1. Rewarding Performance
Chapter 11
Rewarding Performance
In this chapter, we’ll discuss the design and implementation of pay-for-performance (incentive) systems. This chapter will address the major challenges facing managers in their attempts to link pay and performance, offer general recommendations, and describe different types of pay-for-performance programs.
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2. Chapter Challenges
Grasp the major challenges in pay-for-performance systems
Develop competence in dealing with potential problems with pay-for-performance systems
Have familiarity with various types of pay-for-performance plans and their advantages/disadvantages
In Chapter 11, you will specifically grasp the major challenges in pay-for-performance systems, develop competence in dealing with potential problems with pay-for-performance systems, and have familiarity with various types of pay-for-performance plans and their advantages/disadvantages.
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3. Chapter Challenges
Develop competence in designing pay-for-performance plans for executives and salespeople
Learn about how to reward excellence in customer service
Become aware of special concerns with pay-for-performance programs in small firms
You will also develop competence in designing pay-for-performance plans for executives and salespeople, learn about how to reward excellence in customer service, and become aware of special concerns with pay-for-performance programs in small firms.
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4. Pay for Performance Three Assumptions
Individual employees and work teams differ in how much they contribute
The firm’s overall performance depends on the performance of individuals and groups
To attract, retain, and motivate high performers, rewards are given relative to performance
Most workers believe that those who work harder and produce more should be rewarded accordingly. If employees see that pay is not distributed on the basis of merit, they are more likely to lack commitment to the organization, decrease their level of effort, and look for employment opportunities elsewhere. Pay-for-performance systems (incentive systems) reward employee performance on the basis of three assumptions:
Individual employees and work teams differ in how much they contribute.
The firm’s overall performance depends on the performance of individuals and groups.
To attract, retain, and motivate high performers, rewards are given relative to performance.
Before talking about specific types of pay-for-performance plans, we will discuss nine challenges facing organizations that want to adopt an incentive system.
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5. Incentives May Cause Unethical Behaviors
Rewarding hospitals for quality care
Gainsharing for doctors
Doctors paid to prescribe generic pills
Report cards for surgeons
What doctors aren’t disclosing
Use of orthopedic devices
Ethics have been questioned in the medical field, especially with physicians, as many physicians receive incentives from pharmaceutical firms, private insurance companies, and even the federal and state governments. Some estimate that more than half of all health maintenance organizations make such payments. Following are some controversial situations:
Rewarding hospitals for quality care: Hospitals are reimbursed for how they perform on quality measures. However, physicians feel that these measures are inaccurately capturing the whole picture of health of patients (genetics, diet, etc.) and these measures negatively impact the physician’s income.
Gainsharing for doctors: Insurance companies pay physicians (bonus) if their use of equipment and procedures is less than yearly allocated amounts set by the insurance companies. This incentive can sometimes mean that suboptimal care of patients results from less tests being administered.
Doctors paid to prescribe generic pills: Some insurance plans pay doctors $100 for prescribing generic drugs instead of name-brand ones.
Report cards for surgeons: Some states have required report cards for surgeons who perform coronary bypass surgery. The result is that some cardiologists have only accepted relatively healthy patients for heart-bypass surgery.
What doctors aren’t disclosing: Clinical trial reports are being funded by manufacturers of stents and other devices.
Use of orthopedic devices: Companies pay in the millions to physicians as consultants and trainers for using their devices.
Clearly, there are many examples in the medical field of incentives that lead to outcomes that are a conflict of interest for the physicians.
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6. Pay-for-Performance: Challenges
“Do only what you get paid for” syndrome
Unethical behavior
Negative effects on the spirit of cooperation
Lack of control
Difficulties in measuring performance
To avoid the charge that pay is distributed on the basis of subjective judgments or favoritism, pay-for-performance systems tend to rely on objective indicators of performance. What can result is that employees focus only on the objective indicators and ignore other aspects of their job pertaining to performance. The following are what can happen because of objective pay-for-performance systems:
“Do only what you get paid for” syndrome: One example of this is teachers’ pay being linked to student scores. The result is focus on passing tests and less on content and students understanding of the content.
Unethical behavior: The “keeping score” incentive may cause employees to cut corners to make the numbers, deceive, misinform, hide (accidents, for example), and other undesirable behaviors.
Negative effects on the spirit of cooperation: Pay-for-performance systems may encourage competition rather than cooperation if individual efforts are rewarded.
Lack of control: Factors beyond an employee’s control include the supervisor, the performance of other work group members, the quality of materials the employee is working with, working conditions, the amount of support from management, and environmental factors.
Difficulties in measuring performance: It may be hard to decipher the individual contribution from the group contribution in some performance situations.
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7. Pay-for-Performance: Challenges
Psychological contracts
The credibility gap
Job dissatisfaction and stress
Potential reduction of intrinsic drives
Other challenges include the following:
Psychological contracts: A set of expectations based on prior experience. Breaking psychological contracts can have damaging results (e.g., changing terms of pay-for-performance systems multiple times over a period of time).
The credibility gap: Many employees (estimated 75%) question the credibility of pay-for-performance plans and consider them unfair.
Job dissatisfaction and stress: Pay-for-performance plans may lead to higher productivity, but lessen job satisfaction. For example, if the work unit begins to unravel, employees lose satisfaction because their pay is tied to the unit’s performance.
Potential reduction of intrinsic drives: Pay-for-performance programs may push employees to the point of doing whatever it takes to get promised monetary rewards, which may stifle creativity.
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8. Meeting the Challenges of Pay for Performance
Use intrinsic and extrinsic rewards
Link pay and performance appropriately
Pay for performance
Build employee trust
Promote belief that performance makes a difference
Properly designed pay-for-performance systems present managers with an excellent opportunity to align employees’ interests with those of the organization. Here are just a few recommendations to avoid the pitfalls:
Use intrinsic and extrinsic rewards
Link pay and performance appropriately
Pay for performance
Build employee trust
Promote belief that performance makes a difference
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9. Meeting the Challenges of Pay for Performance
Use multiple layers of rewards
Increase employee involvement
Stress the importance of acting ethically
Use motivation and nonfinancial incentives
Some additional ways to avoid the pitfalls of pay-for-performance plans are as follows:
Use multiple layers of rewards
Increase employee involvement
Stress the importance of acting ethically
Use motivation and nonfinancial incentives
All approaches can help to overcome the challenges in a pay-for-performance program.
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10. Types of Pay-for-Performance Plans
This slide shows how pay-for-performance plans can be designed to reward the performance of the individual, team, business unit or plant, entire organization, or any combination of these. All of these plans have advantages and disadvantages, and each is more effective in some situations than in others. Most organizations are best served by using a variety of plans.
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11. Individual-Based Plans
Merit pay, bonuses, and awards
Advantages
Performance that is rewarded is likely to be repeated
Individuals are goal oriented; financial systems can shape a person’s goals
Rewarding individual equity
Fit with an individualistic culture
At the micro-level, firms attempt to identify and reward the contributions of individuals employees. Individual-based pay plans are the most widely used pay-for-performance plans in industry. Merit pay is an increase in base pay, normally given once a year. Bonus programs are financial incentives that are given on a one-time basis and do not raise the employee’s base pay permanently. Awards are a one-time reward usually given in the form of a tangible prize.
Advantages of individual-based plans include:
Performance that is rewarded is likely to be repeated
Individuals are goal oriented; financial systems can shape a person’s goals
Rewarding individual equity
Fit with an individualistic culture
Some cultures, such as the Japanese culture, do not reward individual efforts, but economic pressures have caused the Japanese culture to shift more into the U.S. type of model.
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12. Individual-Based Plans
Disadvantages
May promote single-mindedness
Many do not see link between performance and pay
Quality goals may suffer
May promote inflexibility
Many of the pitfalls of pay-for-performance programs are most evident at the individual level. The two key areas of danger are (1) promoting competition among workers and (2) souring working relationships between subordinates and employees. Other disadvantages include:
May promote single-mindedness: Employees may focus on only individual contributions and not cooperate with other employees or do the tasks that promote overall customer satisfaction, for example, because those organizational goals are hard to link with individuals.
Many do not see link between performance and pay: The underlying beliefs or perception of employees is that they see no link in their individual performance and pay, and some view it as unfair.
Quality goals may suffer: Teamwork and coordination efforts among employees may suffer if too much emphasis is placed on individual performance.
May promote inflexibility: These pay-for-performance (individual) plans may promote too much dependency of the employee on the supervisor.
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13. Individual-Based Plans
Most Likely to Succeed:
When the contributions of individual employees can be accurately isolated
When the job demands autonomy
When cooperation is less critical to successful performance
Individual pay-for-performance plans are most likely to succeed when the contributions of individual employees can be accurately isolated, when the job demands autonomy, and when cooperation is less critical to successful performance. When companies design these individual-based plans, the companies should be aware of the pitfalls and design plans in a way that encourages the success of the plans.
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14. Team-Based Plans Cash or noncash
Provide integral support for effective team arrangements
Members rewarded equally
Members decide on distribution
Growing numbers of firms are redesigning work to allow employees with unique skills and backgrounds to tackle projects together. As with individual-based pay-for-performance plans, team-based plans can be in cash bonuses or noncash payments. A team-based compensation system can provide integral support for effective team arrangements. Additionally, team-based pay plans normally reward all team members equally, based on group outcomes.
Some firms allow the team to decide how its bonus will be distributed within the group.
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15. Team-Based Plans Advantages Foster group cohesiveness
Aid in performance measurement
Disadvantages
Lack of fit with individualistic culture
Free-riders
Social pressures to limit performance
Identifying meaningful groups
Intergroup competition
When properly designed, team-based incentives have two major advantages: (1) they foster group cohesiveness and (2) they aid in performance measurement. Team measurements have been found to be easier than individual measurements.
Managers also need to be aware of the potential pitfalls with team-based plans. Some of these include: (1) Lack of fit with individualistic culture, (2)
free-riders effect, (3) social pressures to limit performance, (4) identifying meaningful groups—teams must be defined, and (5) intergroup competition may arise.
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16. Team-Based Plans Most likely to succeed when:
Work tasks are intertwined
Implemented with team-based incentives
Employees are intrinsically motivated
Group goals exists
Team-based incentives blend diverse backgrounds
Team-based plans are likely to work when work tasks are so intertwined that it is tough to separate individual contributions. Implementation of team-based incentives are successful because there are few levels of hierarchy and teams and individuals are at the same levels and have the same expectations and when technology allows for the separation of work. Additionally, when employees are intrinsically motivated, team-based structures work best. Group goals must exist for this type of plan to work, and team-based incentives blend diverse backgrounds and gain from getting different perspectives for problem solving.
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17. Plantwide Plans Gainsharing Advantages
Capitalize on intrinsically motivated employees
Cost savings earned by treating employees better
Can elicit active employee input and improve the production process
Plantwide pay-for-performance plans reward all workers in a plant or business unit based on the performance of the entire plant or unit. The key performance indicator used to distribute rewards at the plant level is plant or business unit efficiency, which is normally measured in terms of labor or material cost savings compared to an earlier period. Plantwide pay-for-performance plans are generally referred to as gainsharing programs.
Gainsharing: A plantwide pay-for-performance plan in which a portion of the company’s cost savings is returned to workers, usually in the form of a lump-sum bonus.
Some advantages of gainsharing plans are that they capitalize on employees who are intrinsically motivated and encourage active employee input by capitalizing on their talent and reduce the “competition” nature of other pay-for-performance plans. Additionally, there is some research that supports that there is actually a cost savings due to treating all employees well on the gainsharing plan.
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18. Plantwide Plans Disadvantages Protection of low performers
Problems with the criteria used to trigger rewards
Management–labor conflict
Conditions favoring plantwide plans
Firm size
Technology
Historical performance
Corporate culture
Stability of the product market
Plantwide pay plans also come with some disadvantages, including the obvious: protection of low performers. With gainsharing plans, it’s hard to decipher individual performance, and thus low performers are hidden and gain from others’ work. Additionally, problems with the criteria used to trigger rewards are not as problematic, as the formulas are relatively straightforward. However, the formulas may change several times over time. The other disadvantage is management–labor conflict. Some managers feel threatened and thus don’t want to give up that authority, and this fosters negative relationships between supervisors and employees.
Some conditions favoring plantwide plans include: (1) firm size—works well with small- to medium-sized companies; (2) technology—when technology improves efficiency, then gainsharing plans succeed; (3) historical performance—firms should take unit variances into account so that the whole organization doesn’t suffer; (4) corporate culture—the culture must be supportive of the cohesive type of pay plan; and (5) stability of the product market—the best plan when markets are stable.
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19. Employee Stock Ownership Plan (ESOP)
Corporatewide Plans
Profit Sharing
Employee Stock Ownership Plan (ESOP)
The most macro type of incentive program, corporate pay-for-performance plans reward employees based on the entire corporation’s performance. The most widely used program of this kind is profit sharing, which differs from gainsharing in several important ways.
Profit sharing is a corporatewide pay-for-performance plan that uses a formula to allocate a portion of declared profits to employees. Typically, profit distributions under a profit-sharing plan are used to fund employees’ retirement plans.
An employee stock ownership plan (ESOP) is a corporatewide pay-for-performance plan that rewards employees with company stock either as an outright grant or at a favorable price that may be below market value. ESOPs reward employees with company stock, either as an outright grant or at a favorable price that may be below market value. Employers use ESOPs as a low-cost retirement benefit for employees because stock contributions made by the company are nontaxable until the employee redeems the stock.
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20. Corporatewide Plans Advantages Financial flexibility for the firm
Increased employee commitment
Tax advantages
Disadvantages
Employees may be at considerable risk
High exposure to macroeconomic forces
Limited effect on productivity
Long-run financial difficulties
Corporatewide plans have distinct advantages, which include financial flexibility for the firm, increased employee commitment, and
tax advantages.
Some disadvantages include: employees may be at considerable risk, high exposure to macroeconomic forces, limited effect on productivity, and
long-run financial difficulties.
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21. Corporatewide Plans Conditions favoring corporatewide plans Firm size
Interdependence of different parts of the business
Market conditions
The presence of other incentives
Numerous factors influence the successful implementation of corporatewide pay-for-performance plans, including:
Firm size: Larger firms are better suited for ESOP plans.
Interdependence of different parts of the business: Firms with multiple units find corporatewide plans more suitable.
When market conditions are cyclical and have ups and downs, ESOP plans work the best.
The presence of other incentives: ESOP plans should not be used alone, but instead with other individual or group plans.
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22. Designing Pay for Performance
Executive Plans
Salary and short-term incentives
Long-term incentives
Golden parachutes
Rewards for social responsibility
Perks
Directors and Shareholders
Set top management’s pay
Salespeople
Executives and salespeople are normally treated very differently than most other types of workers in pay-for-performance plans.
The median chief executive earns approximately $14 million per year; however, some salaries can be as high or higher than $100 million.
Salary and short-term incentives: The amount of executives’ base pay increases as firms get larger. Most CEOs of Fortune 500 firms earn a base of at least $500,000 per year, with an average of $3.1 million in cash compensation annually based on 2011 estimates. Executives’ bonuses are usually short-term incentives linked to the firm’s specific annual goals; in 2014, the average annual executive bonus among large firms was about $2 million. More than 90% of U.S. firms reward executives with year-end bonuses, but the criteria used to determine the bonuses vary widely.
Most executives receive long-term incentives, either in the form of equity in the firm or a combination of cash awards and stock.
Golden parachutes: Large-sum payments (around $45 million) given to CEOs when exiting the company.
Rewards for social responsibility: Some firms are rewarding and penalizing depending on the social responsibility of the firm.
Perks: Can include club memberships, cars, company plane, airline VIP clubs, financial counseling, etc.
Directors and shareholders are responsible for setting executive pay. Because of recent corporate scandals, the board of directors and shareholders have become more involved in the corporation’s activities.
Salespeople are those who work with the marketing staff and are responsible for bringing revenues into the company. There are many reasons why setting up a compensation program for salespeople is so much different from setting up compensation programs for other types of employees. Salespeople may be paid in the form of straight salary, straight commission, or a combination plan.
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23. Pay for Performance in Small Firms
Active participation can generate greater commitment
It’s easier for employees to discern their contributions
Feedback should be given more often with the goal of helping employees see their contribution
Offers the opportunity to attract and retain talent
Increases employee identification with the firm
Smaller firms face some of the same compensation issues that larger firms face when it comes to attraction, retention, and motivation of employees through the use of pay. When the objective is to reward employees based on their performance, small firms face some unique challenges; however, this slide shows the suggestions for smaller firms.
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24. Summary and Conclusions
Pay-for-Performance: The Challenges
Meeting the Challenges of Pay-for-Performance Systems
Types of Pay for Performance
Designing Pay-for-Performance Plans for Executives and Salespeople
Designing Pay-for-Performance Plans in Small Firms
Compensation systems present many challenges but can also be used effectively to move employees toward organizational goals and objectives. It is very important to weigh the advantages and disadvantages of each plan as you carefully align the program with the strategic goals of the organization.
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25. Pearson Education, Inc. Copyright
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