PART FOUR COMPENSATION
CHAPTER / T TwelvePay for Performance
And Financial
Incentives / 12
Lecture Outline
Strategic Overview
Money and Motivation: An Introduction
Performance and Pay
Individual Differences
Psychological Needs and Intrinsic vs. Extrinsic Motivation
Instrumentality and Rewards: Vroom’s Theory
Types of Incentive Plans
Individual Employee Incentives and Recognition
Piecework Plans
Merit Pay as an Incentive
Merit Pay Options
Incentives for Professional Employees
Recognition—based Awards
On-line Award Programs
Incentives for Salespeople
Salary Plan
Commission Plan
Combination Plan
Setting Sales Quotas
Strategic Sales Incentives
Team or Group Variable Pay Incentive Plans
How to Design Team Incentives
Pros and Cons of Team Incentives
Organization-wide Variable Pay Plans
Profit-Sharing Plans
Employee Stock Ownership Plan (ESOP)
Scanlon and Other Gainsharing Plans
At-Risk Variable Pay Plans
Incentives for Managers and Executives
Short-Term Incentives: The Annual Bonus
Long-Term Incentives
Other Executive Incentives
Strategy and Executive Compensation
Designing and Executing Effective Incentive Plans
Why Incentive Plans Fail
How to Implement Incentive Plans
Incentive Plans in Practice / In Brief: This chapter gives an overview of money and motivation, and then outlines different incentive programs that are used for different types of employees. It also discusses organization-wide incentive plans.
Interesting Issues: There is tension between the concept of providing employees with a secure, stable income (which some feel allows them the ability to be entrepreneurial and take appropriate risks for the company), and the idea of linking pay directly to performance. A good discussion may be developed from this tension as students grapple with their own resolution of this issue.
ANNOTATED OUTLINE
I. Money and Motivation: An Introduction
A. Performance and Pay – Compensation, shareholder value, and turbulence are factors that characterize business today, and they have produced a renaissance for financial incentive/pay-for-performance plans.
B. Individual Differences – the law of individual differences. This means that people differ in personality, abilities, values, and needs.
C. Psychological Needs and Intrinsic versus Extrinsic Motivation
1. Abraham Maslow – argued that people have a hierarchy of five increasingly higher-level needs, which he called physiological, security, social, self-esteem, and self-actualization.
2. Frederick Herzberg - hygiene—motivator theory of motivation similarly divides Maslow’s hierarchy into lower level (physiological, safety, social) and higher-level (achievement, self-actualization) needs.
3. Edward Deci – found that extrinsic rewards could at times actually detract from the person’s intrinsic motivation.
D. Instrumentality and Rewards: Vroom’s Theory – says a person’s motivation to exert some level of effort is a function of three things: the person’s expectancy (in terms of probability) that his or her effort will lead to performance;14 instrumentality, or the perceived connection (if any) between successful performance and actually obtaining the rewards; and valence, which represents the perceived value the person attaches to the reward.
E. Types of Incentive Plans include: individual incentive programs; group incentive programs; and profit-sharing plans. Variable pay generally refers to a group incentive plan that ties pay to some measure of the firm’s (or facility’s) overall profitability.
Know Your Employment Law: Incentives – the employer must comply with the overtime provisions of the Fair Labor Standards Act when designing and administering its incentive plans. Certain bonuses are excludable from overtime pay calculations. The problem is that many other types of incentive pay must be included.
Ø / NOTES / Educational Materials to UseII. Individual Employee Incentive and Recognition Programs
A. Piecework Plans – Piecework is where you pay the worker a sum (piece rate) for each 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.
B. Merit Pay As An Incentive – Merit pay or raise is any salary increase the firm awards to an employee based on his/her individual performance. It is different from a bonus in that it usually becomes part of the employee’s base salary, whereas a bonus is a one-time payment.
C. Merit Pay Options – Traditional merit pay plans have two basic characteristics: (1) merit increases are usually granted to employees at a designated time of the year in the form of a higher base salary, and (2) the merit raise is usually based exclusively on individual performance. Two adaptations of merit pay plans are: (1) one awards merit raises in one lump sum once a year and (2) merit awards are tied to both individual and organizational performance (see Table 12-2).
D. Incentives for Professional Employees – Professional employees are those whose work involves the application of learned knowledge to the solution of the employer’s problems, such as lawyers, doctors, economists, and engineers. Making incentive pay decisions for professional employees can be challenging because they’re usually paid well anyway.
E. Recognition-Based Awards – Studies show that recognition has a positive impact on performance, either alone or in conjunction with financial rewards.
F. Online Award Programs – There are many reasons to use internet sites like these to manage your awards program. The sites can offer a much broader range of products than most employers could catalog and offer themselves. And perhaps most important, the whole process is expedited—it’s much easier to bestow and deliver the awards.
Ø / NOTES / Educational Materials to UseIII. Incentives for Salespeople
A. Salary Plan – offered by some firms. Straight salary makes it simple to switch territories or to reassign salespeople, and it can foster loyalty among the sales staff. A disadvantage is that it can constrict sales and de-motivate potentially high-performing salespeople.
B. Commission Plan – pays salespeople for results, and only for results; thus, they tend to attract high-performing sales people 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.
C. Combination Plan – 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. But they can become complicated, and misunderstandings can result.
D. Setting Sales Quotas – 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.
1. An Example: Auto Dealers – Compensation for car salespeople ranges from a high of 100 percent commission to a small base salary with commission accounting for most of total compensation.
E. Strategic Sales Incentives – Sales commissions remain popular, but employers increasingly link them to non-volume-based measures.
Ø / NOTES / Educational Materials to UseIV. Team or Group Variable Pay Incentive Plans
A. How to Design Team Incentives – There are three approaches:
1. Members are paid based on one of three formulas – 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.
2. Set a production standard based on the final output of the group as a whole.
3. Tie rewards to goals based on some overall standard of group performance.
B. Pros and Cons of Team Incentives – 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.
When You’re On Your Own, HR for Line Managers and Entrepreneurs: Incentives Supervisors Can Use – Most supervisors would not want to rely simply on the employer’s incentive plans to motivate his or her employees. There are a wide variety of things that a supervisor can do. A few are listed in the textbook.
Ø / NOTES / Educational Materials to UseV. Organization-Wide Variable Pay Plans
A. Profit-Sharing Plans involves employees receiving a share of the company’s annual profits. There are several types of profit-sharing plans: cash plans, Lincoln Incentive system, and deferred profit-sharing plans.
B. 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 established to purchase shares of the firm’s stock for employees.
C. Scanlon and Other Gainsharing Plans
1. 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.
2. Gainsharing Plans are incentive plans that engage many or all employees in a common effort to achieve a company’s productivity objectives, with any resulting cost-savings gains shared among employees and the company.
Implementing a Plan – The basic eight steps are: 1) establish general plan objectives; 2) define specific performance measures; 3) decide on a funding formula; 4) decide on a method for dividing and distributing the employees’ share of the gains; 5) make the disbursement significant enough to get participants’ attention and to motivate their behavior; 6) choose the form of payment; 7) decide how often bonuses are to be paid; and 8) develop the involvement system.
D. At-Risk Variable Pay Plans are plans that put some portion of the employee’s weekly pay at risk, subject to the firm meeting its financial goals.
1. Strategic HR – AmeriSteel’s HR-based incentive plan, called Partners in Performance, helped it achieve its strategic aims of increasing productivity and being competitive.
Ø / NOTES / Educational Materials to UseVI. Incentives for Managers and Executives
A. Short-Term Incentives: The Annual Bonus – is aimed at motivating the short-term performance of managers and executives.
1. Eligibility usually includes both top and lower level managers.
2. Fund Size refers to the total amount of bonus money the firm makes available. A nondeductible formula is where they use a straight percentage (usually of the company’s net income) to create the short-term incentive fund. A deductible formula assumes that the fund should start to accumulate only after the firm has met a specified level of earnings.
3. Individual Awards – Typically, a target bonus (as well as maximum amount) is set for each eligible position, and the actual award reflects the person’s performance.
The HR Scorecard, Strategy and Results: The New Incentive Plan – The Hotel Paris did not have an incentive pay program at all. Lisa Cruz set about creating and implementing an incentive plan that uses many of the concepts listed in this book.
B. Long-Term Incentives are used to inject a long-term perspective into their 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; the executive thus hopes to profit by exercising his/her option to buy the shares in the future but at today’s price.
2. Other Stock Option Plans – More companies are implementing broad-based stock option plans in which the potential appreciation is relatively modest, but in which all or most employees can participate.
3. Other Plans – Stock appreciation rights permit the recipient to exercise the stock option (by buying the stock) or to take any appreciation in the stock price in cash, stock, or some combination of these. A performance achievement plan awards shares of stock for the achievement of predetermined financial targets. A restricted stock plan is where shares are usually awarded without cost to the executive, but restricted from selling the stock for a specified time period.
4. Performance Plans are designed so that executives don’t prosper unless the company does; thus, payment is contingent on achievement of predetermined objectives.
C. Other Executive Incentives – Companies provide various incentives to persuade executives to remain with the firm such as golden parachutes and loans.
D. Strategy and Executive Compensation – Few HR practices have as profound or obvious an impact on strategic success as the company’s long-term incentives. In creating the compensation package you should: 1) define the strategic context for the executive compensation program, including the internal and external issues that face the company, and the firm’s business objectives; 2) shape each component of the executive compensation package based on your strategic aims, and then group the components into a balanced plan that makes sense in terms of these aims; 3) create a stock option plan that gives the executive compensation package the special character it needs to meet the unique needs of the executives and the company, and its strategy; 4) check the executive compensation plan for compliance with all legal and regulatory requirements and for tax effectiveness; and 5) install a process for reviewing and evaluating the executive compensation plan whenever a major business change occurs.
Ø / NOTES / Educational Materials to UseVII. Designing and Executing Effective Incentive Plans
A. Why Incentive Plans Fail – Some explanations include: performance pay can’t replace good management; you get what you pay for; “pay is not a motivator;” rewards punish; rewards rupture relationships; rewards can unduly restrict performance; rewards may undermine responsiveness; rewards undermine intrinsic motivation; and people work for more than money.
B. How to Implement Effective Incentive Plans – Some guidelines to follow to make your plan more effective: use common sense; link the incentive with your strategy; make sure effort and rewards are directly related; make the plan easy for employees to understand; set effective standards; view the standard as a contract with your employees; get employees’ support for the plan; use good measurement systems; emphasize long-term as well as short-term success; take the corporate culture into consideration; and adopt a comprehensive, commitment-oriented approach.
C. Incentive Plans in Practice – Most companies have several incentive plans. Figure 12-3 summarizes the percentage of companies using each of several selected plans.
Ø / NOTES / Educational Materials to UseDISCUSSION QUESTIONS
1. Compare and contrast six types of incentive plans. Various types of incentive plans were presented in the text, including piecework plans, straight and guaranteed plans, standard hour plans, plans for salespersons (commissions and combination plans), and group incentive plans. With the piecework plans, earnings are tied directly to what the individual worker produces, and are more appropriate in a manufacturing organization. Commissions are more appropriate for salespeople in situations where they are largely unsupervised. In-group incentive plans like the Scanlon Plan, all workers involved in developing and implementing cost savings share in the benefits of the suggestions.