Pros and cons of gainsharing

Media Library

CHAPTER 12 Media Library

PREMIUM VIDEO

HRM in Action Video

Incentive Pay

LICENSED VIDEO Video

Pay for Performance

Bonuses

image LEARNING OBJECTIVES

After studying this chapter, you should be able to do the following:

12-1. Discuss the major reasons why companies use incentive pay. PAGE 425

12-2. Identify the advantages and disadvantages of both individual and group incentives. PAGE 427

12-3. Briefly discuss options for individual incentives. PAGE 431

12-4. Briefly discuss options for group-based incentives. PAGE 439

12-5. Discuss the major reasons why incentive plans fail and the challenges involved. PAGE 443

12-6. Identify the guidelines for creating motivational incentive systems. PAGE 445

12-7. Discuss the issue of executive compensation and how the major provisions of the Dodd-Frank Act affect the issue. PAGE 449

12-8. Briefly discuss the question of whether incentives improve performance and some options available for incentivizing employees other than knowledge workers. PAGE 453

image CHAPTER OUTLINE

Incentive Compensation

Why Do We Use Incentive Pay?

Individual or Group-Based Incentives?

Individual Incentives

Group Incentives

Options for Individual Incentives

Bonus

Commissions

Merit Pay

Piecework Plans

Standard Hour Plans

Giving Praise and Other Nonmonetary Incentives

Options for Group Incentives

Profit-Sharing Plans

Gainsharing Plans

Employee Stock Ownership Plan (ESOP)

Stock Options and Stock Purchasing Plans

Failures and Challenges in Creating Incentive Pay Systems

Why Do Incentive Pay Systems Fail?

Challenges to Incentive Pay Systems

Guidelines for Creating Motivational Incentive Systems

Executive Compensation

Too Much or Just Enough?

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

Executive Incentives

Short-Term Versus Long-Term

The Goal of Executive Compensation

Trends and Issues in HRM

Does Incentive Pay Actually Improve Performance?

Comprehensive Pay and Incentive Programs Aren’t Just for Highly Skilled Employees

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Practitioner’s Perspective

Cindy reflects: Whether the economy is up or down, your star employees can always find another job. This keeps HR departments looking for ways to keep their best employees motivated and engaged in their positions.

One of Cindy’s colleagues, Terry, is a big advocate of incentive pay. “We need to look at ways to reward our exceptional employees now without expanding our base labor costs into future years,” Terry said at one of their strategy meetings. “I’ve seen evidence to support the case that employees work harder if they know they have a fair chance of being rewarded for that extra effort.”

“Well, I’ve heard lots of complaints against incentive pay,” says Bill, another member of their department. “I’m not sure we want to open our compensation program to those issues.”

Is incentive pay a good idea? The pros and cons plus the methods of implementation are detailed for your consideration in Chapter 12.

INCENTIVE COMPENSATION

LO 12-1

Discuss the major reasons why companies use incentive pay.

Chapter 11 provided an overview of compensation planning, so we now know that the HR department typically develops pay systems1 and that compensation is an important part of the HRM process.2 Recall for a moment the motivation theories that we discussed in that chapter. Incentive compensation takes advantage of both expectancy theory (where the employee expects a reward that matches their effort and performance) and equity theory (where that individual employee evaluates their rewards against others based on the amount of “input” effort that they provide). Incentives allow us to vary the reward based on the individual (or group) effort put into the work process. While we briefly discussed incentive pay in the last chapter, let’s get into some more detail on why we use incentives, what they are, their advantages and disadvantages, and why they might be successful in motivating our workforce.

HRM in Action Incentive Pay

SHRM HR CONTENT

See Appendix: SHRM 2016 Curriculum Guidebook for the complete list

A. Employee and Labor Relations

24. Promotion

25. Recognition

26. Service awards

K. Total Rewards

A. Compensation

5. Pay programs: Merit pay, pay-for-performance, incentives/bonuses, profit sharing, group incentives/gainsharing, balanced scorecard

15. Motivation theories: Equity theory, reinforcement theory, agency theory

B. Employee Benefits

18. Financial benefits (gainsharing, group incentives, team awards, merit pay/bonuses)

image

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Why Do We Use Incentive Pay?

Incentives, or variable pay, is compensation that depends on some measure of individual or group performance or results in order to be awarded. But why do we need variable pay? Isn’t it enough that our employees get a set amount of money each week or month in a paycheck from the organization? The simple answer is “Not always.” So to answer employees’ often unasked question What’s in it for me? companies develop incentive systems.3 People respond to incentives,4 and rewards and recognition are combined to create motivational incentive systems.5 The use of pay for performance rather than hours worked is the trend today.6

In Chapter 11, we identified which employees fit into which pay levels. We noted, though, that individual effort and performance levels can vary. That is why we have pay ranges in each level. We want to be able to reward our best employees so that they feel that they are being recognized.7Recognition is a highly motivational tool that we will discuss in some detail shortly.8 But pay levels only have so much flexibility built into them, so wewould sometimes like to have a tool that will allow us to provide greater rewards to thebest people in our organization. Managers like to use discretion in compensating employees.9 This is why we create incentives.10

SHRM

A:24

Promotion

What are we attempting to do when we provide employees with incentives? We are rewarding them for their past performance, but we are doing it in the hope that they will want similar rewards in the future and therefore will repeat the desired behaviors.11 It issimply a reinforcement process like the one we discussed when we covered learning theories in Chapter 7.

There is a second reason why we use variable pay in organizations. Variable pay moves some of the risk associated with having employees (and the associated payroll costs) from the firm to the individual. If the employee has variable pay that is tied to organizational productivity as part of their annual compensation, and the company (and therefore the employee) doesn’t do well in that year, the individual loses part of their pay. The company does not have to pay out as much in compensation when the organization’s performance in a given year is lower than expected. This effectively moves the risk associated with the incentive payment from the organization to the employee. If all annual compensation was provided in the form of base pay, we would still have to provide it to each employee, no matter how well the company did in a particular year. But if we have part of the annual compensation budget applied to variable pay, we don’t have to pay out as much in lean years.

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Our final reason for incentive pay ties into company strategy. We noted in Chapter 2 that “HRM is a critical component of meeting organizational goals, because without the right people with the right types of education, skills, and mind-set, we cannot expect to accomplish the objectives that we set for ourselves.” However, we can’t get the right people to accomplish organizational objectives without providing some incentives to do so.12 Incentive pay has to aim at the strategic goals of the organization in order to make any sense. Remember that people will not focus on attaining goals that we don’t emphasize as important, and we emphasize what is important by attaching incentives to the achievement of the goal. People respond to incentives and can nearly always be guided toward goals if we find the right incentives.13 Incentives are so important that they are one of the most written-about topics in management.14

INDIVIDUAL OR GROUP-BASED INCENTIVES?

LO 12-2

Identify the advantages and disadvantages of both individual and group incentives.

There are two basic choices in incentive pay—individual or group-based incentives. Groups can be small (a work cell of three people who assemble a computer) or large (an entire manufacturing plant or a call center), but all of these divisions are a bit artificial when it comes to incentive pay and, in fact, even the individual and group categories may cross. So in this text we will just divide incentives into individual or group options. You will see as we go through our incentive pay options that a lot of incentives can work in either an individual or a group setting. For example, bonuses have historically been provided as an individual incentive,15 but they can and are being used as group incentives as well.16 Let’s take a look at the advantages and disadvantages of each and when each option tends to work best.

Individual Incentives

Individual incentives reinforce performance of a single person with a reward that is significant to that person. What are some of the more common advantages and disadvantages of individual incentive plans for the organization? Let’s take a look at Exhibit 12-1 for a brief list.

ADVANTAGES OF INDIVIDUAL INCENTIVES

• Makes it easy to evaluate individual employees. Individual incentive programs, if designed correctly, make it easier to identify individual efforts. This is because performance goals will be set at the personal level, not the group or organizational level. If goals are reached, it will be due to individual efforts, not those of a larger organizational group.

• Offers the ability to match rewards to employee desires. Recall that expectancy theory (Chapter 11) shows the need to reinforce individual performance levels with rewards that are significant to the individual. Individualized incentives allow us to do this to a much greater degree than group incentives.

• Promotes the link between performance and results. Individual incentives provide a direct link between performance levels and the rewards received—pay for performance.17 A side benefit to this link is that we get equitable (fair) distribution of incentives; higher incentive payments go to those who perform at a higher level.

• May motivate less productive employees to work harder. Recall social learning theory: People learn by watching the consequences of others’ behavior (Chapter 7). Less productive employees who see others getting valued rewards for performance may be convinced to increase their own performance levels in order to get similar rewards.

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Exhibit 12-1 INDIVIDUAL INCENTIVE PLAN ADVANTAGES AND DISADVANTAGES

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DISADVANTAGES OF INDIVIDUAL INCENTIVES

• Many jobs have no direct output. We don’t have any way to directly measure results of some jobs in organizations. We discussed this in Chapter 8 when we discussed results-based performance appraisals. What is a measurable result on which we can base an incentive for most managers? How about equipment maintenance personnel or health care providers? It may be very difficult or even impossible in some jobs to identify individual output on which we can base an incentive.

• May motivate undesirable employee behaviors. If rewards are distributed based on personal performance levels, a perception of favoritism can be created if we don’t make clear why some are provided with greater incentives than others. Jealousy can occur because of this perception. Jealousy can then cause other problems, such as dysfunctional conflict or competition—and even sabotage if it is significant enough. Another problem is that even top performers may focus only on the items that are being measured for incentive payments. So we end up with a situation in which only the things that are rewarded get done. Everything else may be allowed to lag.

• Record-keeping burden is high. Individual incentive plans require that we keep track of individual efforts. Supervisors must develop and maintain comprehensive records to manage the program. This makes individual incentive programs much more time intensive than group incentives.

• May not fit organizational culture. Individual incentives may not be acceptable in team-oriented organizations or in societies in which the culture is highly collectivist. For example, in some Central and South American countries and in many countries in Southeast Asia, the national cultures do not condone the rewarding of individual efforts. In these societies, the team or group is what is valued, and therefore the team or group should be rewarded as a whole. In these situations, individual reward systems go against the norms of the employees and will likely cause significant backlash if implemented.

WORK APPLICATION 12-1

Select a job. Assess the advantages and disadvantages of offering incentives for your job and whether the criteria are met for individual incentives to be effective at motivating employees.

CRITERIA FOR INDIVIDUAL INCENTIVES. Individual incentive plans work best in the following circumstances:18

• When there are distinct, measurable outcomes for individual efforts. If we can isolate individual results, individual incentives can work. If not, they won’t be very effective at motivating employees.

• When individual jobs require autonomy. In some jobs, autonomy is a necessary condition, because a group effort may just cause confusion or unnecessary conflict. Individual effort is almost always necessary in one-to-one sales situations, for instance. Or think about your professor. Is at least some part of teaching an individual effort on the part of the professor?

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Exhibit 12-2 GROUP INCENTIVE PLAN ADVANTAGES AND DISADVANTAGES

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Group Incentives

Individual incentive programs obviously work well in some cases. However, group incentives tend to work better in a number of other situations. CEO Alan Mulally said, “We’re aligning compensation with the success of Ford.”19 Group incentives provide reinforcement for actions of more than one individual within the organization. What are the advantages and disadvantages of group incentive plans? See Exhibit 12-2 for a list.

ADVANTAGES OF GROUP INCENTIVES

• Promotes better teamwork. Group incentives, to no one’s surprise, tend to encourage higher levels of teamwork and group cohesiveness. They can foster loyalty and trust between group members. Rewarding members for successfully working within the group creates an enticement to perform in ways that improve group outcomes, not just individual outcomes.

• Broadens individual outlook. Recall the discussion of the job characteristics model in Chapter 4. When we broaden the individual’s job by giving them more and different things to do, we can ultimately increase motivation and productivity. By allowing employees to see how their actions affect others, we create positive psychological states that improve performance. Group incentives encourage this type of understanding because the employee has to know what others are doing and how one’s individual efforts affect each of the members of the group.

• Requires less supervision. Group incentives, at least in some cases, tend to require less supervision. This is due to the tendency for the group to police its own members when they are not performing as well as they can. The “social loafers” in the group will feel pressure to improve their efforts from others in the group who are performing up to standards.

• Is easier to develop than individual incentive programs. Developing incentive programs for groups is less difficult than creating separate incentives for each individual in the organization. We can cover entire segments of the workforce with one set of incentives in many cases, and we may be able to design just a few different incentive program options that will motivate most of our employees.

DISADVANTAGES OF GROUP INCENTIVES

• Social loafing can occur. Social loafers (or free riders) may be able to stay hidden within the group while allowing others to do the majority of the group work. Social loafers avoid providing their maximum effort in group settings because it is difficult to pick out individual performance. This social loafing, if left uncorrected, can cause group morale and ultimately motivation and performance to drop significantly. If you want to learn more about social loafing, search the Internet for the “Ringelmann effect.”

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12-1 APPLYING THE CONCEPT

Individual Incentives

Identify each statement by placing the letter of its advantage or disadvantage on the line next to it.

Advantages

a. Easy to evaluate individual employees

b. Ability to match rewards to employee desires

c. Promotes the link between performance and results

d. May motivate less productive employees to work harder

Disadvantages

e. Many jobs have no direct output

f. May motivate undesirable employee behaviors

g. Record-keeping burden is high

h. May not fit organizational culture

____ 1. The HR staff offered me a few different gifts for my top performance, but I took the cash.

____ 2. The old compensation system without incentives was easier. Now I have to keep track of everyone’s performance.

____ 3. The new incentive system will be easy for me because all my employees are sales reps and we already keep track of each sale.

____ 4. I just do the minimum required for my job. If I want more compensation, I will just have to produce more to earn more.

____ 5. I’m a new high school teacher, and I’m very concerned about how the administration will assess my teaching in order to award tenure.

• Individual output may be discounted. Individual effort and results may get “lost” in the group. Some individuals may feel as if they are providing most of the group’s effort, while others take a “free ride.” Therefore, they may hold back their efforts and commitment,20 especially when the relationship with other group members is not good.21

• Outstanding performers may slacken efforts. If the group is highly cohesive and has low performance norms, individual high-level performers may be pressured to lower their output to conform to group norms. Peer pressure can operate on the individual member to force them to stay within the performance boundaries of the rest of the group.

• Group infighting may arise. There might be a breakdown of communication and/or cooperation among individuals within the group, and they might begin to compete with each other instead of cooperating. High-performance group members may even sanction or coerce low-performance group members to provide greater effort.

WORK APPLICATION 12-2

Select a job. Assess the advantages and disadvantages of offering incentives for your work group and whether the criteria are met for group incentives to be effective at motivating employees.

CRITERIA FOR GROUP INCENTIVES. Group incentive plans work best in the following circumstances:22

• When we need people to cooperate.When a group effort is necessary in order to optimize an outcome or to produce organizational goods or services, group incentives are far more powerful than individual incentives.

• When individual contributions are difficult to identify. When an activity requires the work of many individuals, all doing their part of the job, it may be difficult orimpossible to identify how important one individual’s contribution is compared to that of others in the group. Think about a team designing software: Did the interface engineer do more than the programmer, or vice versa? It may be impossible to tell.

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12-2 APPLYING THE CONCEPT

Group Incentives

Identify each statement by its group advantage or disadvantage.

Advantages

a. Promotes better teamwork

b. Broadens individual outlook

c. Requires less supervision

d. Is easier to develop than individual incentive programs

Disadvantages

e. Social loafing can occur

f. Individual output may be discounted

g. Outstanding performers may slacken efforts

h. Group infighting may arise

____ 6. What happened? Latoya and Katie used to get along so well. Now they are constantly bickering.

____ 7. Katrina, you are not being fair to the rest of us by not doing your fair share of the work.

____ 8. Now that we use a team-based process, the manager doesn’t check up on us like she used to.

____ 9. By assembling the product as a team, we actually increased production by 20%.

____ 10. I know I’m the best, but none of the department members work very hard, so why should I?

LO 12-3

Briefly discuss options for individual incentives.

• When group members possess either similar or complementary skills. If group members all have similar skill levels (think about comparable worth from Chapter11), it may be difficult to determine whose efforts are more significant in creating the desired results. Similarly, if group members complement each other’s skill sets, it may be impossible to say that one set of skills was more important than others.

SHRM

K:A5

Pay Programs

OPTIONS FOR INDIVIDUAL INCENTIVES

Many different potential incentive programs can be used to meet the award needs of every individual.23Remember, each person has to consider the incentive to be significant or it won’t act as a mechanism to motivate that individual to increase their performance. Because of this, sometimes the best thing to do is ask the members of the organization what they want.24 However, some rewards have become commonplace partially because we as managers believe that they work, at least in some cases. Exhibit 12-3 summarizes some of the more common incentive options. In this section we discuss the individual option, while group incentives are presented in the next section.

Exhibit 12-3 INDIVIDUAL AND GROUP INCENTIVE OPTIONS

image

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Luke Sharrett/Bloomberg via Getty Images

Restaurant servers have an incentive through tipping. Darden Restaurants, which operates Olive Garden and Red Lobster, enforces a tip-sharing policy so that servers share tips with bussers and bartenders.

We noted earlier that individual incentives work best when we can isolate individual efforts and when jobs require autonomy. There are six common options for individual incentive programs that are used in a wide variety of organizational settings. Let’s take a brief look at each of these six incentives used to reward individual employee performance.

Bonus

A bonus is a lump sum payment, typically given to an individual at the end of a time period.25 A bonus does not carry over from one period to the next. Over what type of period do we usually provide bonuses? Generally they will be provided annually. Many companies will call them a “seasonal bonus,” “holiday bonus,” or “year-end bonus” or something similar. How would a bonus program have to be designed in order to motivate increased performance? We would need to identify specific and measurable goals that the individual could affect and a bonus that would cause the individual (assuming we are making this an individual incentive program) to change something that they are doing to perform at a higher level.26 If they then reached the measurable goal, they would receive the bonus.27 Bonuses can also be used at the group level but are generally considered an individual incentive.

INEFFECTIVE BONUS IMPLEMENTATION. Let’s look at how motivational the “year-end bonus” is in most companies—remember that we are talking about things that are supposed to be incentives to perform at a higher level! Three years ago, because the company was doing well, senior management decided to provide a bonus at the end of the year to all employees. Joanna received a $3,000 bonus based on her pay level at the time. Two years ago, she again received $3,000 at the end of the year (because the company was doing well). The same thing happened last year, but then this year she received no bonus. Management explained that new competitors and technologies had hurt company performance and, as a result, there would be no bonuses provided at the end of the year. But Joanna had worked hard all year expecting to receive her bonus at year end. How do you think Joanna feels? Is she frustrated and demotivated? Wasn’t a bonus supposed to do the opposite—make her feel like she wanted to perform better?

EFFECTIVE BONUS IMPLEMENTATION. However, to use a bonus as it was originally designed and should be used, what should we do? We create a specific, measurable, and attainable goal that the individual has control over and communicate that goal to the employee. Thegoal is continuously measured during the performance period, and that measurement is communicated to the employee so they know where they stand. When the individual meets the goal, the bonus payment is provided—immediately, not at the end of the year.29 The reward is applied for doing more than was required—it was a bonus! Now, the bonus can act as an incentive to perform. So the biggest problem with a bonus as an incentive is in allowing it to become a time-based entitlement instead of a performance incentive.

WORK APPLICATION 12-3

Select a job. Does the organization offer bonuses? If not, how could it offer bonuses to effectively motivate employees? Assess the advantages and disadvantages of offering bonuses at your organization. Should it offer bonuses?

What did management do wrong? First, they provided the bonus based on a period of time, not based on meeting a performance goal. Reinforcement theory says that variable reinforcement works much better than fixed reinforcement.28 The end of each year is a fixed reinforcement period. That is one error on the part of the managers. What else did they do wrong? What individual goal did they base the bonus on? They didn’t base it on individual results but on company performance, so the employees most likely did nothing different than they had done in the past. In addition, the individual employees most likely have no idea how to affect the overall performance of the company because nobody explained the relationship between their actions and organizational success. Third, because the bonus had been provided on the fixed schedule, as soon as management provided it to the employees twice, the employees started to expect it. It became an entitlement, or something that they felt the company owed them because it had been provided in the past. As soon as the bonus became an entitlement (you owe me), it ceased to motivate any additional performance on the part of employees. This is historically how most companies use a bonus payment. And if we use it this way, it just becomes an expected part of your annual pay.

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In the global competitive environment, many businesses are giving bonuses effectively to keep valuable employees from leaving for other companies. Most bonuses of this type will typically be paid out over several years based on performance goals. Technology companies are closely looking at their top 10% of performers and asking themselves, Are they locked in? What can we do to keep them? Google awarded a $5 million bonus package to a top engineer to keep him from leaving for a job with a start-up firm.30

Commissions

Commissions are well-known incentive tools for sales professionals. A commission is a payment typically provided to a salesperson for selling an item to a customer and is usually paid as a percentage of the price of an item that is sold. If you sell a $100 product and you are on a 10% commission, you would receive $10 for that sale. Salespeople sometimes work on straight commission, where they only get paid when they sell an item, orthey can be paid a salary plus commission, where they receive a lower salary and it is supplemented by commissions on sales. Commissions can also be used at the group level in some cases. In general, commissions are good individual incentives to sell.31

image

Daniel Acker/Bloomberg via Getty Image

Real estate agents are paid on commission. It takes the right type of employee to be successful on commission pay.

INEFFECTIVE COMMISSION IMPLEMENTATION. Are commissions sometimes ineffective as individual incentives? If not implemented correctly, they can certainly be unproductive and maybe even harmful. The salesperson may ignore the customer’s needs or desires in order to sell something that makes the salesperson more money. If the salesperson gets the customer to buy something they didn’t really want, it may harm the long-term relationship between the company and the customer. The company can also create too much competition within the sales force if the commission structure isn’t set up right. We may create dysfunctional conflict among members of the sales force or even motivate one salesperson to sabotage another in order to make the sale themselves.32 Overall, however, commissions are a strong incentive to perform well in a sales role.

EFFECTIVE COMMISSION IMPLEMENTATION. In order for a commission incentive program to work, it must provide a significant return to the salesperson who is successful in selling to the customer, but it also has to provide a disincentive to harm the customer, or the company, to make a “quick sale.” You may have noticed that more automobile dealerships are now using customer satisfaction surveys after a customer buys a vehicle.33 What they are trying to do is determine whether the salesperson may have done anything to damage the long-term relationship between the customer and the company. In some cases, dealers are even making customer complaints part of their commission structure so that if a salesperson gets too many complaints, part of their commissions will have to be reimbursed to the dealership.

Merit Pay

The next incentive option is called merit pay. Merit pay is a program to reward top performers with increases in their annual wage that carry over from year to year. Merit pay is different from most other individual incentives in that if an individual gets merit pay increases consistently over time, their annual pay can become significantly greater than that of others who do not consistently get merit increases.34

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Merit pay works as follows: The company announces a “merit pool” available for pay increases in a given period, usually annually. The merit raises will be given to the top performers in the company based on performance evaluations. Frequently, individuals who receive either outstanding or excellent marks will get merit increases above the average, while average performers will get a lower raise, and those who receive below-average marks will get no raise at all.

WORK APPLICATION 12-4

Select a job. Does the organization offer commissions? If not, how could it offer commissions to effectively motivate employees? Assess the advantages and disadvantages of offering commissions at your organization. Should it offer commissions?

INEFFECTIVE MERIT PAY IMPLEMENTATION. There are some significant potential problems in using merit pay as an incentive. The first issue is that merit pay is typically a very small percentage of the individual’s total pay, which makes it very difficult to use it as a motivator to perform. Remember that people need to feel that the reward is “significant” to them in order for it to motivate. In many cases, merit raises may amount to only an extra 1% of pay in any given year. Many employees won’t consider this significant.

Another major issue is inflation of the performance appraisal process. If the company does not set limits on how many employees can be judged as outstanding or excellent, and supervisors know that a pay increase is attached to the individual’s performance rating, nearly everyone tends to become outstanding or excellent.35 While we know this is not true, the supervisor doesn’t want to be the person to keep someone in their department from getting a pay raise. Also, when you limit the number of people who can get a merit raise in any given year, sometimes the manager rotates who will get merit pay, rather than rewarding the best performers, to keep the majority happy.

In order for merit pay to be valuable as an incentive, it must be significant, which means it must be more than 1% of the employee’s pay. However, there is another problem here. Remember that merit pay increases the individual’s pay from one year to the next and it carries forward, so if merit pay is 5% to 10% instead of 1% to 2%, we can end up with employees who break right through our maximum wage for a specific pay level very quickly. If we had a pay level (from Chapter 11) that began at $12 per hour and went to $16 and an employee was hired with a base pay of $12, they could “max out,” or reach $16 per hour, in only 3 years if they received a merit raise of 10% each year. So merit pay is difficult to use as an incentive to perform at a higher level.

WORK APPLICATION 12-5

Select a job. Does the organization offer merit pay? If not, how could it offer merit pay to effectively motivate employees? Assess the advantages and disadvantages of offering merit pay at your organization. Should it offer meritpay?

EFFECTIVE MERIT PAY IMPLEMENTATION. Merit pay is one of the most frequently used individual incentive programs in companies, and it can be used in some team-based situations as well.36 It requires that we pay attention to some details though. The first and probably most important item that HR needs to develop for a merit pay program is material that communicates the value of merit pay over time. We need to communicate that even what would normally be considered a small incentive can become a significant boost to an individual’s pay when they are judged to have merit over several years. For instance, if we have a merit raise each year of only 2%, because of compounding, this becomes an additional permanent increase in the pay of an individual employee of nearly 10.5% above cost-of-living increases if received for 5 years. Over the employee’s entire work life, this will make a huge difference in total wages earned. So HR needs to communicate the value of merit pay better than has historically been the case.

Secondly, we only want to reward true top performers with merit pay. If we do so, this means that those who are rewarded are truly recognized as having exceptional ability, and it also means that limited amounts of merit pay cash can provide a larger merit increase to those who deserve it. Alternately, if we provide all employees with merit raises, the pool of funds must be spread out among everyone, and the small amount of the supposed “merit” increase doesn’t amount to much. Let’s look at a quick example.

If your company has 1,000 employees and the annual payroll is $60 million, and the leadership decides to provide a 2% merit pool for the coming year, that is $1.2 million inavailable dollars for merit increases. If we spread that money evenly over all 1,000employees, each employee receives an increase in pay of about $100 per month. However, if we truly identify the individuals who are meritorious and limit our payout to the top 30% of the employee group, each individual receives an average merit raise of about $350per month. Most of us would consider an extra $350 per month to be significant, while $100 is probably not significant to many of us. So if we give “all As” to our employees and say that everyone is meritorious, our actual top performers are demotivated because their efforts aren’t being recognized, and nobody in the employee group considers the reward to be significant because it is too small to make much difference in their lives.

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Piecework Plans

Piecework or piece-rate plans are among the simplest forms of compensation, and they can act as an incentive to produce at a higher level because the more workers produce, the more they get paid. In a “straight piece-rate” compensation system, the employee gets paid for every “piece” that they complete. If they are faster than the average, they can make more money than other employees.37 A “differential piece-rate” system (sometimes called a Taylor plan after Frederick Taylor of scientific management theory fame) provides the employee with a base wage to complete a certain amount of work, and if they produce more than the standard, a differential wage is paid for the extra pieces produced. In either case, the employee is being paid for increased speed. Take a look at Exhibit 12-4for an example of a piece-rate system.

INEFFECTIVE PIECEWORK IMPLEMENTATION. Are there any problems associated with a piecework incentive program? There is an obvious one—quality.38 If we pay employees “by the piece,” they may make lots of pieces with lots of quality problems because they are trying to work too fast and not paying attention to how well they are doing the work. So quality is an issue in a piece-rate system. There may also be a problem in determining where the standard is going to be set for a differential piece-rate system, and there are other potential problems.

WORK APPLICATION 12-6

Select a job. Does the organization offer piecework? If not, how could it offer piecework to effectively motivate employees? Assess the advantages and disadvantages of offering piecework at your organization. Should it offer piecework?

EFFECTIVE PIECEWORK IMPLEMENTATION.However, in some situations, a piecework plan can be an incentive to produce at a faster rate. The obvious answer to potential quality problems is to set clear standards that each piece must meet to be accepted and paid for. Thus, if the employees don’t do a quality job, they don’t get paid. Clear standards tell the employee what they need to do in order to benefit from the piecework pay schedule. If they will not be given credit for items that don’t meet quality standards, they need to know this up front. If they will have to rework any items that aren’t correct, they need to know this, too. They also know that they don’t have to “hit a moving target” if the standards are clear from the beginning—that the company isn’t going to just lower the amount paid per piece in order to pay the employees what they have always been paid.

The other key to effective piecework plans is feedback. Employees need to know how they are doing as they go through the workweek. In some cases, they may see that they are not meeting their own goals of performance and pick up the pace, and in others, they may see that their performance is producing a desired result. Many people expect that once the employee reaches a level of production that provides them with an acceptable wage, they will slow down, but there is very little evidence that this occurs in more than isolated cases. Feedback gives the employees information about the “significant reward” that they seek and can motivate continued performance—just as expectancy theory shows.

Standard Hour Plans

Standard hour plans are used quite a bit in some types of service work. In a standard hour plan, each task is assigned a “standard” amount of work time for completion.39 Generally, this time will be shown in a standard-hour manual. The individual doing the job will get paid based on the standard time to complete the job, but good workers can frequently complete the work in less than the standard amount of time. If they do, they can get paid for an hour of work while working less than an hour of time. Take a quick look at Exhibit 12-5 for two examples of a standard hour plan. In many cases, good service employees can do better than the standard most of the time, so they get an incentive to work faster.

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Exhibit 12-4 PIECE-RATE PLANS

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INEFFECTIVE AND EFFECTIVE STANDARD HOUR IMPLEMENTATION. Like the piecework plan, standard hour incentives can cause quality problems. So most standard hour plans also require that if there are any quality problems, the job has to be redone; the worker must do the rework for no additional pay. This is one way to make sure that speed doesn’t create poor quality. Standard hour plans, like most individual incentive programs, can be used for groups if the group is responsible for completion of the work.

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Exhibit 12-5 STANDARD HOUR PLAN

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Standard hour plans are used heavily in automotive and heavy equipment repair and in other areas, like heating and air-conditioning services. The biggest challenge with standard hour plans is creating the manuals showing the allowable time for a job. We have to have a large baseline measuring the amount of time necessary to perform specific tasks in order to figure out the average time needed to do a particular job. We can only do this in jobs where the same task is done many times in a year. We also need to keep an ongoing record of the actual times to do the jobs so we can adjust the standards accordingly and not over- or underpay for each job.

Giving Praise and Other Nonmonetary Incentives

WORK APPLICATION 12-7

Select a job. Does the organization offer a standard hour plan? If not, how could it offer a standard hour plan to effectively motivate employees? Assess the advantages and disadvantages of offering a standard hour plan at your organization. Should it offer a standard hour plan?

People work for money, so financial rewards are critical, but just as important is recognition for the work we do.40 Employee recognition leads to profits,41 so both financial and nonfinancial rewards and recognition are important to motivate employees to meet objectives and put their ideas into practice.42 Nonmonetary recognition can come in many forms (e.g., service awards), but evidence says that honest praise is one of the most effective motivational tools that management has at its disposal.43

INEFFECTIVE RECOGNITION IMPLEMENTATION. Wait just a minute! Service awards—things like Employee of the Month—are motivators? How often is an award such as employee of the month just rotated among the employees? In such a case, is it a motivator, or is it a joke? It is a joke if not used correctly, because everyone knows that there are no criteria that the employee must meet in order to become “employee of the month.” So how do we make an employee-of-the-month award a valuable incentive?

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SHRM

A:26

Service Awards

EFFECTIVE RECOGNITION IMPLEMENTATION. Remember that recognition is a powerful incentive, so we need to use it effectively to motivate our employees. In order for this type of recognition to mean something, there has to be a specific set of criteria that must be met in order to receive the recognition. The employee has to do something extra, above what others do, in order to be recognized.44

How many of you have seen a military awards ceremony at which service members receive meritorious awards? Why do military services all over the world perform these ceremonies? It takes a lot of time and man-hours to do so. The ceremonies are carried out to recognize special efforts by service members, because the officers in charge know that other service members will see such ceremonies and (through social learning!) determine that they can perform at a higher level in order to also receive an award.

If service awards have strong requirements for eligibility, they can become a powerful motivational factor in any workforce. So if our company has an employee-of-the-month or -year program, it needs specific and measurable criteria, clearly communicated to theworkforce, that require performance above the company’s standards in order to be eligible for the award. If this is done, these awards can become excellent motivators.

SHRM

A:25

Recognition

PRAISE AS RECOGNITION. Empirical research studies have found that feedback and social reinforcers (praise) may have as strong an impact on performance as pay. Tom Gimbel, CEO of LaSalle Network and one of the INC. “Best Workplaces 2016,” believes this wholeheartedly. He constantly talks with his employees, and says “I may say the wrong thing sometimes, but I’m never going to have somebody leave here for something I did not say. People want to be appreciated.”45

Praise actually works by boosting levels of dopamine in the brain, a chemical linked to joy. In the 1940s, a survey revealed that what employees want most from a job is full appreciation for work done. Similar studies have been performed over the years with little change in results. Employees want to know that their organization values their contributions and cares about their well-being.46Giving praise is simply complimenting theachievements of others,47 and this recognition increases performance.48 It costs you nothing to give praise,49 involves very little effort, and produces a lot in return.50 It is probably the most powerful, simplest, least costly, and yet most underused motivational incentive there is.

WORK APPLICATION 12-8

Select a job. Does the organization offer a recognition plan? If not, how could it offer a recognition plan to effectively motivate employees? Assess the advantages and disadvantages of offering a recognition plan at your organization. Should it offer a recognition plan?

Ken Blanchard and Spencer Johnson popularized giving praise back in the 1980s through their best-selling book The One-Minute Manager. They developed a technique that involves giving 1 minute of positive feedback. Model 12-1: The Giving Praise Model, is an adaptation. Blanchard called it “one-minute praise” because it should not take more than 1 minute to carry out. It is not necessary for the employee to say anything. The four steps are described and illustrated in Model 12-1.

Step 1: Tell the employee exactly what was done correctly. When giving praise, look the person in the eye. Eye contact shows sincerity and concern. It is important to be very specific and descriptive.51 General statements like “You’re a good worker” are not as effective. On the other hand, don’t talk for too long or the praise loses its effectiveness.

Step 2: Tell the employee why the behavior is important. Briefly state how the organization and/or person benefits from the action. It is also helpful to tell the employee how you feel about the behavior. Be specific and descriptive.

MODEL 12-1 THE GIVING PRAISE MODEL

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Step 3: Stop for a moment of silence. Being silent is tough for many managers. The rationale for the silence is to give the employee the chance to “feel” the impact of the praise. It’s like “the pause that refreshes.” When you are thirsty and take the first sip or gulp of a refreshing drink, it’s not until you stop and maybe say “Ah” that you feel your thirst quenched.

Step 4: Encourage repeat performance. This is the reinforcement that motivates the employee to continue the desired behavior.52 Blanchard recommended touching the employee because it has a powerful impact. However, he recommends doing this only if both parties feel comfortable. Others recommend that you don’t touch employees, as physical contact could lead to a sexual harassment charge.

WORK APPLICATION 12-9

Select a job. How often does your boss criticize your work? How often does your boss praise your work? What is the last thing you did that deserved praise? How often do you criticize and praise others at work? Will you now give more praise, knowing how it affects others?

As you can see, giving praise is easy, and it doesn’t cost a penny. Managers trained to give praise say it works wonders. It’s almost always a much better motivator than giving a raise or other monetary rewards.53

Other nonmonetary recognition, besides praise, also increases motivation if the individual considers it to be significant.54Some of the more common forms are extra time off, ability to choose tasks or jobs, flexible hours, or extra training in a particular area of interest to the employee. Younger workers, especially, often want more flexible hours and working conditions.55

OPTIONS FOR GROUP INCENTIVES

LO 12-4

Briefly discuss options for group-based incentives.

Individual incentives can work well, but what can we use to motivate higher levels of performance from groups? After all, in most of our 21st-century companies, groups and teams are the norm. Let’s take a look at some of the more common group incentive options.

Profit-Sharing Plans

Profit-sharing programs provide a portion of company proceeds over a specific period of time(usually either quarterly or annually) to the employees of the firm through a bonus payment. The programs are designed to cause everyone in the company to focus on total organizational profitability.56 This sounds like a good opportunity for the employee to get a share of the returns that the company receives from their work, right? But how well does it work? What if the company does not have any profit during a particular period? If this is the case, then there is no profit to be shared.

SHRM

K:B18

Financial Benefits

INEFFECTIVE PROFIT SHARING IMPLEMENTATION. If the company doesn’t have any profits, employees may not be motivated to work harder. But how can a company have no profit? It is actually pretty easy for the company to have no profit, or a minimal amount of profit, in any given year.

The company can, and frequently does, manipulate net profit in many ways in order to pay less in tax on corporate profits at the end of the year, and in some cases to minimize profit sharing. Management might put profits back into the company by buying new equipment or other assets. It can decide to pay management an unscheduled bonus, acquire another business, or increase finished goods inventory. However, if the company is manipulating expenses or other cost factors to decrease profit sharing and employees find out, the plan will certainly not be a performance motivator and most likely will cause other problems.

Another issue with profit sharing as a motivator is that it is focused on total organizational profitability. How can the average employee affect company-wide profitability? If the employee doesn’t know what to do in order to increase profits, what will they do differently in their job? The answer is “absolutely nothing.” Remember that we need to be able to personally affect the desired result in order to be motivated to do anything different. So profit sharing in many cases does not provide the company with the expected boost in productivity.57

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12-3 APPLYING THE CONCEPT

Individual Incentive Options

Place the letter of the individual incentive on the line next to the scenario illustrating it.

a. bonus

b. commissions

c. merit pay

d. piecework

e. standard hour

f. nonmonetary awards

g. praise

____ 11. I’m an auto mechanic at a dealership, and we have a set amount of time to complete each type of repair work. I complete a job before a stated time so that I can go on to the next car and get paid extra for being faster than the average guy.

____ 12. I just sold that top-of-the-line BMW M3. I can’t wait to get my pay this week.

____ 13. I’m the top producer in the entire department, so I will get an extra raise for high performance this year.

____ 14. The boss had me come to the front of the room at the annual meeting to get a plaque for 5 years of service to the company. She listed some of my major accomplishments.

____ 15. The boss just thanked me for getting a shipment that was behind schedule out on time today.

WORK APPLICATION 12-10

Select a job at a for-profit company. Does the organization offer profit sharing? If not, how could it offer a profit-sharing plan to effectively motivate employees? Assess the advantages and disadvantages of offering profit sharing at your company. Should it offer a profit-sharing plan?

EFFECTIVE PROFIT SHARING IMPLEMENTATION. To motivate employees, we need to be sure that management is not manipulating factors to minimize profits so it doesn’t have to pay much in profit sharing. The second thing is to be sure to train all employees on how to increase revenues and decrease cost in their job areas so that they can affect the bottom line and increase their profit share. In addition, a running record of organizational revenues and profitability should be maintained and updated on at least a weekly basis. This record should be posted where everyone can see it and keep track of company performance—some companies post it in the lunch/break room. This allows the employees to see how their efforts are affecting profitability of the firm overall. It can also allow interim payments of incentives, which can assist the company in maintaining high worker efficiency over longer periods of time.

Gainsharing Plans

An alternative to profit sharing is a gainsharing program. Gainsharing is similar to profit sharing because in each case, the gain (in either profit or some other factor) is shared with the employees who helped to create the gain. Gainsharing is a bit broader than profit sharing though. Gainsharing can be accomplished using any organizational factor that costs the company money and that can be analyzed and modified for performance improvement.58 Originally, gainsharing usually used corporate revenue, but today, many gainsharing options exist. Some of the more common gainsharing options are increased revenues, increased labor productivity or lower labor costs, improved safety (fewer lost-time accidents), return on assets or investment, and increased customer satisfaction.

WORK APPLICATION 12-11

Select a job. Does the organization offer gainsharing? If not, how could it offer gainsharing to effectively motivate employees? Assess the advantages and disadvantages of offering gainsharing at your firm. Should it offer a gainsharing plan?

INEFFECTIVE AND EFFECTIVE GAINSHARING IMPLEMENTATION. Being somewhat similar to profit sharing, gainsharing has the same potential problems. Here, as with profit sharing, we have to show employees how they can affect the desired outcome in order for them to be motivated to change the way they work.59 However, different from profit sharing, many of the options for gainsharing are more difficult for management to manipulate, so workers feel that they have more control over their results. It is tougher for management to modify total revenue or days lost to accidents, for instance, than it is to modify net profit. So gainsharing sometimes initiates a stronger reaction and more motivation from the workforce than profit sharing.

How do we incorporate gainsharing effectively in the organization? It’s pretty straightforward but easier said than done. Here is the process. We establish the objective(s), identify the performance measure (usually as a per-unit value), determine how to split the gain between the organization and the employees, and then provide the payout when earned.

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WORK APPLICATION 12-12

Select a job at a for-profit company. Does the organization offer ESOPs? If not, how could it offer an ESOP to effectively motivate employees? Assess the advantages and disadvantages of offering ESOPs at your company. Should it offer an ESOP?

Employee Stock Ownership Plan (ESOP)

An employee stock ownership plan (ESOP) ultimately allows at least part of the stock in the company to be provided to the employees over a period of time based on some formula.60 For example, if you work for the company for a year, you might get 10 shares of stock, and for every additional year of employment, you would receive 10% more than the year before. An ESOP is actually a retirement benefits plan because the company putsthe tax-deferred stock in a trust for eventual use by employees who retire. But it also has the potential to be an incentive to the company’s employees, because they become part owners of the firm.

Why would the current owners of the firm give away stock in the company? Well, there are a couple of major reasons. Because an ESOP is basically a “qualified” retirement benefits plan, it has some significant tax advantages to both the firm and the employee in most cases.61 This means that owners can give their employees part of the company and receive a tax break for doing so. A second major reason for giving employees stock in the company is to cause them to act more like owners. It is thought that this will motivate employees to do such things as reduce scrap, increase quality, improve customer service, and pay attention to many other things that cost the company money over the course of ayear.

INEFFECTIVE AND EFFECTIVE ESOP IMPLEMENTATION. But does an ESOP always work as intended? Of course not. Because an ESOP is like the other two group incentives, it is subject to the same potential problems and requires the same lack of manipulation and employee training.

Stock does, however, have a unique potential problem. The entire company typically has to improve in order for the value of its stock to increase. But even if the employees are highly motivated and work really hard, the value of the stock can actually go down for many reasons that are outside the control of the individual and groups. For example, a recession may hit and sales and profits may go down, as well as the price of your stock. Competition can take some or all of your business away, as Netflix did to Blockbuster, or the company can go bankrupt as Hostess did, and you can lose it all.

12-4 APPLYING THE CONCEPT

Group Incentive Options

Place the letter of the group incentive option on the line next to the matching description.

a. profit sharing

b. gainsharing

c. ESOP

d. stock options

e. stock purchasing

____ 16. Our group incentive option gives us a bonus at the end of the year based on how profitable we were for the year.

____ 17. Our group incentive option plan allows me to get stock and put it in my retirement account without paying anything for it.

____ 18. Our group incentive option plan worked like this. The manager told us that if we could cut cost in our department by 5%, as a group we would get 5% of the savings to the company distributed evenly among us.

____ 19. Our group incentive option allows me to buy company stock for 10% less than the market value.

____ 20. Our group incentive option plan allows me to buy $50 shares of the company stock for only $13 apiece next year.

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Stock Options and Stock Purchasing Plans

There are two other common stock plans used by companies as incentives. The first is a stock option plan, and the second is direct stock ownership.

STOCK OPTIONS. Stock options are usually offered to an individual employee to allow them to buy a certain number of shares of stock in the company at a specified point in the future, but at a price that is set when the option is offered.62 Options can be provided either to executives or to nonexecutive employees.63 So, we might offer our employees the option to buy stock in the company in a year at today’s stock price.

WORK APPLICATION 12-13

Select a job at a for-profit company. Does the organization offer stock options and/or stock ownership? If not, how could it offer one or the other to effectively motivate employees? Assess the advantages and disadvantages of offering stock options and stock ownership at your company. Should it offer stock options and/or a stock ownership plan?

The intent here is to motivate the employees to work to improve the value of the company so that when the option to buy the stock comes up in a year, the price of the stock has increased, giving the employee more value than what they paid for. For example, we may offer our employees the option to buy 100 shares of our stock in 1 year at today’s price of $10. If the company’s value increases so that at the end of the year, a share of stock is worth $20, the employee can buy $2,000 worth of company stock for $1,000. However, if the value of the stock doesn’t go up in a year, the option isn’t worth anything.

STOCK PURCHASING. These plans are similar to stock options, but instead of giving you the option to buy stock in the future, they let qualifying employees buy the stock essentially anytime, usually at a discount. ESOPs, stock options, and stock purchasing give employees ownership in the company, but the big difference is that with an ESOP, the employees are given the stock over time, whereas with stock options or purchases, employees have to buy the stock.

12-1 SELF ASSESSMENT

Compensation Options

Answer each question based on how well it describes you:

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____ 1. I enjoy competing and winning.

____ 2. I usually work faster than others.

____ 3. I like working alone more than being part of a group.

____ 4. I don’t need to have approximately the same pay every week; varying income is fine.

____ 5. I enjoy meeting new people and can strike up a conversation with most people.

____ 6. I take risks.

____ 7. I would prefer to get a large sum of money all at once rather many smaller payments.

____ 8. I’m thinking long term for my retirement.

____ 9. I like working toward a set of goals and being rewarded for achieving them.

____ 10. I like knowing that I am one of the best at what I do (merit pay and praise).

There is no simple sum to add up here. Although we would all love to have a high wage or salary with lots of incentive pay on top of it, this is not the reality in most jobs today. In general, the higher your number of “describes me” statements, the more open you are to incentives versus wages/salaries. Following is an explanation of each statement.

Item 1: If you don’t like competing and winning, you may be more comfortable in a job with a wage or salary; you usually have to compete for incentives like merit raises. Item 2: If you are not faster than others, piecework and standard hour incentives may not be your best option. Item 3: Commissions, piecework, and standard hours are often based on individual performance. Item 4: Wages and salaries give you a fixed income, whereas incentives provide a variable income. Item 5 is characteristic of commission salespeople. Item 6: If you don’t like risk, incentives can be risky. Item 7: Getting a large sum at once tends to involve a bonus, profit sharing, or gainsharing incentives. Item 8: ESOPs are retirement plans, and stock purchases can be, too. Item 9 reflects gainsharing and bonuses. Item 10 reflects merit pay and praise.

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INEFFECTIVE AND EFFECTIVE STOCK OPTIONS AND PURCHASING IMPLEMENTATION. Stock options and stock purchasing don’t always work as intended for essentially the same reasons as ESOPs. The hope is that if you are an owner, you will think more about the long-term value of the company and work to improve its performance. But with stock options, there is a unique potential problem. The employee can simply buy the stock and then quickly sell it for a profit so that they are no longer an owner of the company. The same problem can occur with stock purchases, depending on the arrangement; there can be restrictions on the sale of the stock, and if it is part of a qualified retirement plan, there are penalties for selling before retiring.

FAILURES AND CHALLENGES IN CREATING INCENTIVE PAY SYSTEMS

LO 12-5

Discuss the major reasons why incentive plans fail and the challenges involved.

Now that we know a little about the various types of incentives available to the company, let’s discuss some of the issues that we will have to deal with in creating an incentive program that works.

Licensed Video Pay for Performance

Why Do Incentive Pay Systems Fail?

Too often, incentive systems are poorly designed and badly implemented.64 If we are not going to carefully manage a system, then we shouldn’t even create it. It is worse than no system at all. There are many reasons why incentive plans might fail to motivate the workforce, but let’s take a look at some of the more common ones.

POOR MANAGEMENT. Even the best incentive plan won’t work with bad management. Managers are the core of any incentive program, because they have to keep track of individual and group performance in order to reward those who perform the best. Management also has to monitor the program and adjust things as necessary when the environment or the organizational tasks change.

COMPLICATED PROGRAMS. If the employees can’t figure out what they need to do in order to receive the incentives, they won’t do anything different. Complex programs will almost always lead to failure of an incentive program because the workers don’t know how to reach the goals or, in many cases, even what the true goals are.65 In addition, failure to successfully communicate the plan to employees creates the same problem—the employee won’t know how to reach the goals.

THE PLAN DOESN’T REALLY INCREASE REWARDS, OR IT PROVIDES INSIGNIFICANT REWARDS. If a plan takes away from base pay in order to add incentive pay, the employee isn’t really gaining anything. The net result is the same, and employees will see right through such a “rewards” program. Even if there is a minimal increase in pay, often employees will figure that the extra effort required is not worth the return—again, we see expectancy theory in action.66 We have to tailor the incentive program to the things that matter to each specific employee.67

EMPLOYEES CAN’T AFFECT THE DESIRED OUTCOMES. Frequently, we create rewards programs that promise a return to the employee, but we base the promised reward on something the employee can’t do anything about. Think about company profit—what can the housekeeping staff (and many others in the organization) do about company profit? So if the desired outcome is increased profit, the employee doesn’t know what to do to affect profitability.

EMPLOYEES DON’T KNOW HOW THEY ARE DOING. In order for an incentive plan to motivate, the employee has to know how they are doing compared to the desired outcomes.68 If you know that you have to reach a certain production goal by the end of next week in order to get a desired reward and you are currently behind schedule, you will likely work harder to reach the goal. However, if you don’t know where you stand, you may feel that everything is going well and won’t increase your efforts. People have to know how they are doing compared to the program goals.

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Justin Sullivan/Getty Images

Wells Fargo was fined $185 million regarding its incentive program after a number of employees were found to have opened up additional accounts without customers knowing, in order to meet goals and earnincentives.

Challenges to Incentive Pay Systems

There are obviously going to be challenges associated with incentive systems. Employees do respond to incentives, but unfortunately, they don’t always respond to incentives in the way we expect them to.69 Questions covered in this section will discuss four of the major challenges: Do incentives work? Do incentives become entitlements? Will employees only do what they get paid for? And do extrinsic rewards decrease intrinsic motivation?

DO INCENTIVES REALLY WORK? The answer here is “It depends on who you ask.” If you ask the CEO of a company that does incentive planning for other firms, they work great. If you ask some company leaders who have tried them, they don’t work at all. For others, they work some of the time, but not always.70 One of the things that we have found out over the past 20 years or so is that incentives don’t work as well as we might have thought they would in at least some cases.71

There is some recent evidence that group incentives work significantly better than individual incentives when people in the organization have to cooperate or coordinate with one another in completing a set of tasks.72 However, there is little clear evidence that supports company-wideapplications of group incentives. One HR Magazine article noted that “company incentives do little to drive performance. They’re the least effective motivational tool.”73 This is primarily because of the difficulty in establishing a link between the individual employee’s actions and the success of the entire firm.

WORK APPLICATION 12-14

Select an organization that you know or work for. Assess how likely the factors that lead to failed incentives are to occur in the organization.

Does this mean companies shouldn’t use incentives? No, but managers need to make sure that employees understand how their actions connect to the needed results. We have to help our people figure out how they can help the group or organization gain. If we can create the connection between how the employee acts and how they gain from it, we can create strong performance incentives. If not, the incentives will not work.

WORK APPLICATION 12-15

Select an organization that you know or work for. Do incentives really work at your organization, or would they if the firm offered them?

INCENTIVE TO ENTITLEMENT—AN EASY STEP.Remember from our discussion of bonuses that in order for an incentive to continue to motivate, it can’t be considered an entitlement. An entitlement is something that the employee feels they have a right to receive from the company. A common example of an entitlement would be a weekly paycheck. Most employees feel that if they show up to work, the company owes them a paycheck. In academia, some students feel they deserve a B for showing up. It doesn’t matter whether they did anything or not! So we have the same challenge with regular pay and incentive compensation. However, an effective incentive makes the employees actually earn the reward based on their performance—it is not automatic like a salary. The current group of younger employees entering the workforce has been called the entitlement generationbecause of the expectation that they are entitled to certain perquisites just for becoming an employee.74

Consultants are seeing that in many cases, “what was intended to be ‘pay for performance’ in many organizations deteriorated into a bland set of rewards based on an entitlement mindset.”75 As soon as this happens, our incentive program ceases to motivate higher levels of performance. Incentive pay of any kind is going to be a significant portion of overall compensation costs in companies where it is used. In fact, it will almost always be at least a few percent of base pay and in some situations can go up to 100% of base pay or even more, so we have to ensure that we get something in return for the cost.

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WORK APPLICATION 12-16

Select an organization that you know or work for. Do employees in general have a sense of entitlement about pay and/or incentives? Is there a difference in feelings of entitlement between the younger and older workers?

“DO ONLY WHAT GETS PAID FOR” SYNDROME.Another of the challenges associated with incentive programs is the tendency of people to only do what is measured and is paid for. In other words, our people will pay attention to the work that will get them the rewards that they desire. There is a lot of anecdotal evidence that this occurs. However, there is not much empirical evidence that incentive pay fails because of this syndrome. Besides, we have the same challenge with regular compensation. Remember, reinforcement theory notes that if we reward an individual for doing something, they are likely to continue to do that thing in the expectation that they will continue to receive a desired reward.

However, assuming that this might be a problem in some cases, one way to combat it is to make the incentive specific but make overall job performance a part of any variable pay program. The incentive causes the employees to focus on the specific goals that we need accomplished, but the performance component lets everyone know that they still have to do all of the other things that make the organization successful over the long term.

WORK APPLICATION 12-17

Select an organization that you know or work for. Do employees only do what they get paid for?

EXTRINSIC REWARDS MAY DECREASE INTRINSIC MOTIVATION. Extrinsic rewards are valued returns (such as incentive pay for performance) to the individual in exchange for doing something that the organization desires of the employee. Intrinsic motivation means that a person does something because they like it, it is interesting and personally satisfying, and they want to do it. More than 100 studies over many years have shown that there is a relationship between the application of extrinsic rewards and a decrease in intrinsic motivation.76 In other words, when we get an external reward for doing something that we enjoy, the enjoyment level will go down. Some evidence says that this is due to the fact that we may feel like we are being controlled externally and then rebel against that control.

However, there is also evidence that in at least some cases, we can increase internalization of extrinsic motivators (cause the individual to believe that the rewards are for the “right” things), which lowers resistance to the external rewards.77 We always need to be on the lookout for ways to show that the external motivators that we provide are good things for both the employee being rewarded and others who depend on the actions of the employee being rewarded to increase this internalization process.

GUIDELINES FOR CREATING MOTIVATIONAL INCENTIVE SYSTEMS

LO 12-6

Identify the guidelines for creating motivational incentive systems.

So we now know that we have a number of factors that make incentive programs more or less successful. Anytime we are developing a variable pay plan, we have to consider what we need to do to make it work. What will make the system motivational to the workforce while also improving organization success overall? Exhibit 12-6 lists some guidelines that researchers have come up with over many years of analyzing incentive programs that can significantly increase the chances of success. Let’s discuss our guidelines for creation of an effective incentive plan in a little more detail in this section.

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WORK APPLICATION 12-18

Select an organization that you know or work for. Do incentives decrease intrinsic motivation, or would they if the firm offered them?

BASED ON ORGANIZATIONAL STRATEGY AND CULTURE. The incentive program must be based on the goals in the strategic plan—the direction of the organization.78 Think back to when we discussed strategic HR in Chapter 2. We talked about how HR can drive people to do things for the organization that it needs to have done in order to reach its goals. One thing we can use to avoid creating the entitlement mentality that we just discussed is to avoid basing our reinforcement on a fixed period of time or a fixed number of actions by the employee. We need to base the reward on achieving specific and measurable goals and provide at least some reinforcement as soon after the goal is achieved as is feasible. If the incentives are not driving our employees to work toward organizational goals, we won’t reach those goals. One of the most common problems in incentive systems is picking an expedient goal that is easy to measure but doesn’t aim at the strategic goals of the company.

Another thing that we need to keep in mind is to create both short-term and long-term goals for allorganization members. Both short- and long-term incentives should be provided based on those goals at each level in the firm. This will both mix up the timing ofthe rewards provided to the employee and provide them with incentives to improve company performance over the long term.

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Exhibit 12-6 GUIDELINES FOR CREATING MOTIVATIONAL INCENTIVE SYSTEMS

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We also need to make sure that the incentive program is consistent with the organizational culture.79A lot of organizational cultures are egalitarian—everyone expects thatthey will be compensated equally with others in similar positions. Many others are collectivist, meaning the group has a strong desire to work together. In an egalitarian culture, it will be difficult or impossible to provide different rewards to individuals, even if rewards are based on performance differences. In collectivist cultures, the group won’t accept incentives that focus on the individual. So culture must be taken into account in designing incentive systems.80

INCENTIVES FOR ALL. Any incentive program needs to provide performance incentives to all individuals involved in the process that is being targeted.81 We can’t just provide incentives to management, because management will attempt to force lower-level employees to perform so that the manager can get rewarded. This is a recipe for frustration and resistance by the line employees. But what if we only provide incentives for the line workers and not management? Management’s job (at least a significant part of it) is to get obstacles out of the way so that line employees can do their jobs. If the manager has no incentive to move quickly to get obstacles out of the way, we just end up with frustrated employees who can’t meet their incentive goals.

12-5 APPLYING THE CONCEPT

Effective Incentives

Identify each statement by the guideline it is violating using the letters (a) to (l) in Exhibit 12-6. You should read the explanations of each guideline before completing this application.

____ 21. I went to the meeting to find out about the new incentive system, but I didn’t understand what they were talking about.

____ 22. I understand that if the price of the stock goes up next year, I can buy stock at today’s lower price. But I don’t see how my delivering mail can make any difference in the price of the stock.

____ 23. What’s the incentive for me? Management gets great bonuses every year and we do all the work and they don’t give us anything.

____ 24. How can we know if we are the best company in the sporting goods industry?

____ 25. This system isn’t fair to me. I was the top performer, but Sam, who didn’t even meet his quota, got the same bonus.

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Can the incentive apply differentially? Yes, if one group’s job is more important to reaching the goal, then it is OK to give them a differential incentive. However, everyone needs to be rewarded so that they have an incentive to work together.

UNDERSTANDABLE AND CLEARLY COMMUNICATED. Complexity is a part of many organizational environments in today’s businesses. However, our incentive programs have to be set up in such a way that employees at every level of the firm can understand them. If people can’t understand what is expected of them, there is no way that they will reach the goals that we set. In addition, even if the program is understandable, it has to be accurately communicated to everyone in the organization.82All of our employees need to know about the program: how to participate, what their goals are, any assistance that is available to help them meet those goals, how their performance ties in with that of others in the company, and any other pertinent information. Good incentive programs must be clearly and completely communicated to all the personnel affected by the program.83

BASED ON FACTORS THE TARGET CAN AFFECT. The incentive offered should be based on factors that the individual or group, whichever is the target of the incentive, can affect.84 If it is an individual incentive, the individual employee should be able to modify their behavior to affect the outcome of the process, and the same goes for a group of employees. If the individual or group can see no connection between what they do and reaching the goal, they will most likely do nothing different than before the incentive was instituted.

SMART GOALS. Remember in Chapter 8 where we talked about goals having to be SMART—specific, measurable, attainable, relevant, and time based? SMART goals provide a clear link between performance and payout.85 Here again, as with any valuable organizational goal, we have to ensure that our incentive program identifies the goals of the plan in SMART fashion. This is the only way that we can then accurately measure and reward our employees for goal attainment. So remember to use our setting objectives model: To + action verb + specific and measurable outcome + target date.

CLEARLY SEPARATE FROM BASE PAY. Base pay is almost always considered an entitlement by the employees in an organization. We utilize base pay to allow our workforce to meet their basic needs (Maslow’s physiological, safety, and social needs). This base pay very rarely motivates additional actions on the part of our employees. Incentives need to be clearly separated from base pay to avoid creating the impression that they, too, are an entitlement. Employees need to understand that they only receive incentive rewards if they do something extraordinary.

A SIGNIFICANT PIECE OF OVERALL COMPENSATION. What is a “significant piece” of compensation? Compensation studies will tell you different things about what is considered significant.86 A good recommendation would be at least 10% of overall pay and, in some cases, 20% or more. Why? Let’s take a look at an example.

You work for XYZ Co. and are getting paid $40,000 a year. Your manager decides to give you a 2% bonus if you reach your goals this year, or $800. You reach your incentive goals at the end of the year, and it is now time to pay you. If we pay you a lump sum at the end of the year, we generally have to take out 25% for federal withholding taxes and may have to take out state tax as well, so your $800 just dropped to between $500 and $600. At a salary of $40,000 per year, if you are paid twice monthly, you would normally receive about $1,350 or so per paycheck, depending on the state in which you reside. Howmany of you would work really hard next year if you got a whopping $500, a little more than one third of 1 month’s pay, as a bonus for meeting your goals the year before? To most of us, that would be an insignificant reward for meeting our goals for an entire year. Remember what we said when discussing merit pay earlier in the chapter: Merit pay is typically a very small percentage of the individual’s total pay, which makes using it as a motivator for performance very difficult.

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Alternatively, if we make your base pay $36,000 and provide a 10% incentive for reaching certain goals, you will receive around $2,600 after taxes—a sum that most people making $36,000 per year would consider significant. People need to feel that the reward is “significant” to them in order for it to motivate them.

TAKE GREAT CARE IN ADMINISTERING THE PROGRAM. Meticulously measure performance using multiple metrics and vigilantly calculate the rewards to be provided to persons who reach their incentive goals.87 If the company owes an individual or group an incentive award based on reaching their goals, then we must make sure that it is paid. Set attainable standards and then measure them fairly, when and how they are supposed to be measured. Once performance is measured, reward those who attain the goals as soon as possible. If individuals or groups did not meet their goals, communicate that to them so that they know why they didn’t get a reward.

Again, an example helps in understanding what might happen if we fail to be meticulous in our measuring and administration duties. Let’s say we have 600 employees in our company and set some ambitious goals at the beginning of the year for the company and for each individual employee. As a company, we met our goals for the year, and we calculated whether or not each individual employee met their personal goals. But we miscalculated with one person. How fast will the word likely get around the company that we “cheated” that one employee? Via the employee grapevine, it will probably be known throughout the company in 2 days—possibly 1. This employee starts telling their friends that “the company cheated me and lied to me.” And what will happen as soon as one person starts to complain? As soon as one person makes that claim, others will start to wonder whether or not they were treated fairly—even though we were correct in calculating their individual payments! Pretty soon, what was supposed to be a motivational program becomes a massive demotivator due to the fact that people begin to perceive that they may not have been treated fairly. We have to be meticulous in our management of any incentive program.

PROMPTLY APPLY ANY INCENTIVE AWARD. “Keep the time between the performance and reward as short as possible.”88 If the incentive is based on an annual goal, and we use a calendar year as our organizational fiscal year, our year ends in December, and we should provide any incentive awards on the first payday in January, or even on December 31 if we already have results calculated. If incentives are calculated monthly, pay them at the end of the month. Why? We provide the reward to reinforce the employee’s efforts that led to desired results. If you receive a reward 6 months after you do something, you don’t really see the connection. If you don’t see the connection, it does not reinforce your earlier actions.

DON’T FORGET NONMONETARY REWARDS. Remember from our discussion about praise and other nonmonetary recognition that not everyone is motivated by cash.89 Nonmonetary rewards often work better than monetary rewards. Having a bit of time off to play with the company’s resources, like 3M Company provides, can be a huge incentive. 3M gives 15% of work time to employees to use the company’s resources and labs and to just tinker around and see what they can come up with.90Post-it notes were created in just this way in 1974. A 3M employee was tired of bookmarks falling out of his books, so he used an adhesive that had been invented at 3M earlier (but considered a failure) and applied it to small pieces of paper. The incentive was in being allowed to be creative and avoid being bored. Incentives can include providing the ability to choose between work assignments, providing training and learning opportunities, allowing flexible schedules, providing extra paid time off, recognition at an awards ceremony, offers to present results to top management, having greater input into future incentive goals, and many others. We can use an on-site child care center or a gym or lounge as an incentive—for example, “If we reach a certain set of organizational goals by the end of the year, we will be able to build the child care center.” To many people in today’s workforce, this would be a significant incentive. However, to others, it may not be a reward at all. Remember that according to expectancy theory, we have to pay attention to significance.

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DON’T REWARD NONPERFORMERS. When goals are not met, do not apply rewards.91 It seems silly to have to say this, but in many cases, you will want to reward your employees, even when they don’t quite meet the goals that were set. Why would this happen? Let’s look at an example that will explain it.

Andy works for you and didn’t quite meet the goals set for the incentive program at the end of the year. You are a good manager, and you saw Andy consistently come to work and work hard, but he just wasn’t able to reach his goal. At the end of the year, you see that he didn’t make it, but you know that Andy is a hard worker. So you sit down and look at everyone in your department, and everyone except Andy met their goals. Then you think about how hard Andy tries and you say, “I know I saw him working all the time. Iam just going to give the incentive payment to him anyway because I know that he works hard.” Here again, how quickly will the word get around about Andy getting the reward even though he didn’t meet his goals? Again, the communication grapevine will start working, and within 1 or 2 days everyone will know, because Andy is going to tell them.

Well, what will happen next time incentives are being calculated? Next time, maybe several workers miss their goals, and they tell you, “Boss, I worked my tail off, but I just couldn’t reach my goals. But you gave Andy his incentive last time even though he missed his goal. You can go ahead and give it to me too, right?” You have succeeded in destroying your incentive program because you rewarded a nonperformer. Rewarding nonperformers just cannot be allowed if we want the incentive program to continue to work in the future.

WORK APPLICATION 12-19

Select an organization that you know or work for. In which two or three incentive pay guidelines is your organization strongest and weakest at following to ensure it effectively motivates employees?

There is, however, a way that we may be able to reward Andy, at least partially, but we have to identify it at the beginning of the program. We can create a series of progressively more difficult goals in our incentive program. This allows us to provide a minimal incentive for meeting goals that are just above a baseline and provide progressively more significant awards for meeting more difficult goals. This will let us reward Andy for going above the standard but not quite meeting an aggressive incentive goal. So progressive or stair-step goals can help us avoid rewarding people who don’t meet the top-level, or most difficult, goals.

MAKE THE INCENTIVE PROGRAM PART OF A COMPREHENSIVE APPROACH TO MANAGING. Remember that incentives can create a “just do what you get paid for” mentality. So, as we noted earlier in this chapter, we “make the incentive specific but make overall job performance a part of any variable pay program.” We can’t create an incentive for every aspect of every job in most organizations, so we have to continue to evaluate and reward overall performance so that our employees know that they have to do all tasks successfully, even though only some have incentives directly attached to their performance. One easy way to do this is to provide a caveat in the incentive program that receipt of an overall performance appraisal of “Meets Expectations” or higher is required in order to be eligible for incentive rewards.

EXECUTIVE COMPENSATION

LO 12-7

Discuss the issue of executive compensation and how the major provisions of the Dodd-Frank Act affect the issue.

No modern discussion of compensation is complete without at least touching on the topic of executive compensation practices. Executives drive organizational performance more than any other employees. The great debate over how much chief executive officers (CEOs) matter rages on.92 CEOs like the late Steve Jobs of Apple have the power to make or break a company.93 When he retired in August of 2011 and died shortly thereafter, Apple stock lost nearly a third of its market value (about $120 billion!) in a year.94 Research clearly links managerial leadership to positive consequences for both the individual and organizations, including financial performance. Also, substantial evidence demonstrates that sound managerial leadership practice is critical to creating effective organizations.95 So it makes sense that executives are well paid for their managerial and decision-making skills. But has executive pay gotten out of line? The average CEO compensation for the largest 500 US public companies rose to about $11 million in 2016.96