Pay-for-Performance

1. Pay-for-Performance Chapter 10 March 12, 2014

2. Strategic Reasons for Incentive Plans • Variable Pay • Tying pay to some measure of individual, group, or organizational performance. • Incentive Pay Programs • Establish a performance “threshold” to qualify for incentive payments. • Emphasize a shared focus on organizational objectives. • Create shared commitment in that every individual contributes to organizational performance and success.

3. Advantages of Incentive Pay Programs • Incentives are most useful when: • Focused on key performance targets that produce employee and organizational gains. • Variable costs of payouts are linked to the achievement of competitively important results. • Directly relating payouts to achieving operating performance objectives (quantity and/or quality). • Teamwork and unit cohesiveness are fostered by basing payments to individuals on team results. • Used to distribute success among those responsible for producing that success.

4. Employee Opposition to Incentive Plans • Production standards are set unfairly. • Incentive plans are really “work speedup.” • Incentive plans create competition among workers. • Increased earnings result in tougher standards. • Payout formulas are complex and difficult to understand. • Incentive plans cause friction between employees and management.

5. Types of Incentive Plans INDIVIDUAL GROUPENTERPRISE Piecework Team compensationProfit sharing Standard hour plan Scanlon PlanStock options Bonuses Rucker PlanEmployee stockMerit pay Improshare ownership plans Lump-sum merit pay Earnings-at-risk plans(ESOPs) Sales incentives Incentives for professional employees Executive compensation Figure 10.1

6. Successful Incentive Plans • Employees have a desire for an incentive plan. • Employees are encouraged to participate. • Employees see a clear connection between the incentive payments they receive and their job performance. • Employees are committed to meeting the standards. • Standards are challenging but achievable. • Payout formulas are simple and understandable. • Payouts are a separate, distinct part of compensation.

7. Setting Performance Measures—the Keys • Managers or supervisors should: • Ensure that performance measures are consistent with the strategic goals of the organization. • Define the intent of performance measures and champion the cause relentlessly. • Involve employees at all levels. • Consider the organization’s culture and workforce demographics. • Widely communicate the importance of performance measures.

8. Effective Incentive Plan Administration • Grant incentives based on individual performance differences. • Have the financial resources to reward performance. • Set clearly defined, accepted, and challenging yet achievable performance standards. • Use an easily understood payout formula • Keep administrative costs reasonable. • Do not “ratchet up” performance standards.

9. Individual Incentive Plans • Straight Piecework • An incentive plan under which employees receive a certain rate for each unit produced. • Differential Piece Rate • A compensation rate under which employees whose production exceeds the standard amount of output receive a higher rate for all of their work than the rate paid to those who do not exceed the standard amount.

10. 60 minutes (per hour) 5 units per hour = 12 minutes (standard time per unit) $7.50 (hourly rate) $1.50 per unit = 5 units (per hour) Computing the Piece Rate

11. Piecework drawbacks • Problems with piecework systems: • Piecework standards can be difficult to develop. • Individual contributions can be difficult measure. • Not easily applied to work that is highly mechanized with little employee control over output. • Piecework may conflict with organizational culture (teamwork) and/or group norms (“rate busting”). • When quality is more important than quantity. • When technology changes are frequent. • When cross-training is required for scheduling flexibility.

12. Individual Incentive Plans: • Standard hour plan • An incentive plan that sets pay rates based on the completion of a job in a predetermined “standard time.” • If employees finish the work in less than the expected time, their pay is still based on the standard time for the job multiplied by their hourly rate.

13. Bonuses • Bonus • Incentive payment that is supplemental to the base wage for cost reduction, quality improvement, or other performance criteria. • Spot bonus • Unplanned bonus given for employee effort unrelated to an established performance measure.

14. Merit Pay Links an increase in base pay to how successfully an employee achieved some objective performance standard.

15. Problems with Merit Raises • Inadequate funding for merit increases. • Vagueness in how to define and measure performance. • Employees not believing that merit compensation is tied to effort and performance • Allowing organizational politics to influence merit pay decisions. • Failing to differentiate between merit pay and other types of pay increases. • Mistrust between management and employees.

16. Motivation Through Merit Raises • Develop employee confidence and trust in performance appraisal. • Establish job-related performance criteria. • Separate merit pay from regular pay. • Distinguish merit raises from cost-of-living raises. • Withhold merit payments when performance declines.

17. Lump-Sum Merit Pay • Lump-sum Merit Program • Program under which employees receive a year-end merit payment, which is not added to their base pay. • Advantages • Provides financial control by maintaining annual salary expenses and not escalating base salary levels. • Contains employee benefit costs for levels of benefits normally calculated from current salary levels. • Provides a clear link between pay and performance.

18. Incentives for Professional Employees Managerial and Executive Incentives Bonuses and merit increases Double-track wage systems Performance incentive bonuses Profit sharing and stock ownership Executive perquisites (perks)

19. Executive Compensation • The Executive Pay Package • Base salary • Short-term incentives or bonuses • Long-term incentives or stock plans • Perquisites (perks)

20. Restricted Stock/Cash Plans Restricted Stock Restricted Cash Types of Long-Term Incentive Plans Stock Price Appreciation Plans Performance-Based Plans Stock Options Stock Appreciation Rights (SARS) Stock Purchase Phantom Stock Performance Units Performance Shares Formula-value Grants Dividend Units Figure 10.3a

21. Types of Long-Term Incentive Plans

22. Types of Long-Term Incentive Plans (cont’d)

23. Types of Long-Term Incentive Plans (cont’d)

24. Criticisms of Executive Incentive Plans • Incentive payments are excessive compared with return to stockholders. • Time periods for judging and rewarding performance are too short. • Quarterly earnings growth is emphasized at the expense of research and development. • Emphasis is placed upon equaling or exceeding executive salary survey averages. • Benefits do not relate closely to individual performance.

25. The “Sweetness” Of Executive Perks HRM 4

26. Group Incentive Plans • Team Incentive Plans • Compensation plans where all team members receive an incentive bonus payment when production or service standards are met or exceeded. • Establishing Team Incentive Payments • Set performance measures upon which incentive payments are based • Determine the size of the incentive bonus. • Create a payout formula and fully explain to employees how payouts will be distributed.

27. Group Incentive Plans • Gainsharing Plans • Programs under which both employees and the organization share the financial gains according to a predetermined formula that reflects improved productivity and profitability.

28. The Pros of Team Incentive Plans • Team incentives are effective when: • They support group planning and problem solving, thereby building a team culture. • The contributions of individual employees depend on group cooperation. • They broaden the scope of the contribution that employees are motivated to make. • They reduce employee jealousies and complaints over “tight” or “loose” individual standards. • They encourage cross-training and the acquiring of new interpersonal competencies.

29. The Cons of Team Incentive Plans • Team incentives are ineffective when: • Individual team members perceive that “their” efforts contribute little to team success or to the attainment of the incentive bonus. • Intergroup social problems—pressure to limit performance and the “free-ride” effect— arise. • Complex payout formulas are difficult for team members to understand.

30. Lessons Learned: Designing Effective Gainsharing Programs • Enlist total managerial support. • Include all groups—labor, management, employees. • Prevent political gamesmanship. • Bonus formulas must be fair, precise and easily calculated, offer frequent payouts, large enough to encourage employee effort, and create a pay-for-performance environment. • Be certain that employees are predisposed to a gainsharing reward system. • Launch the plan during a favorable business period.

31. Employee Bonus and Gainsharing Plans Scanlon Plan Rewards come from employee participation in improving productivity and reducing costs. Rucker Plan (SOP) Shared rewards come from the difference between labor costs and sales value of production. Improshare Gainsharing based on increases in productivity of the standard hour output of work teams. Earnings-at-risk Encourages employees to achieve higher output and quality standards by placing a portion of their base salary at risk of loss.

32. Bonus and Gainsharing Plans • Scanlon Plan • Employee and management committees cooperate in cost-reduction improvements. • Rucker Plan • Bonus based on the relationship between the total earnings of hourly employees and the production value created by the employees. • Improshare • Gainsharing program for bonuses are based upon the overall productivity of the work team.

33. Earnings-at-Risk Plans • Profit Sharing • Any procedure by which an employer pays, or makes available to all regular employees, in addition to their base pay, current or deferred sums based upon the profits of the enterprise. • Agreement over division of profits between company and employees. • Possibility of no payout due to financial condition of company.

34. Earnings-at-Risk Plans • Earnings-at-Risk Incentive Plans • A portion of the employee’s base pay is placed at risk, but employees are given the opportunity to earn income above base pay when goals are met or exceeded.

35. Earnings-at-Risk Incentive Plans • Stock Options • Granting employees the right to purchase a specific number of shares of the company’s stock at a guaranteed price (the option price) during a designated time period. • The value of an option is subject to stock market conditions at the time that option is exercised.

36. Earnings-at-Risk Incentive Plans • Employee Stock Ownership Plans (ESOPs) • Stock plans in which an organization contributes shares of its stock to an established trust for the purpose of stock purchases by its employees. • The employer establishes an ESOP trust that qualifies as a tax-exempt employee trust under Section 401(a) of the Internal Revenue Code • Stock bonus plans are funded by direct employer contributions of its stock or cash to purchase its stock. • Leveraged plans are funded by employer borrowing to purchase its stock for the ESOP.

37. Rewards and Risks of ESOPS Employee Stock Ownership Plans Advantages Disadvantages Retirement benefits Liquidity and value Pride of ownership Single funding basis Deferred taxes Not insured