12-1 Incentives for Managers and Executives 12-1

2 Incentives for Managers and Executives Short-term Incentives annual bonus Short-term Incentives annual bonus Long-term Incentives capital accumulation plans Long-term Incentives capital accumulation plans

3 Incentives for Managers and Executives Eligibility Fund size Determining individual awards Eligibility Fund size Determining individual awards Annual Bonus - Decisions

4 Incentives for Managers and Executives Stock options Book value plan Stock appreciation rights Performance achievement plan Restricted stock plans Phantom stock plans Performance plans Stock options Book value plan Stock appreciation rights Performance achievement plan Restricted stock plans Phantom stock plans Performance plans Long-Term Incentives

5 Incentives for Salespeople Salary Plan (fixed salary) Salary Plan (fixed salary) Commission Plan (pay in direct proportion to sales) Commission Plan (pay in direct proportion to sales) Combination Plan (salary plus commission) Combination Plan (salary plus commission)

6 Incentives for Other Professionals -salary increase awarded to an employee -based on individual performance -effectiveness based on validity of performance appraisal system -sometimes paid as a lump sum without changing base salary -salary increase awarded to an employee -based on individual performance -effectiveness based on validity of performance appraisal system -sometimes paid as a lump sum without changing base salary Merit Pay

7 Incentives for Other Professionals Incentives for Professional Employees -bonus represents small portion of total pay -incentives based on results longer than one year -up-to-date equipment and facilities -supportive management style -support for research publications -bonus represents small portion of total pay -incentives based on results longer than one year -up-to-date equipment and facilities -supportive management style -support for research publications

8 Organization-Wide Incentive Plans -profit sharing plans -employee share purchase/stock ownership plans -Scanlon plans -gainsharing plans -at-risk variable pay plans -profit sharing plans -employee share purchase/stock ownership plans -Scanlon plans -gainsharing plans -at-risk variable pay plans

9 Organization-Wide Incentive Plans -engages many or all employees in a common effort to achieve a company’s productivity objectives -any resulting incremental cost-savings shared among employees and the company -engages many or all employees in a common effort to achieve a company’s productivity objectives -any resulting incremental cost-savings shared among employees and the company Scanlon Plan

10 Organization-Wide Incentive Plans Clear guidelines regarding plan changes Joint development of the plan Cooperation between management and labour Effective communication Setting achievable goals Gainsharing Plans – Success Factors

11 Short-Term Incentives for Managers And Executives Annual bonus Plans that are designed to motivate short- term performance of managers and are tied to company profitability. Eligibility basis: job level, base salary, and impact on profitability Fund size basis : nondeductible formula (net income) or deductible formula (profitability) Individual awards: personal performance/contribution

12 Developing Effective Incentive Plans -units of output can be measured -clear relationship between employee effort and quantity of output -standardized job, regular workflow with few/consistent delays -quality less important than quantity -units of output can be measured -clear relationship between employee effort and quantity of output -standardized job, regular workflow with few/consistent delays -quality less important than quantity When to Use Incentives

13 Developing Effective Incentive Plans -pay for performance -link incentives to career development and challenging opportunities -link incentives to measurable competencies -pay for performance -link incentives to career development and challenging opportunities -link incentives to measurable competencies Principles for Effective Implementation (1 of 2)

14 Developing Effective Incentive Plans -match incentives to the culture of the organization -keep group incentives clear and simple -overcommunicate -remember greatest incentive is the work itself -match incentives to the culture of the organization -keep group incentives clear and simple -overcommunicate -remember greatest incentive is the work itself Principles for Effective Implementation (2 of 2)

15 Developing Effective Incentive Plans 1.Performance pay cannot replace good managers 2.Firms get what they pay for 3.Pay is not a motivator 4.Rewards can rupture relationships 5.Rewards may undermine responsiveness 1.Performance pay cannot replace good managers 2.Firms get what they pay for 3.Pay is not a motivator 4.Rewards can rupture relationships 5.Rewards may undermine responsiveness Why Incentive Plans Don’t Work

16 Developing Effective Incentive Plans Employee Recognition Programs Lack of recognition and praise is the #1 cause of employee turnover Lack of recognition and praise is the #1 cause of employee turnover

17 Developing Effective Incentive Plans Objectives -show support for employees -enhance employees’ attitudes to the company -increase productivity Objectives -show support for employees -enhance employees’ attitudes to the company -increase productivity Employee Recognition Programs

18 Developing Effective Incentive Plans Cost-effective -> praise and modest gifts Important communication tool Employee Recognition Programs

19 Why Incentive Plans Fail 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 have unintended consequences. Rewards may undermine responsiveness. Rewards undermine intrinsic motivation.

20 Implementing Effective Incentive Plans Ask: Is effort clearly instrumental in obtaining the reward? 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. Adopt a comprehensive, commitment-oriented approach.

21 Agency Theory Agency theory is a theory of governance in the workplace. It tries to solve the problem of separation of ownership (atomistic shareholders) and control (professional executives and non- owners) It also tries to solve conflicts of interest between managers and employees with delegated responsibilities.

22 Agency Theory 1. Principals = owners or managers who delegate responsibilities 2. Agents = managers or employees who manage firm assets for owners or other principals. 3. Information asymmetry = managers or other agents have greater access to strategic information than principals, who are not willing to bear the cost of directly monitoring the agents due to steep agency costs.

23 Agency Theory 4. Risk Preferences – principals are risk neutral and willing to bear greater risks than agents because their asset wealth is more likely to be diversified between corporate assets and other equities/investments. Agents are more risk averse than principals, because most of their wealth is concentrated in the firm and received in the form of pay and opportunities for promotion.

24 Agency Theory 5. Moral Hazard – agent is tempted (and some cases succeeds) in taking advantage of information asymmetry with principal and act opportunistically (defined as making decisions not aligned with principal’s interests) and use the firm resources to maximize wealth of the agent (often at the expense of the principal).

25 Agency Theory 6. Agency Contract – provides solution to moral hazard/agency problem, by establishing “rules of the game” to control agent opportunism – agent’s performance will be judged by outcomes (often financial benchmarks) not behaviors (which require direct supervision of agent’s actions). These outcomes will reflect principal’s goals and risk preferences.

26 Agency Theory 7. Incentive alignment – the agency contract will specify a compensation plan that aligns the interests of the principal and agent. This agency contract will be a type of pay for performance plan. Meeting or exceeding pre-agreed upon financial or non-financial outcomes triggers various forms of compensation (individual or group-based) for the agent. Some agency costs are borne by the principal in the form of financial incentives for the agent.