Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

How Does Pay Influence Individuals? 12-2 Irwin/McGraw-Hill Reinforcement Theory Expectancy Theory - Chapter 5 Agency Theory principals as owners agents as managers Reinforcement Theory Expectancy Theory - Chapter 5 Agency Theory principals as owners agents as managers

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Types of Agency Costs 12-3 Irwin/McGraw-Hill Perquisites Attitudes toward risk Decision-making horizons Perquisites Attitudes toward risk Decision-making horizons

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Factors in the Choice of a Compensation Package 12-4 Irwin/McGraw-Hill Risk Aversion Outcome Uncertainty Job Programmability Measurable Job Outcome Ability to Pay Tradition Risk Aversion Outcome Uncertainty Job Programmability Measurable Job Outcome Ability to Pay Tradition

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Individual Pay Programs: Design Features 12-5 Irwin/McGraw-Hill Programs Merit Pay Incentive Pay Profit Sharing Ownership Gainsharing Skill-based Payment Method Performance Measures Frequency of Payout Coverage - Change in base - Bonus - Equity changes - Bonus - Change in base - Annually - Weekly - Semiannual or annual - Sale of stock - Monthly / quarterly - when skill is acquired - Boss’ appraisal - Output, productivity - Profit - Stock value - Production costs - Skill acquisition - All - Direct labor - All - Production/ service unit - All

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Individual Pay Programs: Consequences 12-6 Irwin/McGraw-Hill Programs Merit Pay Incentive Pay Profit Sharing Ownership Gainsharing Skill-based Performance Motivation CultureAttractionCosts - Change in base - little - some in small units - Little - Little - Learning - High performers - High performers - All - All - Retain employees - those who want to learn - Individual competition - Intra-group competition - Cooperation - Knowledge of business - Sense of ownership - Learning - High maintenance - Good system of appraisal - Variable - Ability to pay - Cost not variable - can be high

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Individual Pay Programs: Contingencies 12-7 Irwin/McGraw-Hill Programs Merit Pay Incentive Pay Profit Sharing Ownership Gainsharing Skill-based Organization Structure Management Style Type of Work - Independent jobs - Measurable jobs / units - Autonomous units - Any company - Most companies - Control - Participation desirable - Participation - Participation - Participation - Participation - Individual, easy to measure - Individual appraisal - All types - All types - Professional

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Merit Pay Programs: Characteristics 12-8 Irwin/McGraw-Hill Tries to identify individual performance differences Supervisor provides most performance information Pay is linked to performance appraisal results Feedback is infrequent Feedback is mostly one way - supervisor to subordinate Tries to identify individual performance differences Supervisor provides most performance information Pay is linked to performance appraisal results Feedback is infrequent Feedback is mostly one way - supervisor to subordinate

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Merit Pay Programs: Criticisms 12-9 © 1999 The McGraw-Hill Companies, Inc., Irwin/McGraw-Hill Individual performance differences are due largely to SYSTEM Discourages teamwork System is not fair Too much reliance on supervisor for rating procedural issue Pay increase are not representative of performance distributive issue Contributes to entitlement mentality Individual performance differences are due largely to SYSTEM Discourages teamwork System is not fair Too much reliance on supervisor for rating procedural issue Pay increase are not representative of performance distributive issue Contributes to entitlement mentality

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Individual Incentives Irwin/McGraw-Hill Most jobs have no physical output Many administrative problems Individuals focus only on the incentive Does not fit with team approach Does not reward obtaining multiple skills Rewards output at the expense of quality or service Most jobs have no physical output Many administrative problems Individuals focus only on the incentive Does not fit with team approach Does not reward obtaining multiple skills Rewards output at the expense of quality or service Used rarely for the following reasons:

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Profit Sharing Irwin/McGraw-Hill Advantages Encourages employees to think like OWNERS Payments are not part of base pay Disadvantages Many plans defer actual payments Few plans pay out during business downturns Advantages Encourages employees to think like OWNERS Payments are not part of base pay Disadvantages Many plans defer actual payments Few plans pay out during business downturns

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Ownership Irwin/McGraw-Hill Similar to profit sharing with employee focus on organizational success even stronger Employee ownership through stock options Stock options typically reserved for executives, however, the trend is toward pushing eligibility further down in the organization. ESOPs Similar to profit sharing with employee focus on organizational success even stronger Employee ownership through stock options Stock options typically reserved for executives, however, the trend is toward pushing eligibility further down in the organization. ESOPs

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Gainsharing Irwin/McGraw-Hill Encourages pursuit of broader (team) goals Measures performance that is controllable by employee Distributes payouts frequently Conditions for success include: – management commitment – commitment to continuous improvement and change – willingness to accept employee input – high level of cooperation and information sharing – agreement on productivity standards – employment security Encourages pursuit of broader (team) goals Measures performance that is controllable by employee Distributes payouts frequently Conditions for success include: – management commitment – commitment to continuous improvement and change – willingness to accept employee input – high level of cooperation and information sharing – agreement on productivity standards – employment security

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Process and Context Issues Irwin/McGraw-Hill Employee participation in decision making Communication Pay and process: intertwined effects Employee participation in decision making Communication Pay and process: intertwined effects

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. Matching Strategy to Operating Strategy Irwin/McGraw-Hill Pay Strategy Dimension Business Unit Strategy DefendersProspectors Risk Sharing (variable pay) Time Orientation Pay level (short run) Pay level (long run) Benefits Level Where Pay Decision Made Pay Unit of Analysis Low Short-term Above market Centralized Job High Long-term Below market Above market Below market Decentralized Skills