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

Chapter Objectives After studying this chapter, you should be able to LEARNING OUTCOME 1 Know how to implement incentive programs. Identify the different types of incentive programs and why they work. Explain why merit raises may fail to motivate employees and discuss ways to increase their motivational value. Indicate to specific ways to compensate salespeople. Differentiate how gains may be shared with employees under the Scanlon and Improshare gainsharing systems. Differentiate between profit sharing plans and explain advantages and disadvantages of these programs. Describe the main types of ESOP plans and discuss the advantages of ESOPs to employers and employees. LEARNING OUTCOME 2 LEARNING OUTCOME 3 LEARNING OUTCOME 4 LEARNING OUTCOME 5 LEARNING OUTCOME 6 LEARNING OUTCOME 7

Strategic Reasons for Incentive Plans Variable Pay Tying pay to some measure of individual, group, or organizational performance. Incentive Pay Programs Establish a performance “threshold” to qualify for incentive payments. Emphasize a shared focus on organizational objectives. Create shared commitment in that every individual contributes to organizational performance and success.

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

Incentive Plans as Links to Organizational 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.

Advantages of Incentive Pay Programs

Do Incentive Plans Work? Requirements for a Successful Plans 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.

Do Incentive Plans Work? 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.

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.

Measurement DOs and DON”Ts

Administering Incentive Plans Incentive systems are effective: When incentives are based on actual differences in individual, team, or organizational performance and not seen as entitlements. When annual incentive budgets are large enough to reward and reinforce exceptional performance. When overhead costs associated with plan implementation and administration are properly considered beforehand and are controllable.

Successful Incentive Plans Employees have a desire for an incentive plan. Employees are encouraged to participate. Employees see a clear connection between the incentive payments they receive and their job performance. Employees are committed to meeting the standards. Standards are challenging but achievable. Payout formulas are simple and understandable. Payouts are a separate, distinct part of compensation.

Effective Incentive Plan Administration Grant incentives based on individual performance differences. Have the financial resources to reward performance. Set clearly defined, accepted, and challenging yet achievable performance standards. Use an easily understood payout formula Keep administrative costs reasonable. Do not “ratchet up” performance standards.

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.

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 =

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.

Individual Incentive Plans (cont.) 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.

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.

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.

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.

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.

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

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.

Incentive Plans for Salespersons (cont.) 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: 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.

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.

Customize Your Noncash Incentive Awards

Establishing Team Incentive Payments 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.

Advantages Team Incentive Plans 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.

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.

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.

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.

Scanlon Plan Suggestion Process

Types of Long-Term Incentive Plans

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

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.

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.

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

Incentives for Professional Employees When it comes to individual, team, and enterprise incentives, professional employees— engineers, scientists, and attorneys, for example—are no different than anyone else. Move into management positions Administrative assignment Extend the salary range “Up or out” Compensation beyond base pay

Incentives for Professional Employees (cont.) Rules for maintaining motivation among professionals Provide clear goals Give prompt feedback Reward performance quickly Involve in decision making Seek their opinions often Provide autonomy in work Hold accountable for results Tolerate impatience Provide varied work opportunities Keep them aware of upcoming challenging goals

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

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.

The “Sweetness” of Executive Perks

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.

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

combined salary and commission plan differential piece rate Key Terms bonus combined salary and commission plan differential piece rate employee stock ownership plans (ESOPs) gainsharing plans Improshare merit guidelines Perquisites profit sharing salary plus bonus plan Scanlon Plan spot bonus standard hour plan straight commission plan straight piecework straight salary plan team incentive plan variable pay

Chapter 10 - Learning Outcomes Learning Outcome Statements Related Outcomes from Body of the Text 1 Know how to implement incentive programs. As a direct competitor of Lincoln Electric, Illinois Tool Works Inc. has decided to develop more performance based incentives. As an HR manager for Illinois Tool Works, how would you successfully implement an incentive program similar to Lincoln Electric’s? 2 Identify the different types of incentive programs and why they work. If Google paid its programmers based on how many programs they wrote per day, what do you think would happen? If Lincoln Electric paid people only a standard hourly rate, would their productivity stay the same? If enlisted soldiers received an additional bonus if they reenlisted in the military, how much more likely would they be to reenlist? 3 Explain why merit raises may fail to motivate employees and discuss ways to increase their motivational value. If you perform well, you most likely want to be rewarded for this. But what is the best model for rewarding employees who do well? Is it better to offer merit bonuses, merit pay raises, or just recognize them for their work? Whatever reward you choose, how do you make sure it motivates your employees? 4 Indicate specific ways to compensate salespeople. Siemens is one of the largest electronics and engineering companies in the world. While they produce many consumer products such as cell phones and household electronics, many of their products are sold to other companies. As a result, Siemens is very dependent upon their salespeople. What are the different payment methods you would use to increase sales at Siemens? 5 Differentiate how gains may be shared with employees under the Scanlon and Improshare gainsharing systems. With the new economic realities and globalization, are gainsharing plans such as Scanlon and Improshare an expensive thing of the past? Do the benefits of these team incentives outweigh the costs? 6 Differentiate between profit sharing plans and explain advantages and disadvantages of these programs. Competitors like Facebook and Twitter have been hiring your best employees away from you. As a result, you have decided to share some of the profits with your employees. Discuss the advantages of profit sharing and identify specific characteristics that will ensure success for your plan. 7 Describe the main types of ESOP plans and discuss the advantages of ESOPs to employers and employees. Consider your favorite grocery store. Is it owned by its employees? Why would your local grocery store implement such a plan? What potential problems might be involved?