Enterprise incentive plans allow all organizational members to participate in the plan's payout.

Pay-for-Performance: Incentive Plans

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In This Session:

We’ll look at how the goals and performances of individuals, teams/groups, and enterprise/organizations might be more effectively linked.

We’ll examine the underlying concepts that distinguish effective incentives from ineffective ones.

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Effective rewards acknowledge what the organization wants to reward. Ineffective rewards do not reward what is hoped for by the organization and, in fact, reward the very things the organization doesn’t want. Kerr’s article, The Folly of Rewarding A While Hoping for B, is a good launching point for discussion of this (next slide).

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Types of Incentive Plans

Introduction

Incentive plans can be grouped into three categories: individual incentive plans, group incentive plans, and enterprise incentive plans, as shown in Figure 10.1.

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Strategic Reasons for Incentive Plans

Variable pay – Tying pay to some measure of individual, group/team, or organizational performance

Variable pay programs consist of bonuses, incentives, or recognition for good work.

Variable pay is more flexible than fixed pay (salaries, hourly wages)

Variable pay not only motivates employees to do what the organization wants them to do, but it also ensures that employees feel the organization is fair and responsive to their individual contributions.

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Variable pay is more flexible than fixed pay (salaries, hourly wages), as variable pay is attached to fixed costs that allow flexibility to increase, decrease, or maintain future payments to employees as business conditions warrant.

Most HR managers see variable pay as strategic because it allows the organization to align its employees’ interests and outcomes with those of the organization.

Variable pay not only motivates employees to do what the organization wants them to do, but it also ensures that employees feel the organization is fair and responsive to their individual contributions.

Pay-for-Performance Philosophy

Section 10.1: Strategic Reasons for Incentive Plans

Figure 10.2 shows that incentive rewards are based entirely upon a pay-for-performance philosophy. Incentive pay plans establish a performance “threshold” (a baseline performance level) that an employee or group of employees must achieve to qualify for incentive payments.

By meshing compensation and organizational objectives, managers believe that employees will assume “ownership” of their jobs, thereby improving their effort and overall job performance.

Incentive pay is highly valued as a compensation strategy to attract and retain top-performing employees.

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Advantages of Incentive Pay Programs

Section 10.1a: Incentive Plans as Links to Organizational Objectives

Figure 10.3 summarizes the major advantages of incentive pay programs as noted by researchers and HR professionals.

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Requirements for a Successful Incentive Plan

For an incentive plan to succeed, employees must be able to see a clear connection between the incentive payments they receive and their job performance.

A successful incentive plan should:

Identify important organizational metrics that encourage employee behavior

Involve employees

Have simple and understandable payout formulas

Establish a clear link between performance and payout

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Setting Performance Measures

When setting performance measures, as a manager, you will need to:

Be able to distinguish between individual contributions and those made by a group

Be able to avoid biases based on who you like and dislike, different personalities, and political agendas

Distinguish how much one group contributed over another group, even if the work they do is highly interdependent

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Management should guard against incentive payments being seen as an entitlement.

Instead, these payments should be viewed as a reward that must be earned through effort.

To achieve their full benefit, incentive plans must be carefully thought out, implemented, and maintained.

Three of the more important points are:

Poor performance must go unrewarded.

Annual salary budgets must be large enough to reward and reinforce exceptional performance.

The overhead costs associated with plan implementation and administration must be determined.

Individual Incentives

Necessary Conditions For Individual Incentive Plans

Individual performance must be identified

Individual competitiveness must be desired

Individualism must be stressed in the organizational culture

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Individual Incentive Plans – Piece-rate

Straight piece-rate:

Employees receive a certain rate for each unit produced

Differential piece-rate:

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

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Managers often determine the quotas or standards by using time and motion studies. For example, assume that the standard quota for a worker is set at 300 units per day and the standard rate is

14 cents per unit. However, for all units over the standard, the employee receives 20 cents per unit. Under this system, the worker who produces 400 units in one day would get $62 (300 × 14¢) + (100 × 20¢). Many possible

combinations of straight and differential piece-rate systems can be used, depending on situational factors.

Piecework: The Drawbacks

Despite their advantages, piecework systems have a number of disadvantages that offset their usefulness.

They may not always be an effective motivator.

Piecework incentive systems can work against an organizational culture promoting creativity or problem-solving because these goals can infringe on an employee’s time and productivity and, therefore, total pay earned.

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Individual Incentive Plans – Standard Hour Plan

An incentive plan that sets rates based on the completion of a job in a predetermined standard time

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

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Individual Incentive Plans - Bonuses

Bonuses: One-time payment that does not become part of the employee’s base pay

Spot bonus: An unplanned bonus given to an employee for exceptionally good behavior

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Individual Incentive Plans - Merit Pay (slide 1 of 2)

Merit pay is normally an annual pay increase tied to performance

Becomes part of base pay once issued regardless of future performance

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Individual Incentive Plans - Merit Pay (slide 2 of 2)

Possible problems with merit pay plans:

Money available for merit increases may be inadequate to satisfactorily raise all employees’ base pay.

Managers may have no guidance in how to define and measure performance; there may be vagueness regarding merit award criteria.

Employees may not believe that their compensation is tied to effort and performance; they may be unable to differentiate merit pay and other types of pay increases.

Employees and their managers may hold different views of the factors that contribute to job success.

Merit pay plans may create feelings of pay inequity.

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Merit guidelines – Guidelines for awarding merit raises that are tied to performance objectives

Individual Incentive Plans - Awards and Recognition

Awards and Recognition

When giving awards, organizations should describe clearly how those receiving the awards were selected

Management professor named winner of ‘Golden Apple,’ CSUSB’s top teaching award

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Sales Incentive Plans

Permits salespeople to be paid for performing various duties that are not reflected immediately in their sales volume

Straight salary plan

Receives a percentage of the value of the sales the person has made

Straight commission plan

Includes a straight salary and commission

Combination salary and commission plan

Pays a salary plus a bonus achieved by reaching targeted sales goals

Salary plus bonus plan

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Group/Team Incentive Plans - Team Compensation

Team incentive plans: All team members receive an incentive bonus payment when production or service standards are met or exceeded

Approaches in establishing team incentive payments

Set performance measures upon which incentive payments are based

Determine the size of the incentive bonus

Create a payout formula and should be explained to employees in detail

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The emphasis on cost reduction and productivity has led many organizations to implement a variety of group incentive plans.

Group plans enable employees to share in the benefits of improved efficiency realized by major organizational units or various individual work teams.

Group plans encourage a cooperative—rather than individualistic—spirit among all employees and reward them for their total contribution to the organization.

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Gainsharing Incentive Plans

Gainsharing plans – Programs under which both employees and the organization share financial gains according to a predetermined formula that reflects improved productivity and profitability

Scanlon plan – A bonus incentive using employee and management committees to gain cost-reduction improvements

Improshare – A gainsharing program under which bonuses are based on the overall productivity of the work team

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The philosophy behind the Scanlon plan is that employees should offer ideas and suggestions to improve productivity and, in turn, be rewarded for their constructive efforts.

Challenges with Group/team Incentives

Challenges with group/team incentives:

Rewards distributed in equal amounts to all members may be perceived as unfair

Free rider: Member of the group who contributes little

Group size: Individual efforts of employees have little effect on the total performance of the group in large groups

Complex payout formulas or insufficient payout rewards

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Problems associated with team compensation:

The perception by individual team members that “their” efforts contribute little to team success or to the attainment of the incentive reward

The “free-rider” effect

Complex payout formulas or insufficient payout rewards

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Conditions for Effective Work Unit or Team Incentives

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Enterprise/Organizational Incentive Plans

Enterprise incentive plans differ from individual and group incentive plans in that all organizational members participate in the plan’s compensation payout.

Common enterprise incentive plans include:

Profit sharing

Stock options

Employee stock ownership plans (ESOPs) – Stock plans in which an organization contributes shares of its stock to an established trust for the purpose of stock purchases by its employees

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Enterprise incentive plans reward employees on the basis of the success of the organization over an extended time period—normally a year, but the period can be longer.

Enterprise/Organizational Incentives: Profit Sharing Plans

Profit sharing – Any procedure by which an employer pays, or makes available to all regular employees, special current or deferred sums based on the organization’s profits

Profit sharing plans are intended to give employees the opportunity to increase their earnings by contributing to the growth of their organization’s profits.

Rather than just increasing rates of production, these contributions may be directed toward:

Improving product quality

Reducing operating costs

Improving work methods

Building goodwill

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Enterprise/Organizational Incentives: Employee Stock Plans

Stock option plan: Gives employees the right to purchase a fixed number of shares of company stock at a specified price for a limited period of time

Employee stock ownership plan (ESOP): Gives employees significant stock ownership in their organizations

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Microsoft: “We have an employee stock purchase plan (the "Plan") for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90% of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period.”

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Advantage and Disadvantage of Employee Stock Ownership Plans (ESOPs)

Advantage

Employers can provide retirement benefits for their employees at relatively low cost

ESOPs can increase employees’ pride of ownership in the organization, providing an incentive for them to increase productivity and help the organization prosper and grow.

Disadvantage

A major problem with privately held companies is their potential inability to pay back the stock of employees when they retire.

Retirement benefit tied to the firm’s future performance

Unlike traditional pension plans, ESOP contributions are not guaranteed by the federally established Pension Benefit Guaranty Corporation.

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Under an ESOP, employees do not actually buy shares; instead, the company contributes its own shares to the plan, contributes cash to buy its own stock, or, most commonly, has the plan borrow money to buy stock, with the company repaying the loan.

Advantages

Favorable tax treatment for ESOP earnings

Employees motivated by their ownership stake in the firm

Employees have a voice in important matters

Disadvantages

Wages and retirement benefit tied to the firm’s future performance

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Video Highlight

This video provides a brief profile of Publix Super Markets, which is the largest employee-owned company in the United States. A primary focus of the video is on the company’s employee stock ownership plan (ESOP).

“This Is the Largest Employee-Owned Company in the U.S.”

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Section 10.6c: Employee Stock Ownership Plans

VIDEO: This Is the Largest Employee-Owned Company in the U.S. (3:08)

This video provides a brief profile of Publix Super Markets, which is the largest employee-owned company in the United States. A primary focus of the video is on the company’s employee stock ownership plan (ESOP).

https://www.youtube.com/watch?v=HAbzddpFlvI

TOPICS/CONCEPTS: employee stock ownership plans, ESOP, enterprise incentive plans

**Levels of Variable Pay

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Incentives for Professional Employees

Offering incentives to employees conducting more specified tasks does not work for employees whose work is ambiguous, complex, and requires creative thought.

For professional employees, where the task is complex and the solution is not easy to figure out, it is important to motivate employees to be more creative.

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Things to Consider When Managing Professionals

Section 10.7: Incentives for Professional Employees

Although pay is still important, employers should incentivize employees based more on overall performance over time, and it should not limit them to a set of certain tasks. In other words, incentives should be based around the impact of someone’s work and not just that a certain task was completed. Figure 10.8 shows that such rewards should provide (1) autonomy to the worker, (2) opportunity to master a skill, and (3) purpose (e.g., helping to build a better organization, curing cancer, alleviating poverty).

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The Executive Pay Package

Executive compensation plans consist of five basic components:

Base salary

Executive base salaries represent between 30 and 40 percent of total annual compensation.

Short-term incentives

Annual bonuses represent the main element of executive short-term incentives.

Long-term incentives

Stock options are the primary long-term incentive offered to executives.

Benefits

Perks

Perquisites – Special nonmonetary benefits given to executives

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Design Issues for Performance-Based Incentives and Rewards

To be effective, incentive and reward systems must:

Specify and measure performance.

Specify the level of aggregation for reward distribution in the organization’s hierarchy.

Specify the type of reward.

Gain employee acceptance.

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Legal Considerations

Discrimination:

Must apply same decision rules to all employees eligible for the reward or incentive.

Employees protected by Title VII and Equal Pay Act.

Taxes and accounting rules:

There may be some unanticipated or unplanned tax consequences for employees.

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Like any employment decision, employers must make sure that incentives and rewards are equitably administered. If a group of employees are eligible to receive a reward, the criteria must be applied equitably across all employees in that group. Note that the criteria must be applied equitably, not equally. This does not mean that all employees should receive the same reward; the process, however, must be applied fairly and the outcomes distributed fairly, based on the set of performance standards set and achieved.

In addition, depending on employers’ choices of the types of incentives and rewards they offer, there may be some unanticipated or unplanned tax consequences for employees. For example, with incentive stock options, tax is deferred as long-term capital gains (15 percent) when the stock is actually sold by the employee. For employees with non-qualified stock options, the spread (i.e., the difference between the price at which the employee bought the stock and the current market value) is viewed as income and is treated as compensation, which is taxed at a rate higher than 15 percent. If the instructor is knowledgeable in this area, they could offer other tax and accounting issues that employers and employees might consider as they decide the mix of rewards.

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