1. Pay-for-Performance Plans
Chapter 10
Pay-for-Performance Plans
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2. Learning Objectives What is a pay-for-performance plan?
Does variable pay improve performance results? The general evidence
Specific pay-for-performance plans: Short term
Team incentive plans: Types
Explosive interest in long-term incentive plans
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3. What is Pay-for-Performance?
Pay-for-performance: Signals a movement:
Away from entitlement
Towards a pay that varies with individual or organizational performance
Increasing interest in variable pay
Competition from foreign competitors
Fast-paced business environment
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4. Specific Pay-for-Performance Plans: Short Term
Merit pay
Lump-sum bonuses
Individual spot awards
Individual incentive plans
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5. Merit Pay Links increases in base pay to: Issues
How highly employees are rated on a subjective performance evaluation
Issues
Expensive
Doesn’t achieve the desired goal of:
Improving employee and corporate performance
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6. Managing Merit Pay Improve accuracy of performance ratings
Allocate enough money to truly reward performance
Increase in merit pay should differentiate across performance levels
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7. Lump-Sum Bonuses Substitute for merit pay Not built into base pay
Viewed as less of an entitlement than merit pay
Less expensive than merit pay over the long run
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8. Exhibit 10.3 - Relative Cost Comparisons
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9. Individual Spot Awards
Viewed as highly or moderately effective
Awarded for exceptional performance
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10. Individual Incentive Plans
A promise of pay for some objective, pre-established level of performance
Use established standards to:
Compare employee performance
Determine magnitude of incentive pay
Dimensions on which plans vary
Method of rate determination
Relationship between production and wages
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11. Exhibit 10.5 - Individual Incentive Plans
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12. Exhibit 10.6 - The Taylor and Merrick Plans
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13. Individual Incentive Plans
Taylor plan - Two piecework rates
Higher than the regular incentive, when production exceeds published standard
Lower than regular wage for production below standard
Merrick system - Three piecework rates are set
High for production exceeding 100 percent of standard
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14. Individual Incentive Plans
Medium for production between 83 and 100 percent of standard
Low for production less than 83 percent of standard
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15. Individual Incentive Plans
Halsey 50–50 method
For tasks completes in less than the standard time:
Savings are allocated 50–50 between the worker and the company
Rowan plan
A worker’s bonus increases as the time required to complete the task decreases
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16. Individual Incentive Plans
Gantt plan
Standard time for a task is purposely set at a level requiring high effort to complete
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17. Exhibit 10.7 - Advantages and Disadvantages of Individualized Incentive Plans
Source: Michael Coates, Psychology and Organizations, Heineman Themes in Psychology (Heineman: Boston, 2001); T. Wilson, “Is It Time to Eliminate the Piece Rate Incentive System?” Compensation and Benefits Review 24(2) (1992), pp. 43–49; Pinhas Schwinger, Wage Incentive Systems (New York: Halsted, 1975).
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18. Team Incentives Plans Group incentive plan Gain-sharing plan
Team performance is measured against a set standard to:
Determine the magnitude of incentive pay
Gain-sharing plan
Pays off for teams defined at the level of a strategic business unit
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19. Team Incentives Plans Causes for failure Varieties in teams
Level problem
Complexity
Control
Communications
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20. Exhibit 10.9 - A Sampling of Performance Measures
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21. Types of Variable-Pay Plans: Advantages and Disadvantages
Plan type
Advantages
Disadvantages
Cash profit sharing
Simple, easily understood
Low administrative costs
Profit influenced by
many factors beyond
employee control
• May be viewed as an
entitlement
• Limited motivational
impact
Stock ownership
or options
Minimal impact on the financial statements
Have powerful impact on employee behavior
Tax deferral to employees
Indirect pay/performance link
Employees may be required to put up money to exercise grants
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22. Types of Variable-Pay Plans: Advantages and Disadvantages
Plan type
Advantages
Disadvantages
Balance Scorecard
Communicates organizational priorities
If financial targets are not met, there may be a reduced payout
Can be complex
Productivity/ gain sharing
Performance–
reward links
• Productivity and quality
improvements
• Knowledge
of business increases
• Fosters teamwork,
cooperation
Administratively
complicated
• Drop-off in quality
• Management must
open the books
• Payouts occur even
if company’s financial
performance is poor
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23. Types of Variable-Pay Plans: Advantages and Disadvantages
Plan type
Advantages
Disadvantages
Team/group
incentives
Reinforces teamwork
and team identity/
• Stimulates
ideas and problem solving
• Minimizes distinctions
between team
members
• May better reflect how work is performed
May be difficult to
isolate impact of team
• Not all employees can
be placed on a team
• Can be administratively
complex
• May create team
competition
• Difficult to set equitable targets for all teams
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24. Exhibit 10.12 - The Choice Between Individual and Group Plans
World at Work and Vivient Consulting, “Private Company Incentive Pay Practice Survey.” Reprinted with permission
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25. Key Elements in Designing a Gain-Sharing Plan
Strength of reinforcement
Productivity standards
Sharing the gains
Scope of the formula
Perceived fairness of the formula
Ease of administration
Production variability
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26. Exhibit 10.13 - Three Gain-Sharing Formulas
Adapted from M. Bazerman and B. Graham-Moore, “PG. Formulas: Developing a Reward Structure to Achieve Organizational Goals,” in B. Graham- Moore and T. Ross, eds., Productivity Gainsharing (Englewood Cliffs, NJ: Prentice-Hall, 1983).
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27. Gain-Sharing Plans Scanlon plan Rucker plan
Designed to lower labor costs without lowering the level of a firm’s activity
Incentives are derived:
As a function of the ratio between labor costs and sales value of production (SVOP)
SVOP includes sales revenue and value of goods in inventory
Rucker plan
Expresses the value of production required for each dollar of total wage bill
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28. Gain-Sharing Plans
Implementation and success of Rucker or Scanlon plan requires:
A productivity norm
Effective measurement of base year data
Acceptance by workers and management of this standard for calculating bonus
Effective worker committees
Evaluate employee and management suggestions
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29. Similarities and Contrasts Between Scanlon and Rucker Plan
Differ from individual incentive plans in their primary focus
Differences
Rucker plans tie incentives to a wide variety of savings
Scanlon plans focus on labor savings
Due to greater flexibility Rucker plans can be linked with individual incentive plans
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30. Gain-Sharing Plans Improshare (improved productivity through sharing)
Develops standard to:
Identify expected hours required to produce an acceptable level of output
Savings are shared by firm and workers
Easy to administer and to communicate
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31. Profit-Sharing Plans Focuses on a predetermined index of profitability
Company should specify the funding formula
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32. Earnings-at-Risk Plans
Success sharing plan
Employee base pay is constant
Variable pay increases in successful years
No reduction in base pay and no variable pay in poorly-performing years
Risk sharing plan
Compared to success sharing plan base pay is reduced by some amount
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33. Exhibit 10.15 - Group Incentive Plans: Advantages and Disadvantages
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34. Group Incentive Plans Can be described by:
The size of the group that participates in the plan
The standard against which performance is compared
The payout schedule
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35. Explosive Interest in Long-term Incentive Plans
Long-term incentives (LTIs)
Focus on performance beyond the one-year time line
Growth in long term plans
Result of desire to motivate longer-term value creation
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36. Exhibit 10.17 - Long-Term Incentives and Their Risk/Reward Tradeoffs
Source: This was originally published in IOMA’s monthly publication ‘Pay for Performance Report’ and is republished here with the express written permission of Kennedy Information, LLC. Copyright © Further use of, electronic distribution or reproduction of this material, requires the permission of Kennedy Information, LLC.
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37. Exhibit 10.17 - Long-Term Incentives and Their Risk/Reward Tradeoffs
Source: This was originally published in IOMA’s monthly publication ‘Pay for Performance Report’ and is republished here with the express written permission of Kennedy Information, LLC. Copyright © Further use of, electronic distribution or reproduction of this material, requires the permission of Kennedy Information, LLC.
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38. Long-Term Incentive Plans
Employee stock ownership plans (ESOPs)
Generate long-term effects
Foster employee willingness to:
Participate in the decision-making process
Have little impact on productivity or profit
Performance plans (performance share and performance unit)
Driven by financial earnings or return measures
Pay for meeting or exceeding specific goals
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39. Long-Term Incentive Plans
Broad-based option plans (BBOPs)
Are stock grants
Are versatile
Combination plans
Use of both individual and group incentives
Self-funding plan
Payouts occur only after the company reaches a certain profit target
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