group/Team Incentives • Work Team Metrics • • • Productivity quotas Timeliness goals Cost savings goals
Group/Team Incentives • Gain Sharing - rewarding greater than expected gains in profits or productivity. • Like profit sharing it is self-funding. • Methods of payment: • Flat rate (every body gets the same). • Same percentage of base salary for all employees. • Percentage of gains attributed to each category of employee (production workers, production supervisors, purchasing agents receiving , etc. ) • Percentage of gains based on individual performance (individual must have satisfactory performance for eligibility)
Group/Team Incentives • Gain Sharing • Variations: • Improshare - group piece rate (total hours and output in physical units). • Scanlon Plan (1927) • Department committees screen and evaluate costsaving suggestions. • Direct incentive rewards to all employees involved in realizing the suggestions.
Organizational Incentives • Profit Sharing (a self-funding incentive) • Objectives: • • Improve productivity Recruit employees Improve product and service quality Enhance employee morale • Methods of determining “Profit: ” • Fixed percentage of profits. • Sliding percentage based on sales or ROA. • Unit profits.
Organizational Incentives • Profit Sharing • Eligibility: all employees (nonexempt, executives). • Methods of allocation: • • • Equally to all employees. Percentage of base salary (employee earnings). Based on a combination of employee earnings and years of service. • Based on employee contribution.
Organizational Incentives • Factors diminishing profit sharing’s effectiveness. • Profits are not under completely under the employees’ control. • Employees may wait a long time to receive their rewards. • Productivity improvement are made in August 2008, profits are not shared until July 2009. • Management may resist disclosing financial records. • Note: Profit Sharing requires full financial disclosure of profit information to employees.
Organizational Incentives • Employee Stock Ownership Programs (ESOPs) - employees are reward by shares of stock in the company. • Advantages: • Firm receives favorable tax treatment for earnings earmarked for the ESOP. • Gives employees a sense of ownership, or at least a sense that they have a “piece of the action. ”
Executive Compensation • Executives are technically those individuals who hold positions in the top two levels of an organization. • • CEO CFO COO Senior Vice-Presidents
Executive Compensation (1) Executive Salaries • Only accounts for 40%-60% of an executive's total compensation. • Often performance-based (2) Supplemental Benefits Executive health plans Life insurance Trusts
Executive Compensation (3) Executive Perquisites noncash items: • • • Free physical examinations Company car Free financial counseling First-class air travel Club membership Personal liability insurance Estate planning Travel for spouse Golden parachutes Silver parachutes
Executive Compensation (4) Executive Bonus Plans (Annual) • To be effective, it must be tied to specific measures: • • • ROI EPS Net profits • Often creates a short-term perspective (5) Stock Options individuals have the right to purchase stock at a lower fixed cost for a specified period of time. Designed to create a long term perspective.
Executive Compensation • Golden parachutes - massive severance compensation in the event the executive loses his/her job. • Example: Former Home Depot CEO Bob Nardelli received a golden parachute of approximately $210 million in 2006. Home Depot's market valuation declined 40 % during Nardelli's tenure. • August 5, 2007, he became chairman and CEO of the newly privatized Chrysler. • Silver parachutes - severance and benefits programs for nonexecutives if job loss is due to acquisition.
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