Copyright © 2008 by Nelson, a division of Thomson Canada Limited. 11–1 Part 4: Compensating Human Resources Chapter 11: Variable Pay and Executive Compensation Prepared by Linda Eligh, University of Western Ontario

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–2 Learning Objectives After you have read this chapter, you should be able to: 1.Define variable pay and identify three elements of successful pay-for-performance plans. 2.Discuss three types of individual incentives. 3.Explain three ways that sales employees are typically compensated. 4.Identify key concerns that must be addressed when designing group/team variable pay plans. 5.Discuss why profit sharing and employee stock ownership are common organizational incentive plans. 6.Identify the components of executive compensation and discuss criticisms of executive compensation levels.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–3 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.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–4 Developing Successful Pay-for-Performance Plans Reasons for Adopting Pay or Incentive Plans:  Link more directly strategic business goals and employee performance.  Enhance organizational results and reward employees financially for their contributions.  Reward employees to recognize different levels of employee performance.  Achieve HR objectives, such as increasing retention, reducing turnover, recognizing training, or rewarding safety and attendance.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–5 Effective Incentive Plans Fig. 11-1

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–6 Metrics for Variable Pay Plans Fig. 11-2

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–7 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.  Keeping plans current and linked to organizational objectives.  Strong links among performance results and payouts that truly recognize performance differences.  Clear identification of variable pay incentives separately from base pay.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–8 Types of Variable Pay Plans Fig. 11-3

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–9 Individual Incentives Individualism Stressed in Organizational Culture Identification of Individual Performance Independent Work Individual Competitiveness Desired Individual Incentive Systems

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–10 Individual Incentives: 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.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–11 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.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–12 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.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–13 Purposes of Special Incentives Fig. 11-4

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–14 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.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–15 Determining Sales Effectiveness Fig. 11-5

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–16 Why Organizations Establish Variable Pay Plans or Groups/Teams Fig. 11-6

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–17 Group/Team Incentives Distribution of Group/Team Incentives Timing of Group/Team Incentives Decision Making About Group/Team Amounts Design of Group/Team Incentive Plans

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–18 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.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–19 Conditions for Successful Group/Team Incentives Fig. 11-7

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–20 Types of Group/Team Incentives Group/Team Results  “Self-funding” pay plans for groups/teams that reward through improved organizational results on the basis of group output, cost savings, or quality improvement. Gainsharing (Teamsharing or Goal Sharing)  The sharing with employees of greater-than-expected gains in productivity through increased discretionary efforts.  Improshare, Scanlon Plan, Rucker Earnings-at Risk (EAR)  Incentive plans designed to enhance performance by creating enough dissatisfaction with base wages that employees become more interested in directing behaviours to what is rewarded with incentive pay.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–21 GainsharingGainsharing Improshare  “Improved productivity through sharing plan”  Time studies determine how many hours it should take to produce one unit of product  When actual productivity is greater than the baseline, a percentage of savings is shared with employees  Easiest of the gainsharing plans to understand and install  Focus is on quantity, not quality

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–22 Scanlon Plan Gains Example Fig. 11-8

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–23 Rucker Plan Gains Example Fig. 11-9

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–24 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

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–25 Framework Choices for a Profit-Sharing Plan Fig

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–26 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.

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–27 Employee Stock Plans Employee Stock Ownership Plan (ESOP)  A plan whereby employees gain significant stock ownership in the organization for which they work.  Advantages  Favourable 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

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–28 Components of Executive Compensation Packages Fig

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–29 Performance Incentives: Long-Term vs. Short Term Sarbanes-Oxley Act (SOX)  U.S. Act containing numerous provisions that affect accounting and financial reporting requirements of different types of executive compensation.  Mandates that CEOs and CFOs of companies listed on the U.S. stock exchanges must certify and sign off on interim and annual statements as well as their corporate governance framework.  Penalties can be swift and severe  Delisting of stock, heavy fines, prosecution of top executives Bill C-198  Canada’s SOX equivalent

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–30 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?

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–31 Common Executive Compensation Issues Fig

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–32 Executive Compensation Boards of Directors  Major policy setting entity that must approve executive compensation packages Compensation Committees  Usually a subgroup of the Board of Directors  Composed of Directors who are not officers of the firm  Make recommendations to the Board on  overall pay policies  salaries for top officers  supplemental compensation (stock options, bonuses)  additional “perks” for executives

Copyright © 2008 by Nelson, a division of Thomson Canada Limited.11–33 Compensation Committees Criticisms  Base pay and bonuses of CEOs is often set by members of Board Compensation Committees who are themselves CEOs and who receive similar compensation packages in other companies.  Compensation consultants and advisers to CEOs often collect large fees which can distort objectivity of advice provided. Corrective Actions  Change composition of Board compensation committees to prohibit “insider” company officers from serving on them.  Empower compensation committees to hire and pay compensation consultants without involving executive management.