1. Compensation Pay for Performance

2. Key Topics – Pay for Performance Merit pay and motivation Merit pay and motivation Types of incentive plans Types of incentive plans Sales incentive programs Sales incentive programs Corporate-wide gainsharing and profit sharing plans Corporate-wide gainsharing and profit sharing plans

3. How Do Companies Pay For Performance ?

4. Merit Pay Merit Pay Program (Merit Raise) Merit Pay Program (Merit Raise) Links an increase in base pay to how successfully an employee achieved some objective performance standard. Links an increase in base pay to how successfully an employee achieved some objective performance standard. Merit Guidelines Merit Guidelines Guidelines for awarding merit raises that are tied to performance objectives. Guidelines for awarding merit raises that are tied to performance objectives.

5. Pay and Motivation Evidence suggests that merit raises of 10-15% motivate changes in behavior. Evidence suggests that merit raises of 10-15% motivate changes in behavior. Typical merit raises range from 2-6% Typical merit raises range from 2-6% Rewards are more motivating if: Rewards are more motivating if: They are timely They are timely They are public rather than secret They are public rather than secret They are scarce rather than common They are scarce rather than common

6. Motivation Through Merit Raises Develop employee confidence and trust in performance appraisal. Develop employee confidence and trust in performance appraisal. Establish job-related performance criteria. Establish job-related performance criteria. Separate merit pay from regular pay. Separate merit pay from regular pay. Distinguish merit raises from cost-of-living raises. Distinguish merit raises from cost-of-living raises. Withhold merit payments when performance declines. Withhold merit payments when performance declines.

7. Lump-Sum Merit Pay Lump-Sum Merit Program Lump-Sum Merit Program Program under which employees receive a year-end merit payment, which is not added to base pay. Program under which employees receive a year-end merit payment, which is not added to base pay. Advantages: Advantages: Provides financial control by maintaining annual salary expenses and not escalating base salary levels. Provides financial control by maintaining annual salary expenses and not escalating base salary levels. Contains employee benefit costs for levels of benefits normally calculated from current salary levels. Contains employee benefit costs for levels of benefits normally calculated from current salary levels.

8. Variable Pay Variable Pay Variable Pay Tying pay to some measure of individual, group, or organizational performance. Tying pay to some measure of individual, group, or organizational performance.

9. Variable Pay Incentives Linking performance to pay Linking performance to pay Individual – Bonuses, piece-rates, stock options Individual – Bonuses, piece-rates, stock options Team – Bonuses and awards Team – Bonuses and awards Plant / Unit / Business – Gainsharing, profit sharing Plant / Unit / Business – Gainsharing, profit sharing Corporation – ESOP’s Corporation – ESOP’s “Line of sight” is the perceived link between individual behavior and the reward. “Line of sight” is the perceived link between individual behavior and the reward.

10. Linking Pay to Performance Performance Pay Motivation Improved Performance

11. Advantages of Incentive Plans

12. Focuses employee efforts on specific performance targets. Costs are variable and linked to the achievement of results. (Base salaries are fixed costs largely unrelated to output.) directly related to operating performance. objectives met, incentives are paid, objectives not met, incentives not paid. Can foster teamwork and unit cohesiveness when payments to individuals are based on team results. Distributes success among those responsible for producing that success. Provides reward or attracts top performers when salary budgets are low.

13. Employee Opposition to Incentive Plans Production standards are set unfairly. Production standards are set unfairly. Incentive plans are really “work speedup.” Incentive plans are really “work speedup.” Incentive plans create competition among workers. Incentive plans create competition among workers. Increased earnings result in tougher standards. Increased earnings result in tougher standards. Payout formulas are complex and difficult to understand. Payout formulas are complex and difficult to understand. Incentive plans cause friction between employees and management. Incentive plans cause friction between employees and management.

14. Individual Incentive Plans Straight Piecework Straight Piecework An incentive plan under which employees receive a certain rate for each unit produced. An incentive plan under which employees receive a certain rate for each unit produced. Differential Piece Rate Differential Piece Rate A compensation rate under which employees whose production exceeds the standard amount of output receive a higher rate for all of their work than the rate paid to those who do not exceed the standard amount. A compensation rate under which employees whose production exceeds the standard amount of output receive a higher rate for all of their work than the rate paid to those who do not exceed the standard amount.

15. Computing the Piece Rate hourper units 5 unit)per time(standard minutes 12 hour)(per minutes 60 = unitper $2.55 hour)(per units 5 rate)(hourly $12.75 =

16. Piecework: The Drawbacks Problems with piecework systems: Problems with piecework systems: Is not always an effective motivator Is not always an effective motivator Piecework standards can be difficult to develop. Piecework standards can be difficult to develop. Individual contributions can be difficult measure. Individual contributions can be difficult measure. Not easily applied to work that is highly mechanized with little employee control over output. Not easily applied to work that is highly mechanized with little employee control over output. Piecework may conflict with organizational culture (teamwork) and/or group norms (“rate busting”). Piecework may conflict with organizational culture (teamwork) and/or group norms (“rate busting”). When quality is more important than quantity. When quality is more important than quantity. When technology changes are frequent. When technology changes are frequent.

17. Individual Incentive Plans (cont’d) Standard Hour Plan Standard Hour Plan An incentive plan that sets pay rates based on the completion of a job in a predetermined “standard time.” An incentive plan that sets pay rates based on the completion of a job in a predetermined “standard time.” If employees finish the work in less than the expected time, their pay is still based on the standard time for the job multiplied by their hourly rate. If employees finish the work in less than the expected time, their pay is still based on the standard time for the job multiplied by their hourly rate.

18. Individual Incentive Plans (cont’d) Bonus Bonus Incentive payment that is supplemental to the base wage for cost reduction, quality improvement, or other performance criteria. Incentive payment that is supplemental to the base wage for cost reduction, quality improvement, or other performance criteria. Spot bonus Spot bonus Unplanned bonus given for employee effort unrelated to an established performance measure. Unplanned bonus given for employee effort unrelated to an established performance measure.

19. Incentive Awards and Recognition Awards Awards Often used to recognize productivity gains, special contributions or achievements, and service to the organization. Often used to recognize productivity gains, special contributions or achievements, and service to the organization. Employees feel appreciated when employers tie awards to performance and deliver awards in a timely, sincere and specific way. Employees feel appreciated when employers tie awards to performance and deliver awards in a timely, sincere and specific way. Noncash Incentive Awards Noncash Incentive Awards Are most effective as motivators when the award is combined with a meaningful employee recognition program. Are most effective as motivators when the award is combined with a meaningful employee recognition program.

20. Customize Your Noncash Incentive Awards Compensation specialists recognize that a successful noncash incentive program will offer employees a wide selection of awards—awards that appeal to a diverse workforce and the uniqueness of individual employees. “One-size- fits-all” is not the approach to take. What appeals to younger employees may not be attractive to older employees. Employee Recognition programs are an example of nonfinancial compensation

21. Sales Incentives Straight Commission Sales Incentive Plans Straight Salary Salary and Commission Combinations

22. Incentive Plans for Salespersons Straight Salary Plan Straight Salary Plan Compensation plan that permits salespeople to be paid for performing various duties that are not reflected immediately in their sales volume. Compensation plan that permits salespeople to be paid for performing various duties that are not reflected immediately in their sales volume. Advantages: Advantages: Encourages building customer relationships. Encourages building customer relationships. Provides compensation during periods of poor sales. Provides compensation during periods of poor sales. Disadvantage: Disadvantage: May not provide sufficient motivation for maximizing sales volume. May not provide sufficient motivation for maximizing sales volume.

23. Incentive Plans for Salespersons Straight Commission Plan Straight Commission Plan Compensation plan based upon a percentage of sales. Compensation plan based upon a percentage of sales. Draw is a cash advance that must be paid back as commissions are earned. Draw is a cash advance that must be paid back as commissions are earned. Disadvantages: Disadvantages: Emphasis is on sales volume rather than on profits. Emphasis is on sales volume rather than on profits. Customer service after the sale is neglected. Customer service after the sale is neglected. Earnings tend to fluctuate widely between good and poor periods of business. Earnings tend to fluctuate widely between good and poor periods of business. Temptation to grant price concessions to get sales. Temptation to grant price concessions to get sales.

24. Incentive Plans for Salespersons Combined Salary and Commission Plan Combined Salary and Commission Plan A compensation plan that includes a straight salary and a commission component (“leverage”). A compensation plan that includes a straight salary and a commission component (“leverage”). Advantages: Advantages: Combines the advantages of straight salary and straight commission forms of compensation. Combines the advantages of straight salary and straight commission forms of compensation. Offers greater design flexibility Offers greater design flexibility Can be used to develop the most favorable ratio of selling expense to sales. Can be used to develop the most favorable ratio of selling expense to sales. Motivates sales force to achieve specific company marketing objectives in addition to sales volume. Motivates sales force to achieve specific company marketing objectives in addition to sales volume.

25. Executive Compensation The Executive Pay Package The Executive Pay Package Base salary Base salary Short-term incentives or bonuses Short-term incentives or bonuses Long-term incentives or stock plans Long-term incentives or stock plans Benefits Benefits Perquisites (perks) Perquisites (perks)

26. Executive Compensation Justifications Justifications Large financial incentives reward superior performance. Large financial incentives reward superior performance. Business competition is pressure-filled and demanding. Business competition is pressure-filled and demanding. Good executive talent is in great demand. Good executive talent is in great demand. Effective executives create shareholder value. Effective executives create shareholder value.

27. Executive Compensation Reform Current Reform Measures Current Reform Measures The Internal Revenue Service (IRS) is looking for tax- code violations in executive pay packages and will make executive pay a part of corporate audits. The Internal Revenue Service (IRS) is looking for tax- code violations in executive pay packages and will make executive pay a part of corporate audits. The Securities and Exchange Commission issued pay disclosure rules which require companies listed on the New York Stock Exchange and NASDAQ to disclose the true size of their top executive pay packages. The Securities and Exchange Commission issued pay disclosure rules which require companies listed on the New York Stock Exchange and NASDAQ to disclose the true size of their top executive pay packages. The Financial Accounting Standards Board (FASB) now requires that stock options be recognized as an expense on income statements. The Financial Accounting Standards Board (FASB) now requires that stock options be recognized as an expense on income statements.

28. Executive Compensation Reform (cont’d) Other Reform Measures: Other Reform Measures: The adoption of performance formulas that peg executive compensation to organizational benchmarks other than stock price The adoption of performance formulas that peg executive compensation to organizational benchmarks other than stock price Shareholder resolutions that allow shareholders the right to vote on executive pay packages Shareholder resolutions that allow shareholders the right to vote on executive pay packages Greater accountability by compensation committees to justify large executive pay awards or severance or retirement packages Greater accountability by compensation committees to justify large executive pay awards or severance or retirement packages

29. Group Incentive Plans Team Incentive Plans Team Incentive Plans Compensation plans where all team members receive an incentive bonus payment when production or service standards are met or exceeded. Compensation plans where all team members receive an incentive bonus payment when production or service standards are met or exceeded. Establishing Team Incentive Payments Establishing Team Incentive Payments Set performance measures upon which incentive payments are based Set performance measures upon which incentive payments are based Determine the size of the incentive bonus. Determine the size of the incentive bonus. Create a payout formula and fully explain to employees how payouts will be distributed. Create a payout formula and fully explain to employees how payouts will be distributed.

30. Team Incentive Plans (cont’d) Advantages Advantages Team incentives support group planning and problem solving, thereby building a team culture. Team incentives support group planning and problem solving, thereby building a team culture. The contributions of individual employees depend on group cooperation. The contributions of individual employees depend on group cooperation. Team incentives can broaden the scope of the contribution that employees are motivated to make. Team incentives can broaden the scope of the contribution that employees are motivated to make. Team bonuses tend to reduce employee jealousies and complaints over “tight” or “loose” individual standards. Team bonuses tend to reduce employee jealousies and complaints over “tight” or “loose” individual standards. Team incentives encourage cross-training and the acquiring of new interpersonal competencies. Team incentives encourage cross-training and the acquiring of new interpersonal competencies.

31. Team Incentive Plans (cont’d) Disadvantages Disadvantages Individual team members may perceive that “their” efforts contribute little to team success or to the attainment of the incentive bonus. Individual team members may perceive that “their” efforts contribute little to team success or to the attainment of the incentive bonus. Intergroup social problems—pressure to limit performance and the “free-ride” effect may arise. Intergroup social problems—pressure to limit performance and the “free-ride” effect may arise. Complex payout formulas can be difficult for team members to understand. Complex payout formulas can be difficult for team members to understand.

32. Group Incentive Plans (cont’d) Gainsharing Plans Gainsharing Plans Programs under which both employees and the organization share the financial gains according to a predetermined formula that reflects improved productivity and profitability. Programs under which both employees and the organization share the financial gains according to a predetermined formula that reflects improved productivity and profitability.

33. Enterprise Incentive Plans Profit Sharing Profit Sharing Any procedure by which an employer pays, or makes available to all regular employees, in addition to their base pay, current or deferred sums based upon the profits of the enterprise. Any procedure by which an employer pays, or makes available to all regular employees, in addition to their base pay, current or deferred sums based upon the profits of the enterprise. Challenges: Challenges: Agreement over the percentages of shared of profits and the forms of distribution (cash or deferred) of profits between company and employees Agreement over the percentages of shared of profits and the forms of distribution (cash or deferred) of profits between company and employees Annual variations and possibility of no payout due to financial condition of company Annual variations and possibility of no payout due to financial condition of company Maintaining motivational connection of profit-sharing to performance of employees Maintaining motivational connection of profit-sharing to performance of employees

34. Enterprise Incentive Plans (cont’d) Stock Options Stock Options Granting employees the right to purchase a specific number of shares of the company’s stock at a guaranteed price (the option price) during a designated time period. Granting employees the right to purchase a specific number of shares of the company’s stock at a guaranteed price (the option price) during a designated time period. The value of an option is subject to stock market conditions at the time that option is exercised. The value of an option is subject to stock market conditions at the time that option is exercised.

35. Pay-for-performance: many challenges Pay-for-performance: many challenges Meeting the challenges requires planning Meeting the challenges requires planning Should be part of larger compensation system Should be part of larger compensation system Should fit with overall strategic plan of org. Should fit with overall strategic plan of org. Pay-for-performance at four levels: Pay-for-performance at four levels: Individual, group, plant, organization wide Individual, group, plant, organization wide If P-f-P plan becomes entrenched If P-f-P plan becomes entrenched Employees will expect them regularly Employees will expect them regularly P-f-P for executives and salespeople requires additional thought P-f-P for executives and salespeople requires additional thought Summary and Conclusions