1. Pay for Performance and Financial Incentives12
Pay for Performance and Financial Incentives
There is tension between the concept of providing employees with a secure, stable income, and the idea of linking pay directly to performance.
Some feel pay for performance allows employees the ability to be entrepreneurial and take appropriate risks for the company. Improved employee performance must be linked to improved organizational performance if incentive pay is to be more than just another labor cost.
For this chapter we will take an overview of money and motivation, then outline different incentive programs used for different types of employees.
We also will discuss organization-wide incentive plans.
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2. Learning Objectives
Explain how you would apply five motivation theories in formulating an incentive plan.
Discuss the main incentives for individual employees.
Discuss the pros and cons of commissions versus straight pay incentives for salespeople.
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3. Learning Objectives
Describe the main incentives for managers and executives.
Name and define the most popular organization-wide variable pay plans.
Outline the steps in designing effective incentive plans.
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4. Money and Motivation Strategy Performance Incentive Pay
Frederick Taylor was an American mechanical engineer who sought to improve industrial efficiencies.
He made three major contributions in the late 1800s.
First he defined a fair’s day work using standards of output.
Second, he is known as the father of the scientific management approach. This approach emphasized improvement of work methods.
Finally, he recognized the use of financial incentives for those whose output exceeded standards.
Today, business is characterized by consideration of compensation, shareholder value, and turbulence.
These three factors have produced a renaissance for financial incentive/pay-for-performance plans.
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5. Five motivation theories in formulating an incentive plan.
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6. Motivational Theories
Maslows Hierarchy of Needs
Herzbergs 2-factor theory
Reinforcement theory
Equity theory
Expectancy theory
Theory X & Y
Most theories on motivation can be broken up into:
Needs theories – all have certain needs.
Reinforcement theories – behaviour is learned and can be influenced through rewards and punishment.
Equity theory – people influenced in behaviour by how fairly they believe they are treated.
Expectancy theory – a certain amount of effort will lead to performance, and in turn to desirable outcomes or rewards.
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7. Motivation and Incentives
Maslow’s Hierarchy of Needs
Abraham Maslow, 1964 – not directed at work behaviours.
Individuals are motivated by desire to fulfil certain behaviours.
Needs are arranged in an ascending order of importance (hence order of importance).
All people have the same array of needs.
e.g. lower level needs satisfied before higher level needs have a significant motivating effect and similarly when people are focused on their basics such as shelter etc they have limited interest in personal growth or advancement.
The law of individual differences means that people differ in personality, abilities, values, and needs. Individuals, therefore, react to different incentives in different ways. T
Several theorists have contributed information relevant to designing incentive plans. Let’s discuss each of them.
The Hierarchy of Needs and Abraham Maslow – This hierarchy includes five types of needs: physiological, security, social (love and belongingness), self-esteem, and self-actualization.
Physiological needs, food, water, shelter.
According to Maslow, people are motivated to satisfy lower-order needs first and then work their way up the hierarchy in sequence,
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8. Motivation and Incentives
Hygiene (extrinsic)
Motivators - intrinsic
Herzberg’s Two-Factory Theory
Deci and demotivators
Motivators and Frederick Herzberg – 2-Factor theory this is divided into 2.
Hygiene factors (extrinsic) include such things as working conditions, salary, and incentives.
Motivators include those factors that make the job more intrinsically motivating, like challenge, feedback, and recognition.
Herzberg further claimed that the absence of hygiene factors would not foster a motivated individual. However, once hygiene factors had been attended to, the presence of motivating factors would create a motivated employee.
Edward Deci found that extrinsic rewards could, at times, actually detract from an employee who already possesses a great deal of intrinsic motivation.
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9. Reinforcement Theory
Behaviorist theory – Skinner They believe that all behaviour results from external stimuli and peoples goals are determined by the desire to achieve pleasure and avoid pain.
Reinforcement theories – behaviour is learned and can be influenced through rewards and punishment.
Rewards are more effective if given soon after the behaviour to which they relate.
Impact of reinforcement diminishes if rewards become irregular or unpredictable.
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10. Equity Theory People are motivated by a desire for fairness.
Equity theory – people influenced in behaviour by how fairly they believe they are treated.
If people believe they are being unfairly treated, people will act to restore their sense of equity. If feel undervalued and can’t do anything about it, they will feel dissatisfied, less productive, absent more frequently and unco-operative in their work relationships.
Expectancy theory – a certain amount of effort will lead to performance, and in turn to desirable outcomes or rewards.
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11. Expectancy Theory Expectancy Theory (Victor Vroom)
This theory is the most dominate means of explaining work motivation. High motivation and consequently high levels of effort, will exist when employees see a link between effort, performance and rewards.
Expectancy theory suggests that a person’s motivation is a function of three things.
First, is the person’s expectancy (in terms of probability) that his or her effort will lead to performance. Do they expect that they will perform.
Second is the instrumentality apparent. This is the individual's perceived connection (if any) between successful performance and actually obtaining the rewards. They can understand the link between action and reward.
Third, valence, represents the perceived value the person attaches to the reward. So if the person doesn’t have high value for the reward they will not be motivated to drive for the reward.
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12. Theory X and Y
Theory X – average workers has an inherent dislike of work and will avoid.
Theory Y – expenditure of physical and mental effort in work is as natural as play or rest.
Developed by McGregor
Theory X – because of this characteristic of not liking work people must be coerced and controlled, directed, threatened with punishment to get them to work. This theory believes that the average human being likes to be directed, avoid responsibility, has little ambition and wants security above all.
Theory Y – People exercise commitment and control, commitment comes from rewards associated with achievement. They seek responsibility.
Managers who accept Theory X will control their employees, managers who accept theory Y will assist employers to achieve.
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13. Motivation and Incentives
Behavior modification
Incentive pay terminology
Employee incentives and the law
Reinforcement Theory - Behavior Modification/Reinforcement and B. F. Skinner – Psychologist B.F. Skinner proposed that to understand behavior, one must understand the consequences of that behavior.
Behavior modification means changing behavior through rewards or punishments that are contingent upon performance.
Traditionally, all incentive plans are pay-for-performance plans – thus they are contingent upon performance.
Variable pay is usually an incentive plan that ties pay to some measure of the firm’s overall profitability.
However, confusing as it may be, some experts have used the term “variable pay” to include incentive plans for individual employees.
Important - The employer must comply with the overtime provisions of the Fair Labor Standards Act (FLSA) when designing and administering its incentive plans. Certain bonuses are excludable from overtime pay calculations. However, many other types of incentive pay must be included. Can’t ask that a person operates over and above their duties e.g. does their job and anothers to achieve an incentive bonus.
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14. Review Money and motivation Motivation theories Incentives Terminology
The law
For this learning objective, we have discussed the relationship between money and motivation. In addition, we covered various theories of motivation including:
Maslow’s Hierarchy of Needs
Herzberg’s Two-Factor Theory
Demotivators
Expectancy Theory
Behavior modification
Incentive pay plans can be limiting – psyche of indiviudal – only works to that plan and not over and above – comes to expect the pay as a normal part of their pay.
Finally, we touched on the terminology used for incentive pay and the relationship of employee incentives to the law.
Let’s now turn our attention to the main incentives for individual employees.
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15. Incentives for individual employees.
Several incentive plans are particularly suited for use with individual employees.
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16. Individual Employee Incentive and Recognition Programs
Piecework plans
Straight piecework
Standard hour plans
Pros and cons
Merit pay as an incentive
Differential pay increases
Merit pay options
Piecework is the oldest and still most popular individual incentive plan. Piecework involves paying the worker a specified amount for each piece or unit he/she produces.
Straight piecework entails a strict proportionality between results and rewards regardless of output. With a standard hour plan, the worker gets a premium equal to the percent by which his/her performance exceeds the standard.
Set standard, employee is rewarded by the percentage to which the standard is exceeded. e.g. sales – set standard amount of sales, if exceeds by X is paid a percentage, if exceeds by xx is paid a higher percentage.
Pros
The pluses for piecework are that piecework plans are understandable, appear equitable, and can be powerful incentives, since rewards are proportionate to performance.
Cons
On the other hand, workers may resist even justified attempts to raise production standards. This may occur in part because a cultural norm has been established between the employees performing the same work. Occasionally, employees may well downplay quality, or resist switching from job to job (since doing so could reduce productivity). Attempts to introduce new technology or processes may trigger resistance, for much the same reason. This tends to happen in more unionised environment.
Merit pay or a merit raise is any salary increase the firm awards to an employee based on his/her individual performance.
Merit plan effectiveness depends on truly differentiating among employees. Both expectancy and equity theories can impact this. Especially if the decision to pay merit is ascertained by the likes of the management teams subjectivity as opposed to objectivity e.g. financials etc.
Two adaptations of merit pay plans are popular: Merit Pay options
1. One awards merit raises in a lump sum once a year and does not make the raise part of the employee’s salary.
2. The other adaptation ties merit awards to both individual and organizational performance.
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17. Individual Employee Incentive and Recognition Programs
Incentives for professional employees
Nonfinancial and recognition-based awards
Incentives managers can use
Online and IT-supported awards
Job design – refer to Oldham & Hackman.
Professional employees are those whose work involves the application of learned knowledge to the solution of the employer’s problems, such as lawyers e.g. ER , doctors e.g. occupational health, decreased sickness etc, economists, and engineers. Incentives can be awarded such employees.
Recognition programs usually refer to formal programs such as employee-of-the-month programs.
Social recognition programs are more informal manager-employee exchanges, including praise and approval.
The best option for motivating employees is also the simplest—make sure the employee has a doable goal with which he or she agrees.
Second, simply recognizing an employee’s contribution is a powerful motivation tool.
Third, the manger can use casual social recognition as positive reinforcement on a day-to-day basis.
There are many reasons to use Internet sites and IT to manage awards programs. The sites can offer a much broader range of products than most employers could catalog and offer by themselves. And perhaps most importantly, the whole process is expedited, so it’s much easier to bestow and deliver the awards.
Research has shown that job design, job responsibility, and feedback from a job are primary drivers of employee engagement.
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18. Review Piecework Merit pay Incentives for professionals
Nonfinancial rewards
Online
Job design
For this learning objective, we have discussed the two types of piecework plans and their pros and cons. In addition, we noted that merit pay requires truly differentiating between employees, which is difficult for some managers due either to a lack of effective recordkeeping or reluctance to distinguish between employees.
Professionals require different non-financial incentives such as time off for participation in professional organizations. Computer-based management of incentive and recognition programs offer several advantages compared to traditional approaches, including more timely distribution of rewards and tracking.
Finally, job design, responsibility and feedback are important to many employees at all levels.
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19. The Pros and Cons of Commissions vs
The Pros and Cons of Commissions vs. Straight Pay Incentives for Salespeople
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20. Incentives for Salespeople
Salary plan
Commission plan
Combination plan
Maximizing sales force results
How effective are your incentives?
Fixed salaries are offered by some firms. Straight salary makes it simple to switch territories or to reassign salespeople, and it can foster loyalty. A disadvantage is that it can constrict sales and de-motivate potentially high-performing salespeople. Setting expectations often overcomes this.
Commission Plan. Salespeople are paid for results, and only for results. Thus, commission plans tend to attract high-performing salespeople who see that effort clearly leads to rewards. But it may cause them to neglect non-selling duties like servicing small accounts, cultivating dedicated customers, and pushing hard-to-sell items.
Most companies pay salespeople a combination of salary and commissions, usually with a sizable salary component. Combination plans give salespeople a floor to their earnings and still provide an incentive for superior performance.
Setting effective quotas is an art. In today’s fast-changing business scene, sales quotas must become more flexible than they have been in the past. There is a tendency to set commission rates informally, without considering how much each sale must contribute to covering expenses.
To maximize performance, answer the following questions;
Do the sales team members understand the compensation plans?
Do they know how we measure and reward performance?
Are quotas set fairly?
Is there a positive correlation between performance and commission earnings?
Are commissions more than covering total salespersons expenses?
Do our commission plan maximize sales of our most profitable products?
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21. Review Types of sales incentives Maximizing results Effectiveness
For this learning objective, we have discussed some of the pros and cons between straight salary plans and commission plans. We also noted that most companies offer a combined program, with a substantial emphasis on salary.
To maximize results, we recommended you use formal and systematic methods of setting sales quotas. Finally, to determine how effective your incentive program is, a number of questions must be answered. Some have to do with the level of understanding of your program by your salesforce. Others have to do with measuring the correlations between your program and the results produced
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22. The main incentives for managers and executives.
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23. Incentives for Managers and Executives
Strategy and the executive’s long-term and total rewards package
Sarbanes-Oxley Act
Short-term incentives, annual bonus
Eligibility
Fund size
Individual performance
Formula
Few HR practices have a profound or obvious impact on strategic success of the company’s long-term strategy as a managers compensation package.
In creating the compensation package, you should:
consider the strategic context;
shape each component of the package, then group them;
create a plan that gives the package a special character;
check for legal compliance and tax effectiveness; and
install a review and evaluation process for major business changes.
The Sarbanes-Oxley Act affects how employers formulate their executive incentive programs. It also injects a higher level of responsibility into executives’ and board members’ decisions. This is important especially in view of the Global financial crisis, it creates more liability and responsibility on the part of the executive, e.g. advertising safety of investment when company in difficulty can see executives go to prison.
For short-term incentives, the annual bonus is aimed at motivating the short-term performance of managers and executives. Eligibility usually includes both top and lower-level managers.
Fund size refers to the total amount of bonus money the firm makes available.
A target bonus and maximum amount is set for each eligible position, and the actual award reflects the person’s performance.
Finally, a formula may be used to base the bonus on specific measures critical to the company.
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24. Incentives for Managers and Executives
Strategic long-term incentives
Stock options
Stock option problems
Other stock plans
Ethics and incentives
Other executive incentives
Strategic long-term incentives are used to inject a long-term perspective into executives’ decisions.
1. Stock options account for over half of executives’ compensation. A stock option is the right to purchase a specific number of shares of company stock at a specific price during a specific period of time. Stock options can reward managers who experience a less than stellar performance. They also can encourage executives to take riskier ventures to increase profits.
2. Other stock plans include stock appreciation rights, a performance achievement plan and a restricted stock plan.
Stock appreciation rights permit the recipient to exercise the stock option (by buying the stock) or to take any appreciation in the stock price.
3. A performance achievement plan awards shares of stock for the achievement of predetermined financial targets.
In a restricted stock plan, shares are usually awarded without cost to the executive, but selling the stock is restricted for a specified time period.
4. Simplistic, financial-performance-oriented incentives, in the absence of strong ethical standards may breed unethical behavior. The solution is to foster a forward-looking ethical culture.
Other executive incentives:
Companies provide various other incentives to persuade executives to remain with the firm, such as golden parachutes and low- or no-interest loans.
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25. Review Strategy and long-term incentives Federal law
Short-term incentives
Strategic long-term incentives
Other incentives
We have discussed the relationship between a firm’s strategy and an executive’s long-term and total rewards package. In doing so, we discovered that the executive’s desires and the needs of the firm are inextricably interwoven.
Federal law such as the Sarbanes-Oxley Act mandate a greater sense of personal responsibility and understanding of the workings of a business to remain successful.
Short-term incentives and annual bonuses consider eligibility, fund size, and individual performance. Some firms use a formula to calculate the proper incentives.
Typical strategic, long-term incentives include stock options, stock plans, and ethical considerations.
Finally, some firms may offer golden parachutes or low- or no-interest loans to top tier executives in order to entice them to stay aboard.
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26. The Most Popular Organization-wide Variable Pay Plans
Let’s look now at incentives for teams, and for all employees company-wide.
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27. Team & Organization-wide Incentive Plans
Designing team incentives
Engineered standards
Pros and cons
HR inequities that undercut team incentives
There are three approaches to designing team incentives.
First, members are paid based on one of three team-based formulas wherein all members receive the pay (a) earned by the highest producer, (b) earned by the lowest producer, or (c) equal to the average pay earned by the group. In negotiation the team chose which they would like.
Second, set a production standard based on the final output of the group as a whole.
Finally, tie rewards to goals based on some overall standard of group performance.
A lot of our work today is organized around teams, so team incentives make sense to encourage cooperation and training. But exceptionally hard-working employees do not get paid according to their efforts, which may reduce motivation. Some studies suggest that team incentives are often counterproductive.
The fundamental problem is inequity.
Unless you actively minimize inequities, it’s probably best to pay employees based on their individual contributions to the team, rather than on collective team performance.
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28. Team & Organization-wide Incentive Plans
Profit-sharing plans
Scanlon plans
Gainsharing plans
At-risk pay plans
Employee stock ownership plans
1. Profit-sharing plans involve employees receiving a share of the company’s annual profits.
2. A Scanlon Plan is an incentive plan developed in 1937 by Joseph Scanlon. The basic features of the plan include: philosophy of cooperation, identity, competence, involvement system, and sharing of benefits formula.
3. Gainsharing plans are incentive plans that engage many or all employees in a common effort to achieve a company’s productivity objectives.
4. At-risk pay plans put some portion of the employee’s weekly pay at risk, subject to the firm meeting its financial goals.
5. Employee stock ownership plans (ESOP) are company-wide plans in which a firm contributes shares of its own stock (or cash to purchase the stock) to a trust. The trust is established to purchase shares of the firm’s stock for employees.
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29. Review Team incentives Inequities Profit-sharing
Scanlon and gainsharing
At-risk
ESOPs
Since many firms are moving to a team-based environment, we have discussed the need for incentive plans that reward teams. We also discussed issues related to why some team-based programs fail or are counterproductive. The chief issue is to manage any inequities in the systems, real or perceived.
Profit-sharing, Scanlon plans, gainsharing, at-risk pay plans and Employee Stock Ownership Plans (ESOPs) are all ways to recognize and reward employees based on company results.
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30. The Steps in Designing Effective Incentive Plans
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31. The Five Building Blocks of Effective Incentive Plans
Common sense
Linkages
Effort Rewards (motivational)
Standards
Contract
Measurement
Follow these guidelines to make your plan more effective:
use common sense; does it make sense to use insentives to drive performance, e.g. health manager with administrators, what is the performance, you are incentivizing for normal performance – no sense.
link the incentive with your strategy;
make sure effort and rewards are directly related to motivate the individual(s).
set effective standards;
view the standard as a contract with your employees;
use good measurement systems that is valid or scientific.
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32. Review Sense Scientific Linkages Standards Motivation
Once again, here are the five areas to address to ensure you are creating an effective incentive plan.
Ask: Does it make sense to use incentives?
Link the incentive with your strategy.
Make sure the program is motivational.
Set complete standards.
Be scientific.
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