Variable Pay and Executive Compensation Chapter 12

Chapter 12Chapter 12

CEO PayMade in America—My StorySam Walton and John Huey (1993)“A lot of what goes on these days with high-

flying companies and these overpaid CEO’s who’re really looting from the top and aren’t watching out for anyone but themselves, really upsets me.”

CEO Pay

If you were creating an executive If you were creating an executive compensation plan, what criteria would compensation plan, what criteria would

you include?you include?

Variable Pay: Incentives for Performance

Variable Pay Compensation linked to individual, group/team,

and/or organizational performance.Basic assumptions:

Some jobs contribute more to organizational success than others.

Some people perform better and are more productive than others.

Employees who perform better should receive more compensation.

Some of employees’ total compensation should be tied directly to performance.

Boeing, Nordstrom, Wal-Mart, Safeway

Successes and Failures of Variable Pay Plans

Successful incentive plans require:The development of clear, understandable

plans that are continually communicated.The use of realistic performance measures.Strong links among performance results and

payouts that truly recognize performance differences.

Clear identification of variable pay incentives separately from base pay.

Piece-Rate SystemsStraight Piece-Rate Systems

Wages are determined by multiplying the number of pieces produced by the piece rate for one unit.

Differential Piece-Rate SystemsEmployees are paid one piece-rate for units

produced up to a standard output and a higher piece-rate wage for units produced over the standard.

Individual Incentives: BonusesBonus

A one-time payment that does not become part of the employee’s base pay.

Spot BonusA special type of bonus used is a “spot”

bonus, so called because it can be awarded at any time.

Special Incentive ProgramsPerformance Awards

Cash or merchandise used as an incentive reward.

Recognition AwardsRecognition of individuals for their performance or

service to customers in areas targeted by the firm.

Service AwardsRewards to employees for

lengthy service with an organization.

Types of Sales Compensation PlansSalary-Only

All compensation is paid as a base wage with no incentives.

CommissionStraight Commission

Compensation is computed as a percentage of sales in units or dollars.

The draw system make advance payments against future commissions to salesperson.

Salary-Plus-Commission or Bonuses Compensation is part salary for income stability and

part commission for incentive.

Group/Team Incentives (cont’d)

Distributing RewardsSame-size reward for each memberDifferent-size reward for each member

Problems with Group/Team IncentivesRewards in equal amounts may be perceived as

“unfair” by employees who work harder, have more capabilities, or perform more difficult jobs.

Group/team members may be unwilling to handle incentive decisions for co-workers.

Many employees still expect to be paid according to individual performance.

Social LoafingThe folly of rewarding A and hoping for B

Organizational IncentivesProfit Sharing

A system to distribute a portion of the profits of the organization to employees.

Primary objectives: Increase productivity and organizational performance Attract or retain employees Improve product/service quality Enhance employee morale

Drawbacks Disclosure of financial information Variability of profits from year to year Profit results not strongly tied to employee efforts

Employee Stock PlansStock Option Plan

A plan that gives employees the right to purchase a fixed number of shares of company stock at a specified price for a limited period of time. If market price of the stock is above the specified

option price, employees can purchase the stock and sell it for a profit.

If the market price of the stock is below the specified option price, the stock option is “underwater” and is worthless to employees.

Employee Stock PlansEmployee Stock Ownership Plan (ESOP)

A plan whereby employees gain significant stock ownership in the organization for which they work.

Advantages Favorable tax treatment for ESOP earnings

Employees motivated by their ownership stake in the firm

Disadvantages Retirement benefit is tied to the firm’s future performance

Management tool to fend off hostile takeover attempts.

Executive Compensation

“Reasonableness” of Executive CompensationWould another company hire this person as an

executive?How does the executive’s compensation compare

with that for executives in similar companies in the industry

Is the executive’s pay consistent with pay for other employees within the company?

What would an investor pay for the level of performance of the executive? Investors are owners We as managers are stewards (agency theory)

If you were creating an executive If you were creating an executive compensation plan, what criteria would compensation plan, what criteria would

you include?you include?

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