1. Compensation Pay for Performance1

2. Key Topics – Pay for Performance
Merit pay and motivation
Types of incentive plans
Sales incentive programs
Corporate-wide gainsharing and profit sharing plans

3. Merit Pay Merit Pay Program (Merit Raise) Merit Guidelines
Links an increase in base pay to how successfully an employee achieved some objective performance standard.
Merit Guidelines
Guidelines for awarding merit raises that are tied to performance objectives.

4. Pay and Motivation
Evidence suggests that merit raises of 10-15% motivate changes in behavior.
Typical merit raises range from 2-6%
Rewards are more motivating if:
They are timely
They are public rather than secret
They are scarce rather than common

5. Motivation Through Merit Raises
Develop employee confidence and trust in performance appraisal.
Establish job-related performance criteria.
Separate merit pay from regular pay.
Distinguish merit raises from cost-of-living raises.
Withhold merit payments when performance declines.

6. Lump-Sum Merit Pay Lump-Sum Merit Program
Program under which employees receive a year-end merit payment, which is not added to base pay.
Advantages:
Provides financial control by maintaining annual salary expenses and not escalating base salary levels.
Contains employee benefit costs for levels of benefits normally calculated from current salary levels.

7. Variable Pay Variable Pay
Tying pay to some measure of individual, group, or organizational performance.

8. Variable Pay Incentives
Linking performance to pay
Individual – Bonuses, piece-rates, stock options
Team – Bonuses and awards
Plant / Unit / Business – Gainsharing, profit sharing
Corporation – ESOP’s
“Line of sight” is the perceived link between individual behavior and the reward.

9. Linking Pay to Performance
Performance Pay
Motivation
Improved Performance

10. Advantages of Incentive Plans

11. Advantages of Incentive Plans
Focuses employee efforts on specific performance targets.
Costs are variable and linked to the achievement of results. (Base salaries are fixed costs largely unrelated to output.)
directly related to operating performance.
objectives met, incentives are paid, objectives not met, incentives not paid.
Can foster teamwork and unit cohesiveness when payments to individuals are based on team results.
Distributes success among those responsible for producing that success.
Provides reward or attracts top performers when salary budgets are low.

12. Employee Opposition to Incentive Plans
Production standards are set unfairly.
Incentive plans are really “work speedup.”
Incentive plans create competition among workers.
Increased earnings result in tougher standards.
Payout formulas are complex and difficult to understand.
Incentive plans cause friction between employees and management.

13. Individual Incentive Plans
Straight Piecework
An incentive plan under which employees receive a certain rate for each unit produced.
Differential Piece Rate
A compensation rate under which employees whose production exceeds the standard amount of output receive a higher rate for all of their work than the rate paid to those who do not exceed the standard amount.

14. Computing the Piece Rate
hour
per
units 5
unit)
time
(standard
minutes 12
hour)
(per 60 =
unit
per
$2.55
hour)
(per
units 5
rate)
(hourly
$12.75 =

15. Piecework: The Drawbacks
Problems with piecework systems:
Is not always an effective motivator
Piecework standards can be difficult to develop.
Individual contributions can be difficult measure.
Not easily applied to work that is highly mechanized with little employee control over output.
Piecework may conflict with organizational culture (teamwork) and/or group norms (“rate busting”).
When quality is more important than quantity.
When technology changes are frequent.

16. Individual Incentive Plans (cont’d)
Standard Hour Plan
An incentive plan that sets pay rates based on the completion of a job in a predetermined “standard time.”
If employees finish the work in less than the expected time, their pay is still based on the standard time for the job multiplied by their hourly rate.

17. Individual Incentive Plans (cont’d)
Bonus
Incentive payment that is supplemental to the base wage for cost reduction, quality improvement, or other performance criteria.
Spot bonus
Unplanned bonus given for employee effort unrelated to an established performance measure.

18. Incentive Awards and Recognition
Often used to recognize productivity gains, special contributions or achievements, and service to the organization.
Employees feel appreciated when employers tie awards to performance and deliver awards in a timely, sincere and specific way.
Noncash Incentive Awards
Are most effective as motivators when the award is combined with a meaningful employee recognition program.

19. Customize Your Noncash Incentive Awards
Compensation specialists recognize that a successful noncash incentive program will offer employees a wide selection of awards—awards that appeal to a diverse workforce and the uniqueness of individual employees. “One-size-fits-all” is not the approach to take. What appeals to younger employees may not be attractive to older employees.
Employee Recognition programs are an example of nonfinancial compensation

20. Sales Incentives Sales Incentive Plans Straight Salary
Straight Commission
Salary and Commission
Combinations 5

21. Incentive Plans for Salespersons
Straight Salary Plan
Compensation plan that permits salespeople to be paid for performing various duties that are not reflected immediately in their sales volume.
Advantages:
Encourages building customer relationships.
Provides compensation during periods of poor sales.
Disadvantage:
May not provide sufficient motivation for maximizing sales volume.

22. Incentive Plans for Salespersons
Straight Commission Plan
Compensation plan based upon a percentage of sales.
Draw is a cash advance that must be paid back as commissions are earned.
Disadvantages:
Emphasis is on sales volume rather than on profits.
Customer service after the sale is neglected.
Earnings tend to fluctuate widely between good and poor periods of business.
Temptation to grant price concessions to get sales.

23. Incentive Plans for Salespersons
Combined Salary and Commission Plan
A compensation plan that includes a straight salary and a commission component (“leverage”).
Advantages:
Combines the advantages of straight salary and straight commission forms of compensation.
Offers greater design flexibility
Can be used to develop the most favorable ratio of selling expense to sales.
Motivates sales force to achieve specific company marketing objectives in addition to sales volume.

24. Executive Compensation
The Executive Pay Package
Base salary
Short-term incentives or bonuses
Long-term incentives or stock plans
Benefits
Perquisites (perks)

25. Executive Compensation
Justifications
Large financial incentives reward superior performance.
Business competition is pressure-filled and demanding.
Good executive talent is in great demand.
Effective executives create shareholder value.

26. Executive Compensation Reform
Current Reform Measures
The Internal Revenue Service (IRS) is looking for tax-code violations in executive pay packages and will make executive pay a part of corporate audits.
The Securities and Exchange Commission issued pay disclosure rules which require companies listed on the New York Stock Exchange and NASDAQ to disclose the true size of their top executive pay packages.
The Financial Accounting Standards Board (FASB) now requires that stock options be recognized as an expense on income statements.

27. Executive Compensation Reform (cont’d)
Other Reform Measures:
The adoption of performance formulas that peg executive compensation to organizational benchmarks other than stock price
Shareholder resolutions that allow shareholders the right to vote on executive pay packages
Greater accountability by compensation committees to justify large executive pay awards or severance or retirement packages

28. Group Incentive Plans Team Incentive Plans
Compensation plans where all team members receive an incentive bonus payment when production or service standards are met or exceeded.
Establishing Team Incentive Payments
Set performance measures upon which incentive payments are based
Determine the size of the incentive bonus.
Create a payout formula and fully explain to employees how payouts will be distributed.

29. Team Incentive Plans (cont’d)
Advantages
Team incentives support group planning and problem solving, thereby building a team culture.
The contributions of individual employees depend on group cooperation.
Team incentives can broaden the scope of the contribution that employees are motivated to make.
Team bonuses tend to reduce employee jealousies and complaints over “tight” or “loose” individual standards.
Team incentives encourage cross-training and the acquiring of new interpersonal competencies.

30. Team Incentive Plans (cont’d)
Disadvantages
Individual team members may perceive that “their” efforts contribute little to team success or to the attainment of the incentive bonus.
Intergroup social problems—pressure to limit performance and the “free-ride” effect may arise.
Complex payout formulas can be difficult for team members to understand.

31. Group Incentive Plans (cont’d)
Gainsharing Plans
Programs under which both employees and the organization share the financial gains according to a predetermined formula that reflects improved productivity and profitability.

32. Enterprise Incentive Plans
Profit Sharing
Any procedure by which an employer pays, or makes available to all regular employees, in addition to their base pay, current or deferred sums based upon the profits of the enterprise.
Challenges:
Agreement over the percentages of shared of profits and the forms of distribution (cash or deferred) of profits between company and employees
Annual variations and possibility of no payout due to financial condition of company
Maintaining motivational connection of profit-sharing to performance of employees

33. Enterprise Incentive Plans (cont’d)
Stock Options
Granting employees the right to purchase a specific number of shares of the company’s stock at a guaranteed price (the option price) during a designated time period.
The value of an option is subject to stock market conditions at the time that option is exercised.

34. Summary and Conclusions
Pay-for-performance: many challenges
Meeting the challenges requires planning
Should be part of larger compensation system
Should fit with overall strategic plan of org.
Pay-for-performance at four levels:
Individual, group, plant, organization wide
If P-f-P plan becomes entrenched
Employees will expect them regularly
P-f-P for executives and salespeople requires additional thought