MGMT 384 ch. 10

employee stock ownership plans (ESOPs)

Employees are given company stock as a form of compensation Company stock as compensation usually takes one of two forms: Stock Grants- employees are given full shares of company stock Has immediate value- the current price of a share of stock at time of grant Ultimate value depends on when the employee sells the stock- time of sale Stock Options- employees are given the "option" to purchase shares of stock at a predetermined price Value of options depends on the difference between the "option price" and the value of stock at the time of "exercise date" (when options are used/cashed in) Stock options are usually only valid for a fixed period of time Options can be worthless if the "option price" is higher than the actual stock price Known as your stock options being "under water" Can be a great way for the company to save money- Microsoft example Is risky for the employee- they bear all the risk

motivational theory

Goal: Managers want to direct and control employee behavior to help achieve organizational success Compensation is used as a tool to direct and control (i.e. motivate) desired behaviors Managers set clear performance stds and reward good performance with compensation Behavioral reinforcement at work- positive reinforcement through compensation Studies show that well-designed pay for performance plans DO improve performance Key is that they need to be well-designed, which doesn't always happen

Types of possible performance standards used in individual incentive plans:

Output/Productivity Work Quality Innovation Cost-savings/reduction

improshare

if 100 workers can produce 50,000 units over 50 weeks. translates to 200,000 hrs (40hr x 50wks) for 50,000 units or 4hr/unit. gains resulting in less than 4hr/unit are shared 50/50 between mgnt/employees

scanlon method

labor cost = 40% of total revenue

theoretical rationale

motivational theory and agency theory

large group incentive plans

1.Profit Sharing Plans Profit-sharing plans are systems where predetermined profit goals are set and if achieved then a percentage of the profits ("the pool") are distributed to employees Profit goals are either: Pre-determined profit level- an actual dollar figure (i.e. profit level) Pre-set percentage increase in profit from the previous year (i.e. profit growth) Amount of employee payout is usually a pre-determined percentage of the employee's pay Ex: Employee can receive up to 10% of their base pay as a profit-sharing bonus The percentage of payout to the employee is usually based on pay grade or compensation level Often employees in lower-level jobs are NOT eligible for profit-sharing Higher-level employees typically are, and the higher the pay grade the greater the % of the bonus Executives often have large % of total compensation based on this

large group incentive plans (continued)

2. Gain-Sharing Plans Gain-sharing plans are systems where the "gains" from employee suggestions/involvement are shared between the company and the employees These are formal "employee involvement" or "labor-management cooperation" programs Ex: Continuous Improvement programs, TQM or Six Sigma systems All involve utilizing employee expertise/knowledge to make improvements that result in financial gains "Improvements" might be cost-savings, productivity increases, innovations "Expertise" can come in form of individual employee suggestions to committees that work on developing ideas for improvements There are lots of specific types of gain-sharing plans (Scanlon, Rucker, Improshare)- all function largely in the same manner They basically differ in the details of how gains & bonuses are calculated

iron rule for compensation

Be very careful what you compensate (incentivize), because you WILL get what you compensate for!! Watch out for unintended consequences!! Lots of stories of well-intentioned incentives gone wrong Always think carefully about what might go wrong Remember: people tend to act in a self-interested manner- align interests Use incentives carefully- avoid incentivizing just one aspect of performance!! Think of performance in a more holistic manner

individual incentive plans

Extra pay (usually bonuses) based on achieving a predetermined level of some kind of individual performance (usually some objective standard) Incentive plan features: A predetermined specific standard is set that represents a goal for employees Remember: goals need to be S.M.A.R.T (specific measurable attainable realistic timely) If the standard is achieved/exceeded, then bonus is awarded Awards are often done annually, semi-annually, or quarterly Amount of the incentive bonus is tied to the level of achievement The higher the above standard of performance, the larger the incentive payout Advantages: very powerful motivator/shaper of behavior, less need for supervision Disadvantages: Conflict between employees & mangers, unintended consequences, difficult to forecast total cost

team/small group incentives

Extra pay (usually bonuses) that accrue to groups of employees based on achieving some predetermined level (standard) of performance "Groups" could mean small teams, units, plants/offices, divisions Very similar in mechanics to individual incentives Predetermined standards are set as goals for people to achieve Level of achievement determines the size of the bonus/incentive Advantages: somewhat powerful motivator, necessary for team-oriented structure, cohesiveness of teams Disadvantages: not as powerful as individual incentives, free-rider problems, motivational issues for high-performing individuals, cost difficult to forecast

work quality

Incentives tied to achieving quality ratings or avoiding errors Ex: incentives for customer satisfaction, bonuses for no defective parts

output/productivity

Incentives tied to amount produced or speed of production Ex: "piece-rate" production plans, sales or production volume/quotas

innovation

Incentives tied to creation of new products or processes Ex: incentives for winning patents, bonuses for bringing new products to market

cost savings/reduction

Incentives tied to reducing waste or increasing efficiency Ex: bonuses for production scrap reduction, incentives for "secondary uses" of products and product recycling ideas

pay for performance

Increasing use of variable pay in the corporate world signals a shift in corporate compensation philosophy Old philosophy was one of entitlement- if you stayed employed, you were entitled to receive a fixed sum of money for your work This worked as long as competition was limited- steady performance was fine New philosophy is that compensation is not an entitlement but should be earned by virtue of merit & performance Employees are responsible to contribute to organizational success- pay should reflect that contribution The use of variable pay reflects this new philosophy Main goal is to tie individual earnings to performance over both short- and long-term time frames Motivates individual employees to perform above "normal" levels Long-term incentives helps the retention of talent over time

compensation for performance link JOB PERFORMANCE EQUATION

Job Performance Performance = Ability * Motivation You need both ability and motivation in order to perform successfully Some scholars state this as: Behavior = f (Motivation, Ability, Environment) Accepting the above equation, compensation should help with: Attraction- helps attract people with necessary abilities Retention- helps retain the talent with those abilities Development- motivates employees to further develop abilities Direction- directs both effort & behavior by rewarding desired behaviors

why pay for performance

Linking pay to performance is designed to accomplish two things: Motivate effort from talented employees Direct employee behaviors in desired ways to support business strategy Ultimate goal is to increase organizational performance!! Research shows that better individual performance yields better org performance Pay-for-Performance can operate on multiple levels: Individual- compensation tied to individual employee performance Ex: merit pay, individual incentives Team- compensation tied to team/group performance Ex: team bonuses or other incentives Business Unit- compensation tied to unit (i.e. location, division) performance Ex: division bonuses, profit-sharing/gain sharing based on business unit Organizational- compensation tied to organizational performance Ex: profit-sharing plans, gain-sharing plans, stock options

long-term incentives

Long-term incentives (LTIs) are defined as additions to base pay that operate over longer than a single year period Simply another form of variable pay Long-term incentive plans have multiple purposes: Motivate long-term value creation (based on increased performance) Encourage employees to remain at company Tax-breaks for employee and employer for deferred compensation LTIs often have legal tax advantages for both parties Long-term incentives also take many different forms: Pension Plans Employee Stock Ownership Plans (ESOPs) Length of Service Incentives

merit pay criticisms and problem

Merit pay has been heavily criticized for NOT being motivational Main problem is the expectation of merit pay- employees expect to receive some sort of merit increase regardless of performance Merit pay doesn't actually reflect "merit", but just average performance Basically becomes a de facto Cost of Living Adjustment (COLA) Many companies have gone along with this expectation, and thus merit pay loses its effectiveness- doesn't actually reward merit PA systems are often very poorly designed & executed

merit pay

Merit pay is an adjustment (usually increase) to base salary designed to reflect the individual employee's contribution to the organization Merit pay is based on the performance appraisal (PA) process, where adjustments to base pay reflect the performance evaluation results Usually comes in the form of a percentile (%) increase in base pay- i.e. 2% increase Merit pay is designed to motivate people to perform at higher levels by rewarding better than average performance Increases in base pay should only be given to those who CONSISTENTLY perform above the average Research shows that merit pay systems DO work to motivate employees if properly designed & administered: PA system must be valid - actually reflect individual performance & contribution Merit increases are only given to those who actually perform above average Employees are clear about performance expectations- what is above average

pension plans

Pensions are compensation systems that defer presently earned compensation for later use during retirement to supplement Social Security payments Two Main Types: Defined Benefit Pension ("Traditional" Pension) Predetermined monthly benefit level based on some formula (this is rapidly going out of use) Usually some variation of: Benefit = Earnings * Years of Service Benefit NEVER runs out- is present until death of individual or his/her beneficiary Investment risk borne by employer- must adequately fund the "pool" of money Defined Contribution Pension ("401 (k)") Predetermined employer contribution to an account Often in the form of a "match" of employee money up to a certain $ amount or % Upon retirement employee retires with their "account" of money and can use it without restriction- lots of flexibility Might run out prior to death or might not Investment risk borne by the employee- they are responsible for managing money (BONUS QUESTION WILL BE ON DEFINING THE DIFFERENCE BETWEEN THESE TWO PENSION PLANS)

agency theory

Problem: people tend to act in their own self interest- maximize their "utility" This leads them to act in ways that might NOT be beneficial to the organization, even though they are supposed to act in the interest of the organization, not themselves Solution: if we can align self-interest with organizational interest, then people's inherent "selfishness" actually benefits the organization We set up compensation systems to align the interests so that people do act as "agents" of the organization- variable pay and incentives are means of doing this

short-term incentives

Short-term incentives are defined as additions to base pay that operate within a time-frame of (roughly) a single year or less Additions to base pay mean that the compensation is variable- is NOT a scheduled or pre-determined form of compensation Base pay & benefits are only fixed forms of compensation Involves a degree of risk to the employee- some like this, others don't Main purpose is to motivate behavior in the short-term Increase performance to support organizational goals Short-term incentives can take many different forms: Merit Pay (% adjustments to base salary) Lump-sum Bonuses & "Spot" Awards Individual Incentive Plans Team/Group Incentive Plans

spot award

Spot Awards reward employees for outstanding performance on specific tasks/duties/activities as a part of regular job and/or a project Performance is so outstanding that it deserves extra reward Focus is shorter-term performance on more finite tasks/activities Not looking for outstanding performance over a longer period of time There is no pre-set "target" or "standard" for performance Just an ad-hoc reward for truly outstanding performance on some activity Rewards might be small monetary bonuses, perks, and/or recognition Ex: After closing the deal landing a big client, a support employee who worked long hours on the project and put together a great report that helped land the client is recognized in front of his/her peers and given a $250 cash bonus Can be very powerful and effective! Tightly tied to behavior, mix of financial & intangible rewards

lump sum

These are one-time bonuses (used in place of % merit pay increases) given to employees to reflect above-average performance over a period of time Function just like merit adjustments (reward consistently above average performance) but don't change an employee's base pay Could be awarded annually, semi-annually, quarterly, etc. Are used as a cheaper alternative to merit adjustments to base pay Bonuses must be earned each year- don't carry forward like merit increases Advantages: Cheaper than using merit pay adjustments Can be tightly tied to desired behaviors- very powerfully motivating Disadvantages: Sends message that bonuses must be earned every year- doesn't reward past performance Some employees recognize this as a cost-cutting measure

chapter 10 questions DOES PAY FOR PERFORMANCE WORK?

What does the research evidence say? Does Pay for Performance actually help to: Attract Talent- yes! Pay Level is important- higher overall pay is generally more attractive Pay Mix also important- employees want "fit" with personality & values Retain Talent- yes! Financial compensation does affect retention- pay satisfaction & fairness Intrinsic/intangible factors are also strongly important Motivate Talent to Develop KSAOs- depends Yes, if development is rewarded through skill-based pay Motivate Talent to Perform Better- yes! Yes, if pay for performance system design & execution are done well Problem is many systems are done poorly, so research conclusions are mixed