Compensation

Chap 10

Pay-for-Performance Plans Mgmt 474

CSULA – Spring 2014

Learning Objectives

 What is a pay-for-performance plan?

 Does variable pay improve performance results? The

general evidence

 Specific pay-for-performance plans: Short term

 Team incentive plans: Types

 Explosive interest in long-term incentive plans

What is Pay-for-Performance?

 Pay-for-performance: Signals a movement:

 Away from entitlement

 Towards a pay that varies with individual or organizational performance

 Increasing interest in variable pay

 Competition from foreign competitors

 Fast-paced business environment

Specific Pay-for-Performance Plans:

Short Term

 Merit pay

 Lump-sum bonuses

 Individual spot awards

 Individual incentive plans

Merit Pay

 Links increases in base pay to:

 How highly employees are rated on a subjective

performance evaluation

 Issues

 Expensive

 Doesn’t achieve the desired goal of:

Improving employee and corporate performance

Managing Merit Pay

 Improve accuracy of performance ratings

 Allocate enough money to truly reward

performance

 Increase in merit pay should differentiate across

performance levels

Lump-Sum Bonuses

 Substitute for merit pay

 Not built into base pay

 Viewed as less of an entitlement than merit pay

 Less expensive than merit pay over the long run

Exhibit 10.3 - Relative Cost Comparisons

Individual Spot Awards

 Viewed as highly or moderately effective

 Awarded for exceptional performance

 Examples?

Individual Incentive Plans

 A promise of pay for some objective, pre-established

level of performance

 Use established standards to:

 Compare employee performance

 Determine magnitude of incentive pay

 Dimensions on which plans vary

 Method of rate determination

 Relationship between production and wages

Exhibit 10.5 - Individual Incentive Plans

Exhibit 10.6 - The Taylor and Merrick

Plans

Individual Incentive Plans

 Taylor plan - Two piecework rates

Higher than the regular incentive, when

production exceeds published standard

Lower than regular wage for production below

standard

 Merrick system - Three piecework rates are set

High for production exceeding 100 percent of

standard

Individual Incentive Plans

Medium for production between 83 and 100

percent of standard

Low for production less than 83 percent of

standard

Individual Incentive Plans

 Halsey 50–50 method

 For tasks completes in less than the standard time:

Savings are allocated 50–50 between the worker

and the company

 Rowan plan

 A worker’s bonus increases as the time required to

complete the task decreases

Individual Incentive Plans

 Gantt plan

 Standard time for a task is purposely set at a level

requiring high effort to complete

Exhibit 10.7 - Advantages and Disadvantages

of Individualized Incentive Plans

Source: Michael Coates, Psychology and Organizations, Heineman Themes in Psychology (Heineman: Boston, 2001); T. Wilson, “Is It Time to Eliminate the Piece Rate

Incentive System?” Compensation and Benefits Review 24(2) (1992), pp. 43–49; Pinhas Schwinger, Wage Incentive Systems (New York: Halsted, 1975).

Team Incentives Plans

 Group incentive plan

Team performance is measured against a set

standard to:

Determine the magnitude of incentive pay

 Gain-sharing plan

Pays off for teams defined at the level of a

strategic business unit

Team Incentives Plans

 Causes for failure

Varieties in teams

Level problem

Complexity

Control

Communications

Exhibit 10.9 - A Sampling of Performance

Measures

Types of Variable-Pay Plans: Advantages

and Disadvantages Plan type Advantages Disadvantages

Cash profit sharing • Simple, easily

understood

• Low

administrative

costs

• Profit influenced by

many factors beyond

employee control

• May be viewed as an

entitlement

• Limited

motivational

impact

Stock ownership

or options

• Minimal impact

on the financial

statements

• Have powerful

impact on

employee behavior

• Tax deferral to

employees

• Indirect

pay/performance link

• Employees may be

required to put up

money to exercise

grants

Types of Variable-Pay Plans: Advantages

and Disadvantages

Plan type Advantages Disadvantages

Balance Scorecard • Communicates

organizational priorities

• If financial targets are not

met, there may be a

reduced payout

• Can be complex

Productivity/ gain

sharing

• Performance–

reward links

• Productivity and

quality

improvements

• Knowledge

of business increases

• Fosters teamwork,

cooperation

• Administratively

complicated

• Drop-off in quality

• Management must

open the books

• Payouts occur even

if company’s financial

performance is poor

Types of Variable-Pay Plans: Advantages

and Disadvantages

Plan type Advantages Disadvantages

Team/group

incentives

•Reinforces

teamwork

and team identity/

• Stimulates

ideas and problem

solving

• Minimizes

distinctions

between team

members

• May better

reflect how work is

performed

• May be difficult to

isolate impact of

team

• Not all employees

can

be placed on a team

• Can be

administratively

complex

• May create team

competition

• Difficult to set

equitable targets for

all teams

Exhibit 10.12 - The Choice Between

Individual and Group Plans

Key Elements in Designing a Gain-

Sharing Plan

 Strength of reinforcement

 Productivity standards

 Sharing the gains

 Scope of the formula

 Perceived fairness of the formula

 Ease of administration

 Production variability

Exhibit 10.13 - Three Gain-Sharing

Formulas

Gain-Sharing Plans

 Scanlon plan

 Designed to lower labor costs without lowering the level of a firm’s activity

 Incentives are derived:

 As a function of the ratio between labor costs and sales value of production (SVOP)

 SVOP includes sales revenue and value of goods in inventory

 Rucker plan

 Expresses the value of production required for each dollar of total wage bill

Gain-Sharing Plans

 Implementation and success of Rucker or Scanlon plan

requires:

 A productivity norm

Effective measurement of base year data

Acceptance by workers and management of this

standard for calculating bonus

 Effective worker committees

Evaluate employee and management suggestions

Similarities and Contrasts Between

Scanlon and Rucker Plan

 Similarities

 Differ from individual incentive plans in their primary focus

 Differences

 Rucker plans tie incentives to a wide variety of savings

 Scanlon plans focus on labor savings

 Due to greater flexibility Rucker plans can be linked with individual incentive plans

Gain-Sharing Plans

 Improshare (improved productivity through

sharing)

Develops standard to:

Identify expected hours required to

produce an acceptable level of output

Savings are shared by firm and workers

Easy to administer and to communicate

Profit-Sharing Plans

 Focuses on a predetermined index of profitability

 Company should specify the funding formula

Earnings-at-Risk Plans

 Success sharing plan

Employee base pay is constant

Variable pay increases in successful years

No reduction in base pay and no variable

pay in poorly-performing years

 Risk sharing plan

Compared to success sharing plan base pay is

reduced by some amount

Exhibit 10.15 - Group Incentive Plans:

Advantages and Disadvantages

Group Incentive Plans

 Can be described by:

The size of the group that participates in the

plan

The standard against which performance is

compared

The payout schedule

Explosive Interest in Long-term

Incentive Plans

 Long-term incentives (LTIs)

 Focus on performance beyond the one-year time

line

 Growth in long term plans

Result of desire to motivate longer-term value

creation

Exhibit 10.17 - Long-Term Incentives and

Their Risk/Reward Tradeoffs

Exhibit 10.17 - Long-Term Incentives and

Their Risk/Reward Tradeoffs

Long-Term Incentive Plans

 Employee stock ownership plans (ESOPs)

 Generate long-term effects

 Foster employee willingness to:

Participate in the decision-making process

 Have little impact on productivity or profit

 Performance plans (performance share and performance unit)

 Driven by financial earnings or return measures

 Pay for meeting or exceeding specific goals

Long-Term Incentive Plans

 Broad-based option plans (BBOPs)

 Are stock grants

 Are versatile

 Combination plans

 Use of both individual and group incentives

 Self-funding plan

Payouts occur only after the company reaches a

certain profit target