1. Chapter 4: Incentive Pay Copyright © 2017 Pearson Education, Inc.4-1

2. Learning Objectives 4-1. Explore the incentive pay approach. 4-2. Describe the differences between incentive pay methods and traditional pay methods. 4-3. Summarize five types of individual incentive pay plans. 4-4. Explain two types of group incentive plans. 4-5. Discuss two types of company-wide incentive plans. 4-6. Summarize considerations when designing incentive pay programs. Copyright © 2017 Pearson Education, Inc.4-2

3. Incentive Pay  Compensation fluctuates according to:  A preestablished formula  Individual or group goals  Company earnings  Adds to base pay on a nonrecurring basis  Controls costs  Motivates employees through explicit goal setting Copyright © 2017 Pearson Education, Inc.4-3 LO 4-1

4. Incentive Pay Assumptions Effective incentive pay systems are based on three assumptions:  Individual employees and work teams differ in how much they contribute to the company, both in what they do as well as in how well they do it  The company’s overall performance depends to a large degree on the performance of individuals and groups within the company  To attract, retain, and motivate high performers and to be fair to all employees, a company needs to reward employees on the basis of their relative performance Copyright © 2017 Pearson Education, Inc.4-4 LO 4-1

5. Contrasting Incentive Pay with Traditional Pay  Traditional pay generally includes an annual salary or hourly wage  Increased periodically on a seniority or merit basis with permanent increase to base pay  Incentive pay generally  Increases base pay on goal attainment with pay increase nonrecurring  Companies use incentive pay to reward individual employees, teams of employees, or whole companies based on their performance Copyright © 2017 Pearson Education, Inc.4-5 LO 4-2

6. Cost Comparison: Merit Pay vs. Incentive Pay Copyright © 2017 Pearson Education, Inc.4-6 LO 4-2

7. Incentive Pay Categories  Individual: these plans reward employees whose work is performed independently  Group: these plans promote supportive, collaborative behavior among employees  Company-wide: these plans tie employee compensation to a company’s performance over a short time frame Copyright © 2017 Pearson Education, Inc.4-7 LO 4-2

8. Incentive Pay Measures Copyright © 2017 Pearson Education, Inc.4-8 LO 4-3

9. Types of Individual Incentive Plans  Piecework plans: reward workers for every item produced over a designated production standard  Management incentive plans: award bonuses to managers when they meet or exceed objectives based on sales, profit, production, or other measures for their division Copyright © 2017 Pearson Education, Inc.4-9 LO 4-3

10. Types of Individual Incentive Plans  Behavior encouragement plans: employees receive payments for specific behavioral accomplishments  Referral plans: employees receive bonuses for recruitment of highly qualified employees  Spot bonuses: employees receive small monetary gifts for outstanding work or effort during a reasonably short time period Copyright © 2017 Pearson Education, Inc.4-10 LO 4-3

11. Piecework Plans  Awards based on individual production vs. objective standards  Awards based on individual performance standards using objective and subjective criteria  Quantity and/or quality goals Copyright © 2017 Pearson Education, Inc.4-11 LO 4-3

12. Calculation of a Piecework Award for a Garment Worker Copyright © 2017 Pearson Education, Inc.4-12 Guaranteed Hourly Base Pay ($) Piecework Award (No. of Garments Stitched Above the Piecework Standard x Piecework Incentive Award) Total Hourly Earnings ($) First Hour4.5010 garments x $0.75/garment = $7.5012.00 Second Hour4.50Fewer than 15 stitched garments, thus piecework award equals 0 4.50 Piecework standard: 15 stitched garments per hour Hourly base rate awarded to employees when the standard is not met: $4.50 per hour That is, workers receive $4.50 per hour worked regardless of whether they meet the piecework standard of 15 stitched garments per hour. Piecework incentive award: $0.75 per garment stitched per hour above the piecework standard LO 4-3

13. Individual Incentive Plan Advantages  Helps relate pay to performance  Promotes equitable distribution of compensation  Helps retain best performers  Compatible with America’s individualistic culture Copyright © 2017 Pearson Education, Inc.4-13 LO 4-3

14. Individual Incentive Plan Disadvantages  May promote inflexibility  Unrealistic standards may hamper employee motivation  Setting performance standards is time consuming  Factors beyond employee’s control may affect outcomes  May promote undesirable behaviors Copyright © 2017 Pearson Education, Inc.4-14 LO 4-3

15. Group Incentive Plans  Reward employees for their collective performance  Use has increased in industry  Two types:  Team based or small group  Gain sharing Copyright © 2017 Pearson Education, Inc.4-15 LO 4-4

16. Types of Teams  Work (process) teams: refer to organizational units that perform the work of the organization on an ongoing basis  Ex: Customer service teams, assembly teams on production lines.  Project teams: consist of a group of people assigned to complete a one-time project  Ex: Engineers working on the construction of a bridge.  Parallel teams (task forces): include employees assigned to work on a specific task in addition to normal work duties Copyright © 2017 Pearson Education, Inc.4-16 LO 4-4

17. Rewards Allocation Methods  Equal incentive payments  Differential payments based on contribution to goals  Differential payments according to base pay Copyright © 2017 Pearson Education, Inc.4-17 LO 4-4

18. Gain Sharing  Incentives based on company performance in  Increased productivity  Increased customer satisfaction  Lower costs  Better safety records  Based on open leadership  Involves employee participation  Includes bonuses Copyright © 2017 Pearson Education, Inc.4-18 LO 4-4

19. Advantages of Group Incentives  Companies can more easily develop performance measures for group plans than individual plans  Greater group cohesion Copyright © 2017 Pearson Education, Inc.4-19 LO 4-4

20. Disadvantages of Group Incentives  May lead to higher employee turnover because of the free-rider effect  Members may feel uncomfortable with the fact that other members’ performance influences their compensation level Copyright © 2017 Pearson Education, Inc.4-20 LO 4-4

21. Company-Wide Incentive Plans  Rewards employees when company meets performance standards  Two types  Profit sharing plans  Employee stock options Copyright © 2017 Pearson Education, Inc.4-21 LO 4-5

22. Profit-Sharing Plans  Current profit-sharing plans  Award cash to employees typically on a quarterly or annual basis  Deferred profit-sharing plans  Place cash awards in trust accounts for employees Copyright © 2017 Pearson Education, Inc.4-22 LO 4-5

23. Profit-Sharing Formulas  Fixed first-dollar-of profits  7% of corporate profits  Graduated first-dollar-of profits  3% of the first $8 million of profits and 6% of the profits in excess of that level  Profitability threshold formula Copyright © 2017 Pearson Education, Inc.4-23 LO 4-5

24. Distribution Methods  Equal payments  Proportional payments based on annual salary  Proportional payments based on contribution to profits Copyright © 2017 Pearson Education, Inc.4-24 LO 4-5

25. Advantages and Disadvantages of Profit-Sharing Plans Advantages  Enable employees to share in companies’ profits  Allow companies greater financial flexibility Disadvantages  Can undermine the economic security of employees  May fail to motivate employees if they do not see a direct link between their efforts and profits Copyright © 2017 Pearson Education, Inc.4-25 LO 4-5

26. Employee Stock Option Plans Companies grant employees right to purchase share of company  Company stock  Company stock shares  Stock options Copyright © 2017 Pearson Education, Inc.4-26 LO 4-5

27. Incentive Pay Considerations  Based on individual or group performance  Acceptable level of risk  Replace traditional pay  Performance criteria evaluated  Appropriate time horizon Copyright © 2017 Pearson Education, Inc.4-27 LO 4-6