Compensation Pay for Performance

Compensation Compensation Pay for PerformancePay for Performance

Key Topics – Pay for Key Topics – Pay for PerformancePerformance

Merit pay and motivationMerit pay and motivation Types of incentive plansTypes of incentive plans Sales incentive programsSales incentive programs Corporate-wide gainsharing and profit Corporate-wide gainsharing and profit

sharing planssharing plans

Merit PayMerit Pay

Merit Pay Program (Merit Raise)Merit Pay Program (Merit Raise) Links an increase in base pay to how Links an increase in base pay to how

successfully an employee achieved some successfully an employee achieved some objective performance standard.objective performance standard.

Merit GuidelinesMerit Guidelines Guidelines for awarding merit raises that are Guidelines for awarding merit raises that are

tied to performance objectives.tied to performance objectives.

Pay and MotivationPay and Motivation

Evidence suggests that merit raises of 10-Evidence suggests that merit raises of 10-15% motivate changes in behavior.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 timelyThey are timely They are public rather than secretThey are public rather than secret They are scarce rather than commonThey are scarce rather than common

Motivation Through Merit Motivation Through Merit RaisesRaises

Develop employee confidence and trust in Develop employee confidence and trust in performance appraisal.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 Distinguish merit raises from cost-of-living raises.raises.

Withhold merit payments when performance Withhold merit payments when performance declines.declines.

Lump-Sum Merit PayLump-Sum Merit Pay

Lump-Sum Merit ProgramLump-Sum Merit Program Program under which employees receive a Program under which employees receive a

year-end merit payment, which is not added to year-end merit payment, which is not added to base pay.base pay.

Advantages:Advantages: Provides financial control by maintaining annual Provides financial control by maintaining annual

salary expenses and not escalating base salary salary expenses and not escalating base salary levels.levels.

Contains employee benefit costs for levels of benefits Contains employee benefit costs for levels of benefits normally calculated from current salary levels.normally calculated from current salary levels.

Variable PayVariable Pay

Variable PayVariable Pay Tying pay to some measure of individual, Tying pay to some measure of individual,

group, or organizational performance.group, or organizational performance.

Variable Pay IncentivesVariable Pay Incentives

Linking performance to payLinking performance to pay Individual – Bonuses, piece-rates, stock optionsIndividual – Bonuses, piece-rates, stock options Team – Bonuses and awardsTeam – Bonuses and awards Plant / Unit / Business – Gainsharing, profit Plant / Unit / Business – Gainsharing, profit

sharingsharing Corporation – ESOP’sCorporation – ESOP’s

““Line of sight” is the perceived link between Line of sight” is the perceived link between individual behavior and the reward.individual behavior and the reward.

Linking Pay to PerformanceLinking Pay to Performance

Advantages of Incentive Plans

Advantages of Incentive Plans

•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.

Employee Opposition to Employee Opposition to Incentive PlansIncentive 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 Incentive plans create competition among

workers.workers. Increased earnings result in tougher standards.Increased earnings result in tougher standards. Payout formulas are complex and difficult to Payout formulas are complex and difficult to

understand.understand. Incentive plans cause friction between Incentive plans cause friction between

employees and management.employees and management.

Individual Incentive PlansIndividual Incentive Plans

Straight PieceworkStraight Piecework An incentive plan under which employees An incentive plan under which employees

receive a certain rate for each unit produced.receive a certain rate for each unit produced. Differential Piece RateDifferential Piece Rate

A compensation rate under which employees A compensation rate under which employees whose production exceeds the standard whose production exceeds the standard amount of output receive a higher rate for all amount of output receive a higher rate for all of their work than the rate paid to those who of their work than the rate paid to those who do not exceed the standard amount.do not exceed the standard amount.

Computing the Piece RateComputing 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=

Piecework: The DrawbacksPiecework: The Drawbacks Problems with piecework systems:Problems with piecework systems:

Is not always an effective motivatorIs 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 Not easily applied to work that is highly mechanized

with little employee control over output.with little employee control over output. Piecework may conflict with organizational culture Piecework may conflict with organizational culture

(teamwork) and/or group norms (“rate busting”).(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.

Individual Incentive Plans Individual Incentive Plans (cont’d)(cont’d)

Standard Hour PlanStandard Hour Plan An incentive plan that sets pay rates An incentive plan that sets pay rates

based on the completion of a job in a based on the completion of a job in a predetermined “standard time.”predetermined “standard time.”

If employees finish the work in less than If employees finish the work in less than the expected time, their pay is still based the expected time, their pay is still based on the standard time for the job on the standard time for the job multiplied by their hourly rate.multiplied by their hourly rate.

Individual Incentive Plans Individual Incentive Plans (cont’d)(cont’d)

BonusBonus Incentive payment that is supplemental to Incentive payment that is supplemental to

the base wage for cost reduction, quality the base wage for cost reduction, quality improvement, or other performance improvement, or other performance criteria.criteria.

Spot bonusSpot bonus Unplanned bonus given for employee Unplanned bonus given for employee

effort unrelated to an established effort unrelated to an established performance measure.performance measure.

Incentive Awards and Incentive Awards and RecognitionRecognition

AwardsAwards Often used to recognize productivity gains, special Often used to recognize productivity gains, special

contributions or achievements, and service to the contributions or achievements, and service to the organization.organization.

Employees feel appreciated when employers tie Employees feel appreciated when employers tie awards to performance and deliver awards in a awards to performance and deliver awards in a timely, sincere and specific way.timely, sincere and specific way.

Noncash Incentive AwardsNoncash Incentive Awards Are most effective as motivators when the award is Are most effective as motivators when the award is

combined with a meaningful employee recognition combined with a meaningful employee recognition program.program.

Customize Your Noncash Customize Your Noncash Incentive AwardsIncentive 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

Sales IncentivesSales Incentives

Straight Commission

Sales Incentive PlansSales Incentive Plans

Straight Salary

Salary and CommissionCombinations

Incentive Plans for Incentive Plans for SalespersonsSalespersons

Straight Salary PlanStraight Salary Plan Compensation plan that permits salespeople to be Compensation plan that permits salespeople to be

paid for performing various duties that are not paid for performing various duties that are not reflected immediately in their sales volume.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 May not provide sufficient motivation for maximizing

sales volume.sales volume.


Straight Commission PlanStraight Commission Plan Compensation plan based upon a percentage of Compensation plan based upon a percentage of

sales. sales. DrawDraw is a cash advance that must be paid back as is a cash advance that must be paid back as

commissions are earned.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 Earnings tend to fluctuate widely between good and poor periods of business.periods of business.

Temptation to grant price concessions to get sales.Temptation to grant price concessions to get sales.


Combined Salary and Commission PlanCombined Salary and Commission Plan A compensation plan that includes a straight salary A compensation plan that includes a straight salary

and a commission component (“leverage”).and a commission component (“leverage”). Advantages:Advantages:

Combines the advantages of straight salary and straight Combines the advantages of straight salary and straight commission forms of compensation.commission forms of compensation.

Offers greater design flexibilityOffers greater design flexibility

Can be used to develop the most favorable ratio of selling Can be used to develop the most favorable ratio of selling expense to sales.expense to sales.

Motivates sales force to achieve specific company Motivates sales force to achieve specific company marketing objectives in addition to sales volume.marketing objectives in addition to sales volume.

Executive CompensationExecutive Compensation

The Executive Pay PackageThe Executive Pay Package Base salaryBase salary Short-term incentives or bonusesShort-term incentives or bonuses Long-term incentives or stock plansLong-term incentives or stock plans BenefitsBenefits Perquisites (perks)Perquisites (perks)

Executive CompensationExecutive Compensation JustificationsJustifications

Large financial incentives reward superior Large financial incentives reward superior performance.performance.

Business competition is pressure-filled and Business competition is pressure-filled and demanding.demanding.

Good executive talent is in great demand.Good executive talent is in great demand.

Effective executives create shareholder Effective executives create shareholder value.value.

Executive Compensation Executive Compensation ReformReform

Current Reform MeasuresCurrent Reform Measures The Internal Revenue Service (IRS) is looking for tax-The Internal Revenue Service (IRS) is looking for tax-

code violations in executive pay packages and will code violations in executive pay packages and will make executive pay a part of corporate audits.make executive pay a part of corporate audits.

The Securities and Exchange Commission issued pay The Securities and Exchange Commission issued pay disclosure rules which require companies listed on the disclosure rules which require companies listed on the New York Stock Exchange and NASDAQ to disclose New York Stock Exchange and NASDAQ to disclose the true size of their top executive pay packages.the true size of their top executive pay packages.

The Financial Accounting Standards Board (FASB) now The Financial Accounting Standards Board (FASB) now requires that stock options be recognized as an requires that stock options be recognized as an expense on income statements.expense on income statements.

Executive Compensation Executive Compensation Reform (cont’d)Reform (cont’d)

Other Reform Measures:Other Reform Measures: The adoption of performance formulas that peg The adoption of performance formulas that peg

executive compensation to organizational executive compensation to organizational benchmarks other than stock pricebenchmarks other than stock price

Shareholder resolutions that allow shareholders Shareholder resolutions that allow shareholders the right to vote on executive pay packagesthe right to vote on executive pay packages

Greater accountability by compensation Greater accountability by compensation committees to justify large executive pay committees to justify large executive pay awards or severance or retirement packagesawards or severance or retirement packages

Group Incentive PlansGroup Incentive Plans Team Incentive PlansTeam Incentive Plans

Compensation plans where all team members Compensation plans where all team members receive an incentive bonus payment when receive an incentive bonus payment when production or service standards are met or production or service standards are met or exceeded.exceeded.

Establishing Team Incentive PaymentsEstablishing Team Incentive Payments Set performance measures upon which incentive Set performance measures upon which incentive

payments are basedpayments are based Determine the size of the incentive bonus.Determine the size of the incentive bonus. Create a payout formula and fully explain to Create a payout formula and fully explain to

employees how payouts will be distributed. employees how payouts will be distributed.

Team Incentive Plans Team Incentive Plans (cont’d)(cont’d)

AdvantagesAdvantages Team incentives support group planning and problem Team incentives support group planning and problem

solving, thereby building a team culture.solving, thereby building a team culture. The contributions of individual employees depend on The contributions of individual employees depend on

group cooperation.group cooperation. Team incentives can broaden the scope of the Team incentives can broaden the scope of the

contribution that employees are motivated to make.contribution that employees are motivated to make. Team bonuses tend to reduce employee jealousies and Team bonuses tend to reduce employee jealousies and

complaints over “tight” or “loose” individual standards.complaints over “tight” or “loose” individual standards. Team incentives encourage cross-training and the Team incentives encourage cross-training and the

acquiring of new interpersonal competencies.acquiring of new interpersonal competencies.

Team Incentive Plans Team Incentive Plans (cont’d)(cont’d)

DisadvantagesDisadvantages Individual team members may perceive that Individual team members may perceive that

“their” efforts contribute little to team success “their” efforts contribute little to team success or to the attainment of the incentive bonus.or to the attainment of the incentive bonus.

Intergroup social problems—pressure to limit Intergroup social problems—pressure to limit performance and the “free-ride” effect may performance and the “free-ride” effect may arise.arise.

Complex payout formulas can be difficult for Complex payout formulas can be difficult for team members to understand.team members to understand.

Group Incentive Plans Group Incentive Plans (cont’d)(cont’d)

Gainsharing PlansGainsharing Plans Programs under which both employees and the Programs under which both employees and the

organization share the financial gains organization share the financial gains according to a predetermined formula that according to a predetermined formula that reflects improved productivity and profitability.reflects improved productivity and profitability.

Enterprise Incentive PlansEnterprise Incentive Plans Profit SharingProfit Sharing

Any procedure by which an employer pays, or Any procedure by which an employer pays, or makes available to all regular employees, in makes available to all regular employees, in addition to their base pay, current or deferred addition to their base pay, current or deferred sums based upon the profits of the enterprise.sums based upon the profits of the enterprise.

Challenges:Challenges: Agreement over the percentages of shared of profits Agreement over the percentages of shared of profits

and the forms of distribution (cash or deferred) of and the forms of distribution (cash or deferred) of profits between company and employeesprofits between company and employees

Annual variations and possibility of no payout due to Annual variations and possibility of no payout due to financial condition of companyfinancial condition of company

Maintaining motivational connection of profit-sharing Maintaining motivational connection of profit-sharing to performance of employeesto performance of employees

Enterprise Incentive Plans Enterprise Incentive Plans (cont’d)(cont’d)

Stock OptionsStock Options Granting employees the right to purchase a Granting employees the right to purchase a

specific number of shares of the company’s specific number of shares of the company’s stock at a guaranteed price (the option price) stock at a guaranteed price (the option price) during a designated time period.during a designated time period.

The value of an option is subject to stock The value of an option is subject to stock market conditions at the time that option is market conditions at the time that option is exercised.exercised.

Pay-for-performance: many challengesPay-for-performance: many challenges Meeting the challenges requires planning Meeting the challenges requires planning

Should be part of larger compensation systemShould 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 wideIndividual, group, plant, organization wide

If P-f-P plan becomes entrenchedIf P-f-P plan becomes entrenched Employees will expect them regularlyEmployees will expect them regularly

P-f-P for executives and salespeople P-f-P for executives and salespeople requires additional thoughtrequires additional thought

Summary and ConclusionsSummary and Conclusions

Documents

Compensation Pay for Performance