Pay-for-Performance: Incentive Rewards

1. Pay-for-Performance:Incentive Rewards The Challenges of Human Resources Management

2. Linking Pay to Performance

3. Pay for Performance

4. How Incentives Sometimes “Work”

5. 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.

6. Incentive Plans as Links toOrganizational Objectives • Incentive Plan Purposes • Encourage employees to assume “ownership” of their jobs, thereby improving effort and job performance. • Motivate employees to expend more effort than under hourly and/or seniority-based compensation systems. • Support a compensation strategy to attract and retain top-performing employees. • Incentive Plan Effectiveness • There is evidence of a relationship between incentive plans and improved organizational performance.

7. Requirements for a Successful Plan • Identify important organizational metrics that encourage employee behavior. • Involve employees. Incentive programs should seem fair to employees. • Find the right incentive payout. Payout formulas should be simple and understandable. • Establish a clear link between performance and payout.

8. Why Incentive Plans Fail • They fail to meet employee expectations for pay gains. • There is confusion about incentive payment calculations due to poor design and implementation of the plan. • Employees do not have the capability to change their performance levels. • The organization environment does not support plan.

9. Incentive Plans as Links to Organizational Objectives Contemporary arguments for incentive plans focus on linking compensation rewards, both individual and group, to organizational goals.

10. 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.

11. 60 minutes (per hour) 5 units per hour = 12 minutes (standard time per unit) $12.75 (hourly rate) $2.55 per unit = 5 units (per hour) Computing the Piece Rate

12. Pros and Cons of Piecework • Easily understandable, equitable, and powerful incentives • Employee resistance to changes in standards or work processes affecting output • Quality problems caused by an overriding output focus • Possibility of violating minimum wage standards • Employee dissatisfaction when incentives either cannot be earned or are withdrawn • May conflict with organizational culture and/or group norms

13. Norms: A Group’s Unspoken Rules

14. 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.

15. Individual Incentive Plans(cont.) • 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.

16. Merit Pay • Merit Pay Program (Merit Raise) • 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.

17. Merit 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

18. Example of Merit Increase Grid

19. 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.

20. Problems with Merit Raises • Money for merit increases may be inadequate to satisfactorily raise all employees’ base pay. • Managers may have no guidance in how to define and measure performance; there may be vagueness regarding merit award criteria. • Employees may not believe that their compensation is tied to effort and performance; they may be unable to differentiate between merit pay and other types of pay increases. • Employees and their managers may hold different views of the factors that contribute to job success. • Merit pay plans may create feelings of pay inequity.

21. Sales Incentives Sales Incentive Plans Straight Salary Straight Commission Salary and Commission Combinations

22. 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.

23. Incentive Plans for Salespersons (cont.) • Straight Commission Plan • Compensation plan based upon a percentage of sales. • Drawis a cash advance that must be paid back as commissions are earned. • Disadvantages: • Salespeople will stress high-priced products. • Customer service after the sale is likely to be neglected. • Earnings tend to fluctuate widely between good and poor periods of business, an turnover of trained sales employees tends to increase in poor periods. • Salespeople are tempted to grant price concessions.

24. Incentive Plans for Salespersons (cont.) • 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.

25. Group/Team 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.

26. Team Incentive Plans • 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.

27. Team Incentive Plans (cont.) • 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.

28. Team Incentive Plans (cont.) • 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. • Increase in productivity is gained when: • Greater output is obtained with less or equal input. • Equal production output is obtained with less input.

29. Gainsharing Incentive Plans Scanlon Plan Rewards come from employee participation in improving productivity and reducing costs. Improshare Gainsharing based on increases in productivity of the standard hour output of work teams.

30. Scanlon Plan Components Philosophy of cooperation Identity Competence Involvement system Benefits sharing formula Gainsharing Plans

31. Scanlon Plan Suggestion Process

32. Improved Productivity through Sharing (Improshare): An Example • A standard of the number of person-hours required to produce an expected level of output is developed • 5000 hours of labor to produce 1000 units each week (5 hours per unit) • In a given week 5000 labor hours produced 1300 units • 1500 hours have been saved (300 x 5) • 50-50 split between firm and employees; employees get 750 hour bonus • 750/5000 = 15% bonus • Employees receive a 15% bonus for the week

33. 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. • Deferred profit-sharing plans • A predetermined portion of profits based on the employee’s contribution to the firm’s profits is placed in each employee’s retirement account under a trustee’s supervision. • Employees’ income taxes on the distributions are deferred, often until the employee retires.

34. Enterprise Incentive Plans Profit Sharing 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

35. Enterprise Incentive Plans (cont.) • 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.

36. Enterprise Incentive Plans (cont.) • Employee Stock Ownership Plans (ESOPs) • Stock plans in which an organization contributes shares of its stock to an established trust for the purpose of stock purchases by its employees. • The employer establishes an ESOP trust that qualifies as a tax-exempt employee trust under Section 401(a) of the Internal Revenue Code • Stock bonus plans are funded by direct employer contributions of its stock or cash to purchase its stock. • Leveraged plans are funded by employer borrowing to purchase its stock for the ESOP.

38. Rewards and Risks of ESOPS Enterprise Incentive Plans (cont.) Advantages Disadvantages Retirement benefits Liquidity and value Pride of ownership Single funding basis Deferred taxes Not insured

39. Advantages of ESOPs • For the Company • Can take a tax deduction equal to the fair market value of the shares transferred to the ESOP trustee • Gets an income tax deduction for dividends paid on ESOP-owned stock • Can borrow against ESOP in trust and then repay the loan in pretax rather than after-tax dollars • For the Employees • Develop a sense of ownership in and commitment to the firm. • Do not pay taxes on ESOP earnings until they receive a distribution. • For the Shareholders of Closely-Held Corporations • Can place assets into an ESOP trust which will allow them to purchase other marketable securities to diversify their holdings

40. Incentives for Executives (cont.) • 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.

41. Incentives for Executives • The Executive Pay Package • Base salary • Short-term incentives or bonuses • Long-term incentives or stock plans • Benefits • Perquisites (perks)

42. Types of Long-Term Incentive Plans

43. The “Sweetness” of Executive Perks

44. 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.

45. Executive Compensation Reform (cont.) • 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

46. Pay for Performance??? Give Me a Break: Big Bucks for Execs as Companies Flounder Nardelli out at Home Depot

47. Nonfinancial and Recognition Awards • Effects of Recognition-Based Awards • Recognition has a positive impact on performance, either alone or in conjunction with financial rewards. • Day-to-day recognition from supervisors, peers, and team members is important. • Ways to Use Recognition • Social recognition • Performance-based recognition • Performance feedback

48. 1501 Ways to Reward Employees (2012)

49. Social Recognition and Related Positive Reinforcement Managers Can Use • Being provided with ample encouragement • Being allowed to set own goals • Compliments • Expression of appreciation in front of others • Note of thanks • Employee-of-the-month award • Special commendation • Bigger desk • Bigger office or cubicle • Challenging work assignments • Freedom to choose own work activity • Having fun built into work • More of preferred task • Role as boss’s stand-in when he or she is away • Role in presentations to top management • Job rotation • Encouragement of learning and continuous improvement

50. Customize Your Noncash Incentive Awards