MODULE 7: Chapter 12 - Pay for Performance & Financial Incentives
Professional Employees
Work involves the application of learned knowledge to the solution of employer's problems. Reach their positions through prolonged periods of formal study. Incentive pay plans in the form of bonuses. Non-salary items needed to complete best work: - up to date facilities - support for professional publication - supportive management - Modern equipment
Standard Hour Plan
Worker is rewarded by percentage premium that equals the percentage by which their performance is above standard.
Incentives for all Employees
1) Merit Pay / Merit Raise 2) Employee share purchase/stock ownership plans (ESOPs) 3) Profit Sharing Plans 4) Gainsharing Plans
Incentives for Operations Employees
1) Piecework Plans 2) Team or Group Incentives
Executive Compensation
Executive compensation more likely to b effective if linked to corporate strategy. Compensation experts suggest defining strategic context for executive compensation plan before creating package itself by: - Checking for compliance with legal requirements - Defining external issues that face company and its business objectives - Checking for tax effectiveness - Installing a process for review and evaluation whenever a major business change occurs
Demotivators and Edward Deci
Extrinsic rewards can detract from person's intrinsic motivation.
Expectancy Theory and Victor Vroom
Person's motivation to exert some level of effort depends on three factors: 1) Expectancy (probability) - Person's expectations that effort will lead to performance - Training, job descriptions, confidence building and support are important in using incentives 2) Instrumentality - Perceived relationship btw successful performance and obtaining the reward - Managers can accomplish this by creating easy to understand incentive plans 3) Valence - Perceive value a person attaches to the reward - Manager should take into account individual employee preferences
Incentives for Senior Managers and Executives
Five elements in compensation package: 1) Salary 2) Benefits 3) Short-term incentives 4) Long term incentives 5) Perquisites
Types of Pay
Fixed Pay - Compensation that is dependent of the performance level of the individual, group or organization Variable Pay - Any plan that ties pay to productivity and profitability
Gainsharing Plans
Incentive plan that engages employees in a common effort to achieve productivity objectives. All cost-saving gains are shared amongst employees and the company. Popular Types of Gainsharing Plans 1) Ruckers - Sales value minus materials & supplies all divided into payroll expenses - includes participative management systems that use committees. 2) Improshare - creates production standards for each department - considers participation an outcome of bonus plan Get rid of us vs. them mentality - in order to work evryone has to understand how the business is run.
Types of Incentive Plans
Individual Incentive Programs - Give income over and above base salary to individual employees who meet a specific individual performance standard Group Incentive Programs - Provide payments over an above base salary to all team members when they meet specified standard for performance Organizational Wide Incentive Plans - Provide monetary incentives to all employees of the organization - Ex. profit sharing plans provide employees with a share of organization's profits for improvements in their productivity Non-Monetary Recognition Programs - Motivate employees through praise and expressions of appreciation for their work
Long Term Incentives
Intended to motivate and reward top management for firm's long term growth and prosperity to inject a long term perspective into exec decisions. Individual Awards - Most popular amongst executives Capital Accumulation Programs - Long term incentives most often reserved for senior execs Stock Options - Right to purchase a stated number of shares of a company stock at today's price at some time in the future Restricted Stock Plans - Shares awarded without cost to the executives, but with certain restrictions that are imposed by employer Phantom Stock Plans Stock Appreciation Rights Performance Plan - Payment or value is contingent on financial performance measured against objectives set at the start of a multi-year period
Piecework Plans
Piecework - System of pay based on the number of items processes by each individual worker in a unit of time, such as items per hour or items per day Straight Piecework Plan - Set payment for each piece produced or processed Guaranteed Piecework Plan - Minimum hourly wage plus an incentive for each unit produced above a set number of units per hour Differential Piece-Rate Plan - Plan by which a worker is paid a basic hourly rate plus an extra percentage of base rate for production exceeding standard production per hour of per day - Similar to piecework payment but based on percentage premium Advantages: - Simple to calculate - Easily understood by employees - Appear equitable in principle - Incentive value can be powerful bc rewards directly tied to performance Disadvantages - Employers habits of raising production standards when they find workers earning excessive wages
Team or Group Incentives
Plan in which a production standard is set for a specific work group and its members are paid incentives if the group exceeds production standards. Seen to be more effective when there are higher levels of communication with employees about specifics of the plan. Advantages - Reinforce group planning and problem solving - Reduce jealousy - Facilitate on the job training Disadvantage - Worker's rewards are no longer based solely on their own effort - Employee does not see their effort leading to desired reward 1)Set work standards for members and maintain a count of output by each Members paid based on one of three formulas - All members receive the pay earned by the highest producer - All members receive the pay earned by the lowest producer - All members receive payment equal to the average pay earned by the group 2) Set production standard based on final output of group as a whole - All members receive the same pay - Based on either the piece rate or standard hour plan 3) Measurable definition of group performance or productivity that group can control - Ex total labour hours per final product
Employee Share Purchase/Stock Ownership Plans (ESOPs)
Plan whereby a trust is established to hold shares of company stock purchases for or issues to employees. Trust distributes the stock to employees on retirement, separation from service or as otherwise prescribed by plan. Helps encourage employees to develop a sense of ownership in the commitment to the firm. Tax treatment can cause problems - Plan requires employees to complete a certain period of service before taking ownership of the shares - Employees who leave before period don't receive shares in which they paid taxes on - Employees may have had paid greater amount on tax than on value of shares if it drops overtime
Incentives for Salepeople
Salary Plan - Sales people paid fixed salary - Main objective is finding new clients - Occasional incentives in the form of bonuses, sales contest prizes - Advantages: employees known in advance what their income will be and long term perspective kept in mind and firm has fixed expenses Commission Plan - Pays salespeople in direct proportion to their sales - Advantages: company's selling investment in reduced, greatest incentive, attracts high performers, sales cost proportional to sales - Disadvantage: Pay excessive in boom times and very low in recessions Combination Plan - Advantages of both straight salary and commission plan
Individual Award
Target bonus is set for eligible position, and adjustments are made for greater-or-less-than-targeted performance.
Scanlon Plan
- Formula for sharing of benefits - Identify around which to focus employee involvement - Guaranteed min payouts - Competence required from all employees Successful at reducing costs and fostering a sense of sharing & cooperation among employees.
Issues with Short Term Award Management Bonuses
1) Eligibility - Decided in one of three ways --> Key position: determine eligibility, a job by job review conducted in key jobs that have measurable impact on profitability --> Salary level cut off point - all employees earning over that threshold amount are automatically eligible for short term incentives --> Salary grade - refinement of salarly level as a cut off (ex. all managers eligible for short term incentives) 2) Fund size Several formulas used to total amount of bonus money available to be paid out. --> Non-deductible formula: Company's net income used to create short term incentive funds --> Deductible formula: on the assumption that the short term incentive fund should begin to accumulate only after firm has met specified level of earnings 3) How to determine individual awards - Discretionary basis - Target bonus set for eligible - Split award method: breaks bonus into two parts
How to Implement Incentive Plans
1) Pay for performance - Performance tied to successful achievement of critical business goals 2) Link incentives to other activities that engage employees in the business - Ex. career development and challenging opportunities 3) Link incentives to measurable competencies that are valued by the organization 4) Match incentives to the the culture of the organization - Vision, mission and operation principles
When to Use Incentives
1) Performance pay cannot replace good management 2) Firms get what they pay for 3) Pay is not a motivator 4) Rewards rupture relationships 5) Rewards may undermine responsiveness
Developing Effective Incentive Plans
1) When to Use Incentives 2) How to Implement Incentive Plans
Profit Sharing Plans
A plan whereby most or all employees share in the company's profits. A plan that offers each person a bonus on the company's results, regardless of the person's actual effort Tax advantages for employees - Tax deferrals and income splitting Weaknesses - Line of sight: unlikely employees perceive that they personally have the ability to influence overall company profit - Provide an annual payout, which is not as effective as more frequent payouts Cash plans is a type of profit sharing plan - Percentage of profits is distributed as profit shares at regular intervals
Merit Pay / Merit Raise
Any salary increase awarded to an employee based on his or her individual performance. Popular amongst white collar employees. Advocates - Only pay/reward directly from performance can motivate for improvements Detractors - Usefulness depends on validity of the performance appraisal system - Supervisors tend to minimize differences in employee performance (give most employees the same raise) - Majority of employees think they're above average performers - Results in competition Merit Raises - Adaptation of merit plans that are paid in one lump sum once a year - Based on individual performance - Overall level of company profits may affect total sum for merit raises
Motivators - Federick Herzberg
Best Mode of Motivation - Organizing jobs that present challenges that are later recognized so employee feels a sense of accomplishment meets higher level needs Hygiene Factors - Satisfy lower level needs - Different from motivators that satisfy or partially satisfy higher level needs - Outside the job itself (Ex. working conditions, salary, etc) Extrinsic Motivation - Adding more hygiene factors to the job is an inferior way to motivate someone - Lower level needs quickly satisfied - Employees will quickly want more (Ex. raise) Intrinsic Motivation - Motivation that derives from pleasure someone gets from doing the job or task - Comes from within the person, rather than externally
Split Award Method
Breaks bonus into two parts. Manager gets two separate bonuses. - One separate bonus based on individual effort - Another based on organization's effort Drawback: - Pays too much to marginal performer - Ex. manager whose individual performance was poor might even receive a company performance based bonus Solution to Drawback: - Multiplier Method - Outstanding performers should receive larger awards than managers
Employee Recognition Programs
Recognition is critical component of the total rewards mix because it's cost efficient and effective. Effective Recognition is... 1) Specific 2) Immediate 3) Personal 4) Spontaneous Barriers to more frequent recognition: - Manager's potential apprehension about articulating feelings in public - Recognition from line managers is preferred by employees 2 to 1 over recognition from other sources.