Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter Pay for Performance 11

11-2 Does PFP Work?  Certain types of PFP systems are correlated with performance.  Characteristics of the individual as well as the PFP system can affect outcomes.  extroverts and high performers are more accepting of PFP systems  Dramatic changes in performance when pay contingent on it, whereas little change in performance when everyone receives a pay increase not tied to performance.  Systems in general should be:  tailored to work situation  perceived as attainable  equitable with expected outcomes

11-3 Pay Importance

11-4 Effective PFP Systems  Determinants of effective PFP Systems:  worker value outcomes (money, prizes)  outcome is valued relative to other rewards  desired performance is measurable  worker must be able to control rate of output or quality  worker must be capable of increasing output or quality  worker must believe that capability to increase exists  worker must believe that increased output will result in receiving a reward  size of reward must be sufficient to stimulate increased effort  performance measures must be compatible with strategic goals for short and long term

11-5 Expectancy/Instrumentality Theory Expectancy (probability that efforts will lead to desired performance) Expectancy (probability that efforts will lead to desired performance) Valence (value of outcome to individual) Valence (value of outcome to individual) Instrumentality (probability that performance will produce desired outcomes) Instrumentality (probability that performance will produce desired outcomes) Effort Performance Outcomes (pay, recognition, other rewards) Outcomes (pay, recognition, other rewards)

11-6 Main Problems with PFP Programs  Expensive to develop and maintain.  High initial costs of changeovers required.  Employees perceive that rewards are not closely linked to performance.  Employees perceive that performance is not accurately measured.  The performance rewarded is not related to the firm's objectives.  Employees may not have control over performance due to task constraints.  Amount of money available is not worth the extra effort in employees' minds.

11-7 Failures of PFP Systems  Reasons for the failures of PFP Systems:  poor perceived connection between performance and pay  the level of performance-based pay is too low relative to base pay; the cost of more highly motivating programs may be prohibitive  lack of objective, countable results for most jobs, requiring the use of performance ratings  faulty performance appraisal systems, with poor cooperation from managers, leniency bias in the appraisals, and resistance to change  union resistance to PFP systems  poor connection between PFP outcomes and corporate performance measures

11-8 Selecting a PFP System  In designing a PFP system, three major questions should be asked:  Who should be included in the PFP system?  Answer: In general, all groups should be included in a PFP system, but each system should be tailored to particular work situations.  How will performance be measured?  Answer: A performance appraisal system will provide a system of measure at the individual, group, or company level.  Which incentives will be used?  Answer: Cash payments, percentage increases in base pay, numerous non-cash prices, and stock options provide incentives for short- and long-run objectives.

11-9 Selecting a PFP System  What are the rewards in a PFP system?  cash payments, percentage increases in base pay, and noncash prizes are still the most common and used for short-term objectives  stock awards and stock options best for long-term objectives  Discrepancy between research and practice.  PFP increases should be bonus-based and not tied to base pay  Should you use individual, group, or company level PFP? Depends on:  extent outcome controlled at group or individual level  whether individual contributions can be measured  extent teamwork affects PFP system  preference for individual level systems  When should team-based PFP be used?  better approach particularly when it is part of a comprehensive team-based model of HRM and compensation

11-10 Individual PFP Plans  Individual PFP plans.  merit pay plans—calls for a distribution of pay based on an appraisal of a worker's performance; the most common and perhaps the most troublesome of PFP systems because performance is typically measured by ratings done by supervisors  incentive plans—based on units produced and provides the closest connection between individual effort or performance and individual pay; rely on some countable result or results to be used as a basis for setting to PFP rate  straight piece-rate  differential rate  standard hourly rate  commission plans  draw-plus commission system

11-11 Group Incentive Plans  Group Incentive plans.  profit sharing—distributes a portion of corporate profits among designated employees  increases in productivity from 7-9%  workers’ beliefs about ability to contribute to profitability is critical  gain-sharing—sharing in financial benefits of cost reductions or productivity increases among groups covered by the plan  Scanlon plan  Rucker plan  IMPROSHARE plan  Winsharing plan  employee stock options plans (ESOPs)—distribute stocks and stock options to employees based on corporate performance measures such as return on equity

11-12 Approaches to Gain-Sharing  Four approaches to gain-sharing.  Scanlon Plan—the most common gain-sharing plan, measures the relationship between the sales value of production and the labor costs  Rucker Plan—similar to the Scanlon plan but includes the value of all supplies, materials, and services resulting in a bonus formula based on the value added to the product per labor dollar; thus, an incentive is created to save on all inputs, including materials and supplies  IMPROSHARE (Improved Productivity Through Sharing)—similar to Scanlon plan except that the IMPROSHARE ratio uses standard hours rather than labor costs; savings in hours result in reward allocation to workers  Winsharing—combines gain-sharing with profit sharing

11-13 Designing a Gain-Sharing Program  Factors to consider in designing a gain-sharing program:  performance and financial measures  plant or facility size  types of production  workforce interdependence  workforce composition  potential to absorb additional output  potential for employee efforts  present organizational climate  union-management relations  capital investment plans  organized employee suggestion system

11-14 Gain-Sharing Versus Profit Sharing  Differences between gain-sharing and profit sharing.  in profit-sharing, employees want to be rewarded when profits go up, but not share in the responsibility when profits go down  gain-sharing is based on a measure of productivity, not profit  gain-sharing rewards are given out frequently, whereas profit sharing is annual and often tied to a retirement plan as deferred payment  Review of Scanlon, Rucker, and IMPROSHARE:  IMPROSHARE is easier for workers to understand  IMPROSHARE gives workers more control over physical productivity  IMPROSHARE does not require management to reveal sensitive corporate financial information  Scanlon and Rucker plans actually allow workers to share in the financial risks of the company  Scanlon allows for more integration with problem-solving

11-15 Managerial and Executive Pay  Executive incentives are linked to net income, return on investment, or total dividends paid.  dramatic increases in 2004  some companies moving away from stock options to restricted stock grants  tying executive compensation to earnings has coincided with dramatic increase in earnings restatements.  Lower-level managers typically have incentives based on short- term measures.  Executives have incentives based on both short- and long-term performance incentives.

11-16 Results and Challenges  Results of a well-designed PFP system:  lower costs  higher profits  higher degree of individual or group motivation  Challenges:  emphasizing one measure can lead to reduced performance in other measures  increased overhead expense of installing and maintaining the PFP system  difficulty in setting standards that accurately reflect task requirements and are perceived as fair  resistance to any change involving employee compensation, particularly when base pay is affected