Variable Pay & Executive Compensation MN 301 – Human Resource Management Craig W. Fontaine, Ph.D. Pine Manor College Fall 2014

Variable: Incentives for Performance Variable pay - Compensation tied to performance Individual Group/ team Organizational Beneficial for both employees and employer Employers - More output per employee Employee - More pay

Why Use Variable Pay? Variable Pay Assumptions Some people perform better and are more productive than others Better performing employees should receive more compensation Some jobs contribute more to organizational success than others Total compensation should be tied directly to performance and results

A Variety of Possible Incentives

Pay-for-Performance Plans Reasons for Pay-for-Performance Plans Enhance results and reward employees financially Link strategic goals and employee performance Reward and recognize employee performance Promote achievement of HR objectives

Factors for Successful Variable Pay Plans

Categories of Variable Pay

Individual Incentives

Piece-rate systems Straight piece-rate system Wages are determined by multiplying the number of units produced by the piece rate for one unit Differential piece-rate system Pays employees one piece-rate wage for units produced up to a standard output and a higher piece-rate wage for units produced over the standard

Individual Incentives Bonus One-time payment that does not become part of the employee’s base pay Massive kinked bonuses Very large all or nothing bonus (example: golfer) Spot bonuses Can be awarded at any time

Individual Incentives Nonmonetary incentives Performance awards Incentive rewards for performance Recognition awards Recognizes individual employees for their work Service awards Recognize service

Individual Incentives Commissions Percentage of the money taken in on sales Often given on top of salary

Design of Group/Team Incentive Plans

Group/Team Incentives Distributing rewards issue: Same-size reward for each member Different-size reward for each member

Group/Team Incentives Challenges with group/team incentives Rewards distributed in equal amounts to all members may be perceived as unfair Free riders - Member of the group who contributes little Team size - Individual efforts of employees have little effect on the total performance of the group in large groups

Conditions for Successful Group/Team Incentives

Types of Group/Team Incentives Group/team results Group production Cost savings Quality improvement Gainsharing: Sharing with employees of greater-than- expected gains in productivity through increased discretionary efforts

Organizational Incentives 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 Profit Sharing

Framework Choices for a Profit-Sharing Plan

Employee Stock Plans Stock option plan Employees can buy fixed number of shares of company stock At a specified price for a limited period of time Employee stock ownership plan (ESOP) Gives employees significant stock ownership in the organization they work

Advantages and Disadvantages of ESOP Advantages Favorable tax treatment for ESOP earnings Employees motivated by their ownership stake in the firm Disadvantages Retirement benefit tied to the firm’s future performance

Metric Options for Variable Pay Plans

Types of Sales Compensation Plans Salary-only All compensation is paid as a base wage with no incentives Straight commission Compensation is computed as a percentage of sales in units or dollars Draw system makes advance payments against future commissions to the salesperson Salary-plus-commission or bonuses Compensation is part salary for income stability and part commission for incentive

Sales Metric Possibilities

Executive Compensation Handled differently than other employees’ pay, why:

Legal Aspects of Executive Compensation Say on Pay Publically listed companies must allow share holders to vote on executive compensation Clawbacks Allows a company to recover any incentive based pay that was paid out during the prior 3 years if it would not have been paid under restated financial statements

Executive Compensation Packages

Executive Compensation Considerations and Concerns Would another company hire this person as an executive? How does the executive’s compensation compare with that for executives in similar companies? What would an investor pay for the level of performance of the executive? Is the executive’s pay consistent with pay for other employees within the company? Reasonableness of Executive Compensation

Common Executive Compensation Criticisms

Executive Compensation and Boards of Directors In most organizations the board of directors is the major policy-setting entity Must approve executive compensation packages Compensation committee : Subgroup of the board of directors that is composed of directors who are not officers of the firm