Learning Objectives

2. Learning Objectives Describe the two basic requirements of an effective incentive plan. List and briefly discuss at least three types of individual incentives. Distinguish between a bonus and a merit pay increase. Discuss the role bonuses play in managerial compensation. Differentiate between nonqualifi ed stock options and incentive stock options (ISOs).

3. Learning Objectives (cont.) Differentiate among the following different types of stock option related plans: stock-for-stock swaps, stock appreciation rights, phantom stock plans, restricted stock plans, premium priced options, and performance vesting options. Discuss the major issues related to the executive pay controversy. Discuss the prevalence of stock options among nonmanagerial personnel.

4. Learning Objectives (cont.) Describe how group incentives work. Explain what a gain-sharing plan is. Discuss Scanlon-type plans. Explain how an employee stock ownership plan (ESOP) works. Identify what distinguishes variable pay plans from most other incentive pay plans.

5. Incentive Pay Plans • Incentive or variable pay plans • Pay plans designed to relate pay directly to performance or productivity; often used in conjunction with a base wage and salary system.

6. Requirements of Incentive Plans The first concerns the procedures and methods used to appraise employee performance. Second requirement is that the incentives (rewards) must be based on performance.

7. Requirements of Incentive Plans • Individual-based incentive plans • require that employees perceive a direct relationship between their own performances and their subsequent rewards. • Group-based plans • require employees to perceive a relationship between the group’s performance and the subsequent rewards of the group’s members

8. Individual Incentives • Differential piece rate plan • Piece rate plan devised by Frederick W. Taylor that pays one rate for all acceptable units produced up to some standard and then a higher rate for all pieces produced if the output exceeds the standard.

9. Plans Based on Time Saved • Standard hour plans • Similar to piece rate plans; a standard time is set in terms of time it should take to complete a particular job • Incentive plans based on time saved give an employee a bonus for reaching a given level of production or output in less than standard time

10. Individual Incentives • Commission plan • Incentive plan that rewards employees, at least in part, based on their sales volume.

11. Plans Based on Commissions • Advantage • Relates rewards directly to performance • Disadvantages • Things beyond control of an employee can adversely affect sales • Environmental factors can also affect an employee’s sales

12. Individual Incentives • Bonus • Reward that is offered on a one-time basis for high performance. • Merit pay increase • Reward based on performance but also perpetuated year after year.

13. Individual Bonuses • Advantage • Must be earned each year and organization is not obligated over long run

14. Individual Bonuses • Drawback – Can become an extension of salary and occurs: • When awarding bonus becomes practically guaranteed since it is not tied to profits or some other measure of performance • Because profits have been consistently high for an extended period of time • When recipients do not view it as resulting from individual performances or from profits of organization • When serious dissatisfaction can result if expected bonus is not granted for legitimate reasons

15. Individual Incentives • Suggestion systems • Systems that usually offer cash incentives for employee suggestions that result in either increased profits or reduced costs.

16. Incentives for Managerial Personnel

17. Incentives for Managerial Personnel • Annual cash bonus – Most common type of incentive • Usually based on organizational or group performance • Still considered individual incentives because of the key roles managers play in the success of an organization

18. Incentives for Managerial Personnel • Performance share plan (unit plan) • Incentive plan that awards top executives a set number of performance units at the beginning of the performance period • actual value of the units is then determined by the company’s performance over the performance period.

19. Top Executive Eligible for Bonus and/or Other Cash Compensation Payments Table 14.1

20. Stock Options for Managerial Personnel • Qualified stock options • Stock options approved by the Internal Revenue Service for favorable tax treatment. • Nonqualified stock options • Similar to qualified options, except that they are subject to a less favorable tax rate and are not subject to the same restrictions.

21. Stock Options for Managerial Personnel • Incentive stock option (ISO) • Form of qualified stock option plan in which the manager does not have to pay any tax until the stock is sold

22. Stock Options for Managerial Personnel • Stock-for-stock swap • Allows options to be exercised with shares of previously purchased company stock in lieu of cash; postpones the taxation of any gain on stock already owned.

23. Top-Paid Chief Executives Table 14.2

24. Stock Options for Managerial Personnel • Stock appreciation rights (SARs) • Type of nonqualified stock option in which an executive has the right to relinquish a stock option and receive from the company an amount equal to the appreciation in the stock price from the date the option was granted. • Under an SAR, the option holder does not have to put up any money, as would be required in a normal stock option plan.

25. Stock Options for Managerial Personnel • Phantom stock plan • Special type of stock option plan that protects the holder if the value of the stock being held decreases • does not require the option holder to put up any money.

26. Stock Options for Managerial Personnel • Restricted stock plan • Plan under which a company gives shares of stock to participating managers, subject to certain restrictions • The major restriction of most plans is that shares are subject to forfeiture until “earned out” over a stipulated period of continued employment.

27. Stock Options for Managerial Personnel • Premium-priced options • Stock options with an exercise price significantly above stock’s current market price. • Performance-vesting options • Stock options priced at market price but only exercisable if stock price reaches or exceeds price goal within defined period.

28. The Status of Executive Pay Most stock option plans link pay to performance When there is a sustained bull market, tying executive reward to price may be fundamentally flawed

29. The Status of Executive Pay The problem is that when most stocks are going up, stock prices often provide an inaccurate measure of a company’s actual strength The same could be said when the market is in a substantial bear market

30. The Status of Executive Pay • Financial Accounting Standards Board (FASB) issued the Statement of Financial Accounting Standard 123R • Requires a range of equity-based compensation arrangements to be treated the same as other forms of compensation • Companies now have to expense stock options just like salaries • Company profits will be lowered by the value of stock options

31. Group Incentives • Group incentives • Incentives based on group rather than individual performance. • Organizationwide incentives • Incentives that reward all members of the organization based on the performance of the entire organization.

32. Gain Sharing • Gain sharing • Incentive plans that involve employees in a common effort to achieve the company’s productivity objectives. • Based on the concept that the resulting incremental economic gains are shared among employees and the company

33. Scanlon-Type Plans • Scanlon plan • Organizationwide incentive plan that provides employees with a bonus based on tangible savings in labor costs.

34. Employee Stock Ownership Plans • Employee stock ownership plan (ESOP) • Form of stock option plan in which the organization provides for employee purchase of its stock at a set price for a set time period based on the employee’s length of service and salary and the profits of the organization.

35. Major Benefits of Employee Stock Ownership Plans Table 14.3

36. Summary of Most Commonly Used Incentive Plans Table 14.4