Variable Pay and Executive Compensation

1. Module 4 Variable Pay and Executive Compensation

2. CEO Pay • Made in America—My Story • Sam Walton and John Huey (1993) • “A lot of what goes on these days with high-flying companies and these overpaid CEO’s who’re really looting from the top and aren’t watching out for anyone but themselves, really upsets me.” • CEO Pay

3. If you were creating an executive compensation plan, what criteria would you include? Write it down

4. Variable Pay: Incentives for Performance • Variable Pay • Compensation linked to individual, group/team, and/or organizational performance. • Basic assumptions: • Some jobs contribute more to organizational success than others. • Some people perform better and are more productive than others. • Employees who perform better should receive more compensation. • Some of employees’ total compensation should be tied directly to performance.

5. Effective Incentive Plans Boeing, Nordstrom, Wal-Mart, Safeway

6. Successes and Failures of Variable Pay Plans • Successful incentive plans require: • The development of clear, understandable plans that are continually communicated. • The use of realistic performance measures. • Strong links among performance results and payouts that truly recognize performance differences. • Clear identification of variable pay incentives separately from base pay.

7. Types of Variable Pay Plans

8. Piece-Rate Systems • Straight Piece-Rate Systems • Wages are determined by multiplying the number of pieces produced by the piece rate for one unit. • Differential Piece-Rate Systems • Employees are paid one piece-rate for units produced up to a standard output and a higher piece-rate wage for units produced over the standard.

9. Individual Incentives: Bonuses • Bonus • A one-time payment that does not become part of the employee’s base pay. • Spot Bonus • A special type of bonus used is a “spot” bonus, so called because it can be awarded at any time.

10. Special Incentive Programs • Performance Awards • Cash or merchandise used as an incentive reward. • Recognition Awards • Recognition of individuals for their performance or service to customers in areas targeted by the firm. • Service Awards • Rewards to employees for lengthy service with an organization.

11. Types of Sales Compensation Plans • Salary-Only • All compensation is paid as a base wage with no incentives. • Commission • Straight Commission • Compensation is computed as a percentage of sales in units or dollars. • The draw system make advance payments against future commissions to salesperson. • Salary-Plus-Commission or Bonuses • Compensation is part salary for income stability and part commission for incentive.

12. Determining Sales Effectiveness

13. Group/Team Incentives (cont’d) • Distributing Rewards • Same-size reward for each member • Different-size reward for each member • Problems with Group/Team Incentives • Rewards in equal amounts may be perceived as “unfair” by employees who work harder, have more capabilities, or perform more difficult jobs. • Group/team members may be unwilling to handle incentive decisions for co-workers. • Many employees still expect to be paid according to individual performance. • Social Loafing • The folly of rewarding A and hoping for B

14. Conditions for Successful Group/Team Incentives

15. Organizational Incentives • Profit Sharing • A system to distribute a portion of the profits of the organization to employees. • Primary objectives: • Increase productivity and organizational performance • Attract or retain employees • Improve product/service quality • Enhance employee morale • Drawbacks • Disclosure of financial information • Variability of profits from year to year • Profit results not strongly tied to employee efforts

16. Framework Choices for a Profit-Sharing Plan

17. Employee Stock Plans • Stock Option Plan • A plan that gives employees the right to purchase a fixed number of shares of company stock at a specified price for a limited period of time. • If market price of the stock is above the specified option price, employees can purchase the stock and sell it for a profit. • If the market price of the stock is below the specified option price, the stock option is “underwater” and is worthless to employees.

18. Employee Stock Plans • Employee Stock Ownership Plan (ESOP) • A plan whereby employees gain significant stock ownership in the organization for which they work. • Advantages • Favorable tax treatment for ESOP earnings • Employees motivated by their ownership stake in the firm • Disadvantages • Retirement benefit is tied to the firm’s future performance • Management tool to fend off hostile takeover attempts.

19. Components of Executive Compensation Packages

20. Executive Compensation • “Reasonableness” of Executive Compensation • Would another company hire this person as an executive? • How does the executive’s compensation compare with that for executives in similar companies in the industry • Is the executive’s pay consistent with pay for other employees within the company? • What would an investor pay for the level of performance of the executive? • Investors are owners • We as managers are stewards (agency theory)

21. Common Executive Compensation Issues

22. If you were creating an executive compensation plan, what criteria would you include? Discussion- did it change?

23. Exercise On Variable Pay