Chapter 21 Rewarding Performance Cost Accounting Traditions and Innovations Barfield, Raiborn, Kinney

Learning Objectives (1 of 2) Explain the relationship between compensation and maximization of stockholder wealth List the different ways of rewarding performance Describe the movement toward rewarding group, as well as individual, performance List the positive and negative consequences of incentive pay programs

Learning Objectives (2 of 2) Explain why incentive programs may involve shares of, or options for, common stock Describe the importance of nonmonetary rewards in motivating managers Clarify how taxes affect compensation plan design Describe the role of ethics when designing a compensation package Identify expatriate compensation issues

Rewarding Performance

Compensation Strategy Unites goals and strategies, performance measurements, and rewards Board of directors and top management determine compensation strategy Compensation committee –Establishes compensation strategy –Sets compensation policies/guidelines Is this a conflict of interest?

Set strategic goals Identify critical success factors, set operational targets and compensation strategy Identify performance measures Set performance rewards Employee or employee group performs tasks Measure/monitor performance Determine rewards Plan-Performance-Reward Model

Traditional Compensation Strategy Top managers –salary and significant financial incentives Middle managers –salary and raises based on performance Workers –wages and small bonuses

Contemporary Strategy Incentive-based compensation to all employees Based on group or individual performance Encourages –higher level of employee performance and loyalty –lower overall costs

Pay-for-Performance Plans Correlation with organization goals –Maximization of shareholder wealth Appropriate time horizon –Long-run perspective –Reward with stock or stock options Subunit mission Age of employee Balance of group and individual benefits Management ownership

Setting Performance Measures Degree of control over performance output Minimize risk to worker of random effects workerspecific, short-run measures upper less specific, longer-time horizon, managementorganization longevity measures

Setting Performance Measures Incentives relative to organization level workerweighted toward monetary and short-term measures upperweighted toward nonmonetary managementand long-term measures

Worker Compensation Choice of plan affected by: –Competitive focus –Organizational culture –Local laws –Union affiliation –Political consideration

Pay Plan Periodic compensation –function of time at work, not tasks accomplished –affected by seniority, skill, education level –no link between performance and reward

Performance-Based Pay Plans Merit pay Contingent pay Piece rate These do not consider overall organizational success

Profit Sharing Contingent on organizational success Current and/or deferred incentives in form of cash or stock Allocated among employees based on –personal performance measures –seniority –team performance –managerial judgment –specified formulas Profit Sharing

Stock Options Employee can purchase shares of company stock at a set price during a specific time period More valuable as company stock price increases

Stock Appreciation Rights Employee may receive cash, stock, or a combination of cash and stock Amount based on company stock price at a future date More valuable as company stock price increases

Employee Stock Ownership Plan (ESOP) Profit-sharing compensation invested in company stock More valuable as company stock price increases

Nonfinancial Incentives Recognition of efforts Participation in decision making Good Job

Managerial Compensation Monetary Perquisites - Perks –vacations –free child care –free parking –personal assistants or private secretaries –health care –recreational club memberships –office with a view –flexible work hours

Not-for-Profit and Governmental Time-based pay plans; not a strong link between pay and performance 90% of government workers support plans that would link pay and performance Only 20% of not-for-profits provide bonus plans for top executives

Possible Tax Treatments of Compensation Elements Full and immediate taxation Tax deferral - pay tax at a future date Tax exempt - pay no tax

Taxation of Fringe Benefits Employer-provided accident and health insurance –deductible by employer –not taxable to employee Cafeteria benefit plans –both nontaxable and taxable benefits Benefits

Deferred Compensation Profit-sharing, pension, and various stock-based plans including ESOPs Company receives an immediate deduction Employee is not taxed until distributions made (tax deferred)

Ethical Considerations Organizational governance Role of capital markets –Takeover, raiders, and golden parachutes Compensation differentials

Global Compensation Expatriate compensation Domestic base salary and fringe benefits plus adjustments for –cost of living - housing, education, security –currency fluctuations –tax implications –retirement benefits in home currency

Questions What are some different ways of rewarding performance? Why do many incentive programs involve shares of, or options for, common stock? What are some ethical issues to consider when designing a compensation package?