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Chapter 10: Pay-for-Performance

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Win Arcega

on 9 February 2014

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Transcript of Chapter 10: Pay-for-Performance

Chapter 10
Incentive Rewards

Chapter 10:
Prepared by
: Arcega, Depusoy, Espiritu, Pan

Piecework: The Drawbacks
Problems with piecework systems:
Is not always an effective motivator
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.

Merit Pay
Merit Pay Program (merit raise)
Links an increase in base pay to how successfully an employee achieved some objective performance standard.
Merit Guidelines
Guidelines for awarding merit raises that are tied to performance objectives.

Sales Incentives
Straight Salary Plan
Compensation plan that permits salespeople to be paid for performing various duties that are not reflected immediately in their sales volume.
Straight Commission Plan
Compensation plan based upon a percentage of sales.
Combined Salary and Commission Plan
A compensation plan that includes a straight salary and a commission component (“leverage”).

Individual Incentive Plan
Individual incentives are used by companies as a means to motivate employee by providing them the opportunity to earn additional Income. Incentives often take the form of cash, but they can also be paid in the form of a product or a family vacation. In some cases, incentives can make up the bulk of an employee's income, such as a salesperson who is compensated on a commission basis.
Executive short-term Incentives
• Bonus payment may take in form of cash or stock and may be paid immediately
• Deferred for a short time or deferred until retirement
• Most strategies pay their short term incentive bonuses in cash, in keeping with their pay-for-performance strategy
• Based on the contribution of the individual to the company
• May be based on a percentage of company’s total profits or profits in excess of a particular shareholder
• “Balanced scorecards” way of measuring customer satisfaction, ability to innovate, product or service leadership.

Chapter 10: Pay-for-Performance
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.

Incentive Plans as Links Organizational Objectives
Incentive Plan Purposes
Encourage employees to assume “ownership” of their jobs, thereby improving effort and job performance.
Motivate employees to expend more effort than under hourly and/or seniority-based compensation systems.
Support a compensation strategy to attract and retain top-performing employees
Incentive Plan Effectiveness
There is evidence of a relationship between incentive plans and improved organizational performance.

Advantages of Incentive Pay Programs
Incentives focus employee efforts on specific performance targets. They provide real motivation that produces important employee and organizational gains.
Incentive payouts are variable costs linked to the achievement of results. Base salaries are fixed costs largely unrelated to output.
Incentive compensation is directly related to operating performance. If performance objectives (quantity and/or quality) are met, incentives are paid. If objectives are not achieved, incentives are withheld.
Incentives foster teamwork and unit cohesiveness when payments to individuals are based on team results.
Incentives are a way to distribute success among those responsible for producing that success.
Incentives are a means to reward or attract top performers when salary budgets are low.

Successful Incentive Plan
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.

Setting Performance Measures
Performance measures—at all organizational levels—must be consistent with the strategic goals of the organization.
Define the intent of performance measures and champion the cause relentlessly.
Involve employees.
Consider the organization’s culture and workforce demographics when designing performance measures.
Widely communicate the importance of performance measures.

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.

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.

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.

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.

Lump-Sum Merit Pay
Program under which employees receive a year-end merit payment, which is not added to their base pay.

Incentive Awards and Recognition
Often used to recognize productivity gains, special contributions or achievements, and service to the organization.
Employees feel appreciated when employers tie awards to performance and deliver awards in a timely, sincere and specific way.
Noncash Incentive Awards
Are most effective as motivators when the award is combined with a meaningful employee recognition program.

Incentives for professional employees

• Professional employees are those whose work involves the application of learned knowledge to the solution’s to their employer’s problem.
• Driven their desire to produce high caliber of work and receive recognition form colleagues
• Encourage greater individual performance

The Executive Pay Package
Executive base salaries
• Base salary- regular annual salary of the executive
• Represent between 30 and 40 percent of total annual compensation
• Largest portion of executive pay is received in long term incentive rewards and bonuses
• Intended to motivate executives to reach organizational performance goals

Executive long-term incentives
• The most common long-term incentive is the stock option, which either gives the executive free company stock or allows him or her to purchase company’s stock in a reduced price for a period of time

Types of long-term incentives
Executive perquisite

• also called as perks
• special benefits and services for executives and other top employees of the company
• perquisites are nonmonetary rewards given to executives.
• means of demonstrating the executive’s performance to the organization.
• Eg. Car service, executive dining room, special parking, membership in clubs
• the dark side of perks is that they are viewed as wasteful spending and overly lavish.

Executive Compensation: Ethics and Accountability
One concern about the high pay level for executives is that they may encourage executives to make business decisions for themselves rather than the organization.
Second, the use of stock options as an incentive
Finally, lower-level employee pay has not risen at the same rate. There is a continually widening gap in compensation in different levels of the organization
Corporate Compensation committees justify big bonuses in the following ways:
1. Large financial incentives are a way to reward superior performance
2. Business competition is pressure-filled and demanding
3. Good executive talent is in great demand
4. Effective executives create shareholder value

Executive Compensation Reform

• Executive Compensation- or executive pay is composed of the financial compensations and other non-financial awards received by an executive of a firm.
• Companies and compensation committees must now weigh the benefits provided by stock option programs against potential charge to earnings.
• The adoption performance formulas that peg executive compensation to organizational benchmarks other than stock price
• Shareholder resolutions that allow shareholders the right value to vote on executive pay packages
• Greater accountability by compensation committees to justify large executive pay awards or severance or retirement packages

Based on Jim Harvey's speech structures
• Stock options-
Rights granted to executives to purchase shares of their organization’s stock at an established priced for a fixed period of time.
• Stock appreciation rights-
cash or stock award determined by increased in stock price during any time chosen by the executive in the option period
•Stock purchase-
Opportunities for executive to purchase shares of their organization’s stock valued at full market or a discount price
• Phantom stock-
grant of units equal in value to the fair market value or book value of a share of stock
• Restricted stock-
grant of stock or stock units at a reduces price with the condition that the stock not be transferred or sold before a specific employment date

Performance units-
grants analogous to annual bonuses except that the measurement period exceeds one year
• Performance grant shares
- actual stock or phantom stock. Value is contingent on both predetermined performance objectives over a specified period of time and the stock market.

Group Incentive Plans
Team Compensation
3-step approach:
• Set performance measures on which incentive payments are based
• Incentive bonus must be determined
• A payout formula is established & fully explained to employees

Problems associated with team compensation
• Individual team members may perceive that their efforts contribute little to team success
• “Free-rider” effect
• Insufficient payout rewards

• A technique that compensates workers based on improvements in the company's productivity.

Types Of Gainsharing Plans:
• Scanlon Plan
- “working smarter, not harder”
• Improshare-
improved productivity through sharing

Gainsharing Incentive Plans
Enterprise Incentive Plans
Profit Sharing Plans
any procedure by which employer pays, to all regular employees, special current or deferred sums based on organizations’ profit
Agreement over division of profits between company and employees.
Possibility of no payout due to financial condition of company.

Employee Stock Options Plan
grant the employees the right to purchase a specific number of shares in the company at a fixed price for a certain number of years
The value of an option is subject to stock market conditions at the time that option is exercised
Employee Stock Ownership Plans (ESOPs)

An ESOP is a kind of employee benefit plan. a company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares.
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.

Retirement benefits
Pride of ownership
Deferred taxes
Liquidity and value
Single funding basis
Not insured
The success of incentive pay plan depends on the organizational climate in which it must operate employee confidence in it, and its suitability to employee and organizational needs. Importantly, employees must view their incentive pay as being equitable and related to their performance. Performance measures should be quantifiable, be easily understood, and bear a demonstrated relationship to organizational performance.
Piecework plans pay employees a given rate for each unit satisfactorily completed. Employers implement these plans when output is easily measured and when the production process is fairly standardized. Bonuses are incentive payments above base wages paid on either an individual or team basis. A bonus is offered to encourage employees to exert greater effort. Standard hour plans establish a standard time for job completion. An incentive is paid for finishing the job in less than the pre-established time. These plans are popular for jobs with a fixed time for completion.
Merit raises will not serve to motivate employees when they seen as entitlements, which occurs when these raises are given yearly without regard to changes in employee performance. Merit raises are not motivational when they are given because of seniority or favoritism or when merit budgets are inadequate to sufficiently reward employee performance. To be motivational, merit raises must be such that employees see a clear relationship between pay and performance, and the salary increase must be large enough to increase inflation and higher income taxes.
Salespeople may be compensated by a straight salary, a combination of salary and commissions, salary plus bonuses or commission only. Paying employees on straight salary allows them to focus on tasks other than sales such as service and customer goodwill. A straight commission plan causes employees to emphasize sales goals. A combination of salary and commission or bonus provides the advantages of both the straight salary and straight commission form of payments.
The Scanlon and Improshare gainsharing plans pay to bonuses to employees unrelated to profit levels. Each of these plans encourages employees to maximize their performance and cooperation through suggestions offered to improve organizational performance. The Scanlon plan pays an employee a bonus based on saved labor cost measured against the organization’s sales value of production. The improshare is paid when employees increase production output above a given target level.
Profit sharing plans pay employees sums of money based on the organizations profits. Cash payments are made to eligible employees at specified times, normally yearly. The primary purpose of profit sharing is to provide employees with additional income through their participation in organizational achievement. Employee commitment to improved productivity, quality and customer service will contribute to organizational success and in turn to their compensation. Profit sharing plans may not achieve their stated gains when employee performance is unrelated to organizational success or failure. This may occur because of economic conditions, other competition, or environmental conditions. Profit sharing plans can have negative effect on employee morale when plans fail to consistently reward employees.
With an ESOP, each year the organization contributes to stock or cash to buy stock that is then placed in an ESOP trust. The ESOP holds the stock for employees until they either retire or leave the company, at which the stock is sold back to the company through a brokerage firm. Employers receive tax benefits for qualified ESOP; they also hope to receive their employees’ commitment to organizational improvements. Employees, however, may lose their retirement income should the company fail or stock prices fall. Another drawback to ESOPs is that they are not guaranteed by any federal agency.
Correlation to current events
Wage hike or performancebased incentives?
Employers prefer performace-based bonuses rather than wage hikes, the head of an employers group said
In an interview with ANC's Headstart, Employers Confederation of the Philippines (ECOP) President Ed Lacson justified performance-based incentives, saying the fixed "minimum wage setting...is robbing the employers of the prerogative and the pleasure of rewarding excellent performers."
This however is being opposed by the largest labor group in the country, saying a system of performance-based incentives will only create division among workers.
The Department of Labor and Employment (DOLE) reiterated its push for a two-tier wage system where wage increases and incentives will be based on the performance of the workers.
Any huge increase in minimum wage will distort the labor market which could result in lay-offs
“The government has also the mandate to preserve employment, meaning we cannot just decide when the effect of the decision will be for business to be closing out or lay off. That is not the intent of the law. The intent of the law when it was legislated in 1989 is to provide for wage adjustments that should encourage investments in the countryside,” Fameronag said, citing the Wage Rationalization Act of 1989, which was enacted to rationalize the fixing of minimum wages.

The employers concurred, saying the Philippines already has the highest minimum wage among 8 Asian countries even without the P10 wage hike.

"If we keep increasing the minimum wage, we are sending a very wrong message to all investors to come,” said Lacson.

According to Fameronag, there have been 12 wage increases in NCR since 1999, with a total increase of over P200 per day.

Tanjusay meanwhile said skilled and unskilled workers should have the same pay because "pag labas naman nila ng factory, pareho naman sila ng hinaharap na bigas na binibili, pareho naman sila ng gastusin, ng mga tuition fees na binabayaran."

Managing Human Resource by Scott A.Snell and George W. Bohlander
Full transcript