Ch. 10 Pay for Performance Plans

Free riders

have a harder time loafing when there are clear performance standards

merit pay system

links increases in base pay to how highly employees are rated on a performance evaluation •Most use a merit increase grid to determine merit pay on the basis of performance and also position in the salary range, or grade •Captured by the compa-ratio - employee salary divided by range midpoint •Ratios are plugged into the grid to determine size of merit increase

Mixing Individual & Group Plans Goal:

motivate individual behavior and insure employees work together to promote team and corporate goals Plans start with the standard individual and group measures

Profit Sharing Plans Adv. and Disadv.

+: •Pays out when company has profit •Can include all employees •Promotes awareness •Opportunity to explain financials •Low administrative costs •Effective for small companies -: •Difficult to link to individuals •Results affected by outside factors •Accounting adjustments •Financial measures difficult for some •No performance differentialtion

Large Group Incentive Plans

1. Gain sharing plans use operating measures to gauge performance 2. Profit sharing plans use financial measures

PFP: Short-Term Incentive Plans

1. merit bonuses 2. spot awards 3. individual incentive plans

Salary increases due to promotion are much larger, ranging around _%

15% •Salary could double every 5 years

Typical Mix of individual and group plans

A typical plan might call for a 75-25 split •75% of the payout is based on individual performance and 25% on corporate performance

Group plans can suffer from

Free rider problem

Spot awards

are given for exceptional performance, often on special projects or for performance exceeding expectation

Long-term incentive plans

focus on performance beyond one year (usually 2-5)

Gain sharing

identifies areas where employees have some impact on savings - such as reduced scrap •Studies report positive results •Can lead to the sorting effect

Individual incentive plans

offer a promise of pay for some objective or pre-established level of performance

scanlon plan formula

payroll costs / net sales (+ or - inventories)

Broad-based option plans (BBOPs) are

stock grants with a firm giving employees shares of stock over a designated time period •The strength of BBOPs is versatility •Depending on their distribution, they reinforce performance or inspire greater commitment and retention •They are a growing trend

Profit sharing plans are..

typically designed as an organization-wide plan where all employee groups are eligible

Performance plans feature

corporate performance objectives for a time three years in the future •Driven by financial earnings or return measures and pay out for meeting or exceeding specific goals

The most common performance basis is a combination of

corporate, unit, and individual objectives

Profit Sharing Plans

Plans where employees receive a share of the profits of an organization

improshare formula

actual hours worked / total standard value hours

High risk businesses with uncertain outcomes:

better off NOT having incentive plans at all

Variable pay greater interest can be traced to two trends:

1. Increasing competition from foreign producers forces U.S. firms to cut costs and/or increase productivity 2. Today's fast-paced business environment means employees must be willing to adjust what they do and how they do it

Merit pay is widely used and the average merit pay increase is about _% per year

3 •An average employee would double their salary in about 23 years •Higher performers will get larger merit pay increases and their salary will increase faster, but it will still take a while

___% of organizations use some form of short-term incentive plan

99

Compa-Ratio

Salary compa-ratio= [(actual salary) / (salary midpoint)] *100

Three Gain-Sharing Formulas

Scanlon plan rucker plan improshare

Employee Stock Ownership Plans (ESOPs)

Some companies link employees to success or failure of a company through ESOPs •The effects are long-term •Management cannot predict what makes stocks rise, a central ingredient in the reward component of ESOPs

Merit plans are evaluated

at the end of a performance year - merit pay INCREASES, unlike variable pay, is added to base pay - What the employee does this year is rewarded every year the employee remains with the employer

Merit bonuses differ from merit pay in that

employees receive an end-of-year bonus that does not build into base pay •Over time, these can be considerably less expensive than merit pay

Pay for Performance Plans

is an incentive pay plan. It includes bonuses, profit sharing and commissions and is designed to retain good workers. Pay for performance is an attempt to overcome the principal agent problem.

Improshare (Improved Productivity through Sharing)

is easier to administer and to communicate. First, a standard is developed identifying the expected hours required to produce an acceptable level of output •The standard comes either a time-and-motion study or from a base-period measurement of the performance factor Any savings arising from production of the output in fewer than expected hours is shared by the firm and the workers •Gains are split 50-50 between employees and management

rucker plan formula

labor cost / value added

Long-term incentive plans are more likely to be used for

officers/executives and other higher job levels

Group incentive plans

when focusing on people working together - established standard measures team performance to determine the magnitude of incentive pay

Scanlon and Rucker Gain Sharing Plans: TWO MAJOR COMPONENTS

•A productivity norm requires effective measure of the base-year and employee acceptance

Rucker Plan

•A ratio is calculated expressing the value of production required for each dollar of the total wage bill •Production savings are split similarly to the Scanlon plan, including the emergency fund

Long term incentive plans types

•Equity based - track share price or total shareholder return -Stock purchase, stock options, stock grants, restricted stock •Cash based - target organizational performance measures

Scanlon Plan

•Incentives derived as a function of the ratio between labor costs and sales value of production (SVOP) •25% of wage savings goes back to the company and 75% of the remainder is distributed as employee bonuses •With the remaining 25% placed in an emergency fund

Profit Sharing Plans: objectives

•Increase employee identification with the organization's success •Create a common focus on important objectives of the organization

Incentive plans boost performance

•Individual incentives yield higher productivity gains, but group incentives often are right when team coordination is the issue

Long-term incentive plan objectives:

•Motivate long-term value creation & org performance •Assist in attracting & retaining top talent

Team performance standards are typically based on:

•Productivity improvements •Customer satisfaction measures •Financial performance •Quality of goods and services

Scanlon and Rucker Gain Sharing Plans: TWO DIFFERENCES

•Rucker plans tie incentives to a variety of savings, not just labor •Rucker plans are more linkable with individual incentive plans

Team incentive plans : not encouraging

•Teams come in many varieties •The "level problem" creates difficulty equalizing when assigning rewards •Some plans are simply too complex •Control and fairness are key issues •Team-based plans are simply not well communicated

Group incentive plans have common features:

•The size of the group that participates in the plan •The standard against which performance is compared •The payout schedule Example: Reduced scrap, safety incentive (zero accident)

ESOPs why:

•They foster employee willingness to participate in decision-making Impact is modest with little impact on productivity or profit •Critics argue the plans are not used effectively •If combined with high goal setting, improved communication, and greater participation, ESOPs may have a positive impact

self-funding plan

•Triggers specific payouts only after the company reaches a certain profit target

Scanlon and Rucker Gain Sharing Plans differ from individual incentive plans in FOCUS

•individual plans focus on wage incentives to motivate •The Scanlon/Rucker plans focus on organizational behavior variables •The key is participation developed through group unity