Human Resources Case Study

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12 Incentive Pay

Case 12.1. Executive Compensation: New Developments in Executive Compensation Human resources leaders and compensation experts will always need to attract talented managers to their corporations. However, newer laws are in place to help rein in large executive salaries.

Sarbanes-Oxley (SOX) in 2002 has allowed the Securities and Exchange Commission (SEC) to “claw back” executive pay and stock awards retroactively. SOX has mandatory reporting requirements of all company perks, jets, country club memberships, and so on.1

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was signed into federal law by President Barack Obama on July 21, 2010. Commonly known as the Dodd-Frank, it requires that a public company present to its sharehold- ers a plan to approve compensation, and “enhanced compensation” must be disclosed to the SEC. The goal is to monitor executive compensation by making sure executives are meeting performance-based goals.

The Dodd-Frank Section 953 requires additional disclosure about certain compen- sation matters, including pay-for-performance and the ratio between the CEO’s total compensation and the median total compensation for all other company employees.2

SOX and Dodd-Frank are very large laws that HR people might not be able to fol- low on a daily basis. However, since the recession of 2008, there has been much more attention paid to the large salaries executives receive.

Most large salaries come in the form of stock and stock options in the company. CEOs are rewarded for their performance by receiving these stock options. For exam- ple, CEO Larry Ellison of Oracle was paid $96 million in 2012 and $77 million in 2013 (he declined a performance bonus and took $1 in salary).

However, a study by professors found that, the more CEOs got paid, the worse their companies did.3 One conclusion was that the CEOs became overconfident in their abilities and made poor decisions. Another conclusion might be that they lost their focus and motivation and found other pursuits outside the company to follow. For example, Ellison is very active and a big supporter of yacht racing.

The clawback issue is still being pursued in 2015 as part of Dodd-Frank. The SEC voted to propose a rule that would require exchanges to establish standards for

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Chapter 12 • Incentive Pay 6 3

revoking executive bonuses when companies restate earnings or make accounting errors leading to the restatement of earnings, regardless of the executive’s fault.4 The clawback window would extend for 3 years after the bonus was given.

There is also a call for improving the Sarbanes-Oxley legislation since it has been more than 10 years since the regulation has been established. BoardProspects is an online professional community dedicated to building better boards of directors for private, public, and nonprofit organizations. Mark Rogers, the founder and chief exec- utive, posts that the real problem with executive compensation starts with the board of directors. He points at the collapse of Enron as a failure of the board of directors. The board didn’t safeguard Enron shareholders and contributed to the collapse of the seventh largest public company in the United States. The board allowed Enron to engage in high-risk accounting, inappropriate conflict of interest transactions, extensive undisclosed off-the-books activities, and excessive executive compensation. Rogers claims that executive pay would be more reasonable if there were term limits on how long a person can serve on a board, limits on the number of boards a person can sit on at one time, and requirements for continuing education on governance as part of his or her training.5

Case Questions

1. What is a clawback process in regard to executive compensation?

2. How do the newer laws impact the job of the HR person or compensation expert?

3. Why is the Dodd-Frank legislation so important to executive compensation?

4. Why is Sarbanes-Oxley an important part of HR?

5. What is the role of the board of directors in setting executive pay?

Case 12.2. Trends and Issues in HRM: The Giving Praise Model in Action The first time David Shaker went to work and was paid was when he was 18 years old. Although David did jobs such as raking leaves and shoveling snow, he was more focused on playing sports than getting a part-time job. During his first year of college, he found his first real job at a McDonald’s. The part-time job at McDonald’s taught David almost everything he learned about business, and he has used it throughout the rest of his life.

One such learning lesson at McDonald’s was in regard to compensation and incentive pay. Individual incentives reinforce performance with a reward that is sig- nificant to the person. At 18 years old, David was very happy with a minimum wage of $1.65 and the benefit of a free meal for each shift he worked. Since David was evaluated on his personal performance at the restaurant, it was pretty easy for his

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Part IV • Compensating6 4

manager Naino Leo to evaluate the quality, cleanliness, and service David provided to customers. Plus, it was fairly easy to evaluate David since his job had a distinct outcome (the quality and appearance of the cooked hamburger).

After David graduated from college in 1982, he took a marketing position with the old AT&T. David was evaluated on the performance of the entire group of marketers and their ability to sell expensive telephone systems to business customers. Group incentives provide reinforcement for the actions of more than one individual within the organization. The group evaluation at AT&T did promote teamwork because the employees in David’s area had to work together to earn their bonus. Most of the team members were loyal and trusted each other to complete the sales. However, the prob- lem with teamwork at AT&T was that a few employees played the social loafer role. That meant that they didn’t work nearly as hard and made fewer sales to customers. These social loafers still expected to share in the bonus each employee would get if the team met or went beyond their sales goal. A bonus is a lump sum payment, typi- cally given to an individual at the end of a time period. Like all employees, David was happy to get a “holiday bonus.”

David’s next step in his career path led him to Monarch Insurance, where he learned all about the strengths and weaknesses of commission-based sales. A com- mission is a payment typically provided to a salesperson for selling an item to a customer, usually calculated as a percentage of the price of the item sold. In David’s case, he sold insurance policies to employees at other companies as part of the ben- efit those employees were offered. Thus, if David sold an employee from Company ABC an insurance policy to protect his family in case of his death, then David would earn a commission. Many salespeople are paid on a straight commission, meaning that they get paid only if they sell an item. In David’s case, he was paid a lower base salary, which was supplemented by commissions on his sales. David felt his salary plus commission compensation structure was implemented properly, and he enjoyed the motivation to increase his paycheck by making more sales. It was important for David to treat customers properly (as he was trained at McDonald’s), even if he made a smaller commission. He would rather see that the customers got the correct life insurance policy. Commission sales can motivate salespeople to want to earn the highest commission possible—even if it means that customers buy more product than they actually need.

David felt fortunate that he never worked under a piecework or piece-rate plan. However, he once took a tour of a toy factory, which was under a piece-rate plan, and he watched the employees sorting pieces to include in a 72-piece set. The employees working around the machine were quite calm and peaceful. They just kept inserting bricks, such as the toy head for the person, into the set. When asked, the employees said they were paid for each set of products that was made to the expected quality and specifications. The employees also noted that they enjoyed job rotation and would exchange seats around the machine and belts. That would allow the person to take a different part and insert that part into a different spot in the box. The key for the employees was to work at the proper pace so that they were not working too slowly or too fast. Working too slowly could mean that you weren’t making enough of the product. Working too fast could mean that you made mistakes because you didn’t have enough time to be careful.

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Chapter 12 • Incentive Pay 6 5

But for all the different compensation plans that David experienced in his differ- ent jobs, he was most happy when someone told him he was doing a good job. If the customers said he was doing a good job . . . great! If a manager said he was doing a good job . . . great! If his wife praised him about doing a good job—that was also great!

The Giving Praise Model has four steps. The first step is to tell the employee exactly what was done properly. The second step is to tell the employee why the behavior is important. The third step is to allow a moment of silence to give the employee a chance to feel the impact of the praise. The fourth step is to encourage repeat perfor- mance so the employee continues to do great work.

Upon reflection, David was always impressed with the praise he received at McDonald’s from his boss Naino Leo. Naino gave praise fairly easily, and it didn’t cost McDonald’s a penny! Managers who use praise will realize that it really works and that employees work even harder to keep up the good work. At times, David did receive praise for finishing his college education, selling telephones for AT&T, or selling an insurance policy. But he also was a little sad that he never quite had the same praise that he had received at 18 years old from his boss Naino.

Case Questions

1. How would you compare hourly wages, having a salary, or being paid by commission?

2. What is the benefit of the Giving Praise Model?

3. Why do companies have a piece-rate system?

4. What is the key step in the praise model?

5. Which type of compensation incentive would you be most likely to receive if you stayed with the same company for 20 years?

Notes

1. Nemer, Kirk D., “New 2015 Developments in Executive Compensation,” Executive Career Insider, May 28, 2015, https://www.bluesteps.com/blog/executive-compensation-2015.

2. https://www.sec.gov/spotlight/dodd-frank/corporategovernance.shtml. 3. Adams, Susan, “The Highest-Paid CEOs Are the Worst Performers, New Study Says,” Forbes,

June 16, 2014, http://www.forbes.com/sites/susanadams/2014/06/16/the-highest-paid-ceos- are-the-worst-performers-new-study-says/.

4. “SEC Proposes Executive Bonus ‘Clawback’ Rule,” ABA Banking Journal, July 1, 2015, http:// bankingjournal.aba.com/2015/07/sec-proposes-executive-bonus-clawback-rule/.

5. Rogers, Mark, “Sarbanes-Oxley 10 Years Later: Boards Are Still the Problem,” Forbes, July 29, 2012.

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