Variable Pay Incentives for Performance Variable Pay Compensation

Variable Pay: Incentives for Performance • Variable Pay Ø Compensation linked to individual, group/team, and/or organizational performance. • Basic assumptions: Ø Some jobs contribute more to organizational success than others. Ø Some people perform better and are more productive than others. Ø Employees who perform better should receive more compensation. Ø Some of employees’ total compensation should be tied directly to performance. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 1

Developing Successful Pay-for-Performance Plans • Reasons for Adopting Pay or Incentive Plans: Ø Link more directly strategic business goals and employee performance. Ø Enhance organizational results and reward employees financially for their contributions. Ø Reward employees to recognize different levels of employee performance. Ø Achieve HR objectives, such as increasing retention, reducing turnover, recognizing training, or rewarding safety and attendance. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 2

Effective Incentive Plans Figure 13– 1 Copyright © 2005 Thomson Business & Professional Publishing.

Metrics for Variable Pay Plans Figure 13– 2 Copyright © 2005 Thomson Business &

Successes and Failures of Variable Pay Plans • Successful incentive plans require: Ø The development of clear, understandable plans that are continually communicated. Ø The use of realistic performance measures. Ø Keeping plans current and linked to organizational objectives. Ø Strong links among performance results and payouts that truly recognize performance differences. Ø Clear identification of variable pay incentives separately from base pay. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 5

Types of Variable Pay Plans Figure 13– 3 Copyright © 2005 Thomson Business &

Individual Incentives Identification of Individual Performance Independent Work Individual Incentive Systems Individualism Stressed in Organizational Culture Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. Individual Competitiveness Desired 13– 7

Piece-Rate Systems • Straight Piece-Rate Systems ØWages are determined by multiplying the number of pieces produced by the piece rate for one unit. • Differential Piece-Rate Systems ØEmployees 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. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 8

Individual Incentives: Bonuses • Bonus Ø A one-time payment that does not become part of the employee’s base pay. • Spot Bonus Ø A special type of bonus used is a “spot” bonus, so called because it can be awarded at any time. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 9

Special Incentive Programs • Performance Awards Ø Cash or merchandise used as an incentive reward. • Recognition Awards Ø Recognition of individuals for their performance or service to customers in areas targeted by the firm. • Service Awards Ø Rewards to employees for lengthy service with an organization. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 10

Purposes of Special Incentives Figure 13– 4 Copyright © 2005 Thomson Business & Professional

Types of Sales Compensation Plans • Salary-Only Ø All compensation is paid as a base wage with no incentives. • Commission Ø Straight Commission v Compensation is computed as a percentage of sales in units or dollars. v The draw system make advance payments against future commissions to salesperson. Ø Salary-Plus-Commission or Bonuses v Compensation is part salary for income stability and part commission for incentive. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 12

Determining Sales Effectiveness Figure 13– 5 Copyright © 2005 Thomson Business & Professional Publishing.

Why Organizations Establish Variable Pay Plans for Groups/Teams Figure 13– 6 Copyright © 2005

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 Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 15

Group/Team Incentives (cont’d) • Distributing Rewards Ø Same-size reward for each member Ø Different-size reward for each member • Problems with Group/Team Incentives Ø Rewards in equal amounts may be perceived as “unfair” by employees who work harder, have more capabilities, or perform more difficult jobs. Ø Group/team members may be unwilling to handle incentive decisions for co-workers. Ø Many employees still expect to be paid according to individual performance. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 16

Conditions for Successful Group/Team Incentives Figure 13– 7 Copyright © 2005 Thomson Business &

Types of Group/Team Incentives • Group/Team Results Ø “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) Ø The sharing with employees of greater-than-expected gains in productivity through increased discretionary efforts. v Improshare v Scanlon Plan Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 18

Organizational Incentives • Profit Sharing Ø A system to distribute a portion of the profits of the organization to employees. Ø Primary objectives: v Increase productivity and organizational performance v Attract or retain employees v Improve product/service quality v Enhance employee morale Ø Drawbacks v Disclosure of financial information v Variability of profits from year to year v Profit results not strongly tied to employee efforts Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 19

Framework Choices for a Profit-Sharing Plan Figure 13– 8 Copyright © 2005 Thomson Business

Employee Stock Plans • Stock Option Plan Ø 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. v If market price of the stock is above the specified option price, employees can purchase the stock and sell it for a profit. v If the market price of the stock is below the specified option price, the stock option is “underwater” and is worthless to employees. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 21

Employee Stock Plans • Employee Stock Ownership Plan (ESOP) Ø A plan whereby employees gain significant stock ownership in the organization for which they work. Ø Advantages v Favorable tax treatment for ESOP earnings v Employees motivated by their ownership stake in the firm Ø Disadvantages v Retirement benefit is tied to the firm’s future performance v Management tool to fend off hostile takeover attempts. Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 22

Components of Executive Compensation Packages Figure 13– 9 Copyright © 2005 Thomson Business &

Executive Compensation • “Reasonableness” of Executive Compensation Ø Would another company hire this person as an executive? Ø How does the executive’s compensation compare with that for executives in similar companies in the industry Ø Is the executive’s pay consistent with pay for other employees within the company? Ø What would an investor pay for the level of performance of the executive? Copyright © 2005 Thomson Business & Professional Publishing. All rights reserved. 13– 24