Pay-for-Performance:

Incentive Rewards

Managing Human Resources

Bohlander • Snell 14th edition

© 2007 Thomson/South-Western. PowerPoint Presentation by Charlie Cook

All rights reserved. The University of West Alabama
 Objectives
After studying this chapter, you should be able to:

1. Discuss the basic requirements for successful

implementation of incentive programs.
2. Identify the types of, and reasons for
implementing, individual incentive plans.
3. Explain why merit raises may fail to motivate
employees adequately and discuss ways to
increase their motivational value.
4. Indicate the advantage of each of the principal
methods used to compensate salespeople.

© 2007 Thomson/South-Western. All rights reserved. 10–2

 Objectives (cont’d)
After studying this chapter, you should be able to:

5. Differentiate how gains may be shared with

employees under the Scanlon, Rucker, and
Improshare gainsharing systems.
6. Differentiate between profitsharing plans and
explain advantages and disadvantages of these
programs.
7. Describe the main types of ESOP plans and discuss
the advantages of ESOP to employers and
employees.

© 2007 Thomson/South-Western. All rights reserved. 10–3

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–4

 Figure 10–1 Types of Incentive Plans

INDIVIDUAL GROUP ENTERPRISE

Piecework Team compensation Profit sharing
Standard hour plan Scanlon Plan Stock options
Bonuses Rucker Plan Employee stock
ownership plans
Merit pay Improshare
(ESOPs)
Lump-sum merit pay Earnings-at-risk plans
Incentive awards
Sales incentives
Incentives for professional
employees
Executive compensation

© 2007 Thomson/South-Western. All rights reserved. 10–5

 Incentive Plans as Links to
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.

© 2007 Thomson/South-Western. All rights reserved. 10–6

 Figure 10–2 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.

© 2007 Thomson/South-Western. All rights reserved. 10–7

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–8

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–9

 Highlights in HRM 1
Assessing Incentive Program Effectiveness

Source: Christian M. Ellis and Cynthia L. Paluso, “Blazing a Trail to Broad-Based Incentives,” WorldatWork
Journal 9, no. 4 (Fourth Quarter 2000): 33–41. Used with permission, WorldatWork, Scottsdale, Arizona.
© 2007 Thomson/South-Western. All rights reserved. 10–10
 Highlights in HRM 2

Setting Performance Measures—The Keys

• 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.

© 2007 Thomson/South-Western. All rights reserved. 10–11

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–12

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–13

 Computing the Piece Rate

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)

© 2007 Thomson/South-Western. All rights reserved. 10–14

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–15

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–16

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–17

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–18

 Highlights in HRM 3
Merit Pay Guidelines Chart
A merit pay guidelines chart is a “lookup” table for awarding merit
increases on the basis of
(1) employee performance,
(2) position in the pay range,
(3) time since the last pay increase.
Concerns:
What should unsatisfactory performers be paid?
What should average performers be paid?
How much should superior or outstanding performers be paid?

© 2007 Thomson/South-Western. All rights reserved. 10–19

 Problems with Merit Raises
• Money available for merit increases may be inadequate to
satisfactorily raise all employees’ base pay.
• Managers may have no guidance in how to define and measure
performance; there may be vagueness regarding merit award
criteria.
• Employees may not believe that their compensation is tied to
effort and performance; they may be unable to differentiate
between merit pay and other types of pay increases.
• The performance appraisal objectives of employees and their
managers are often at odds.
• There may be a lack of honesty and cooperation between
management and employees.
• Merit pay plans do not necessarily motivate higher levels of
employee performance.

© 2007 Thomson/South-Western. All rights reserved. 10–20

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–21

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–22

 Incentive Awards and Recognition
• Awards
 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.

© 2007 Thomson/South-Western. All rights reserved. 10–23

 Sales Incentives

Sales Incentive Plans

Straight Salary

Straight Commission

Salary and Commission

Combinations

© 2007 Thomson/South-Western. All rights reserved. 10–24

 Incentive Plans for Salespersons
• Straight Salary Plan
 Compensation plan that permits salespeople to be
paid for performing various duties that are not
reflected immediately in their sales volume.
 Encourages building customer relationships.
 Provides compensation during periods of poor sales.
 May not provide sufficient motivation for maximizing
sales volume.

© 2007 Thomson/South-Western. All rights reserved. 10–25

 Incentive Plans for Salespersons
• Straight Commission Plan
 Compensation plan based upon a percentage of
sales.
 Draw is a cash advance that must be paid back as
commissions are earned.
 Disadvantages of straight commission incentive
 Emphasis is on sales volume rather than on profits.
 Customer service after the sale is neglected.
 Earnings tend to fluctuate widely between good and poor
periods of business.
 Temptation to grant price concessions to get sales.

© 2007 Thomson/South-Western. All rights reserved. 10–26

 Incentive Plans for Salespersons
• Combined Salary and Commission Plan
 A compensation plan that includes a straight salary
and a commission component (“leverage”).
 Advantages
 Combines the advantages of straight salary and straight
commission forms of compensation.
 Offers greater design flexibility
 Can be used to develop the most favorable ratio of
selling expense to sales.
 Motivates sales force to achieve specific company
marketing objectives in addition to sales volume.

© 2007 Thomson/South-Western. All rights reserved. 10–27

 Incentives for Professional Employees

Managerial
Managerial and
and Executive
Executive Incentives
Incentives

Bonuses
Bonusesand
and merit
merit increases
increases

Double-track
Double-trackwage
wagesystems
systems

Performance
Performanceincentive
incentivebonuses
bonuses

Profit
Profit sharing
sharingand
and stock
stockownership
ownership

Executive
Executiveperquisites
perquisites(perks)
(perks)

© 2007 Thomson/South-Western. All rights reserved. 10–28

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

© 2007 Thomson/South-Western. All rights reserved. 10–29

 Types of Long-Term Incentive Plans
Stock Price Performance-Based
Appreciation Plans Plans
Stock Options Performance Units
Stock Appreciation Performance Shares
Rights (SARS)
Formula-value Grants
Stock Purchase
Dividend Units
Phantom Stock

Restricted
Stock/Cash Plans
Restricted Stock
Restricted Cash

© 2007 Thomson/South-Western. All rights reserved. 10–30

 Figure 10–3 Types of Long-Term Incentive Plans

Stock options
Stock appreciation rights
(SARs)
Stock purchase
Phantom stock
Restricted stock
Performance units
Performance shares
© 2007 Thomson/South-Western. All rights reserved. 10–31
 Executive Compensation: Ethics and
Accountablility
• 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.
© 2007 Thomson/South-Western. All rights reserved. 10–32
 Highlights in HRM 4

The “Sweetness” of Executive Perks

• Company car • Spouse travel

• Company plane • Physical exams
• Executive eating facilities • Mobile phones
• Financial consulting • Large insurance policies
• Company-paid parking • Income tax preparation
• Personal liability insurance • Country club membership
• Estate planning • Luncheon club membership
• First-class air travel • Personal home repairs
• Home computers • Loans
• Chauffeur service • Legal counseling
• Children’s education • Vacation cabins

© 2007 Thomson/South-Western. All rights reserved. 10–33

 Executive Compensation Reform
• Current Reform Measures
 The Internal Revenue Service (IRS) is looking for tax-
code violations in executive pay packages and will
make executive pay a part of corporate audit.
 The Securities and Exchange Commission ruled that
companies on the New York Stock Exchange and
NASDAQ must obtain shareholder approval before
granting stock options and other equity compensation
to executives and employees.
 The Financial Accounting Standards Board (FASB)
now requires that stock options be recognized as an
expense on income statements.

© 2007 Thomson/South-Western. All rights reserved. 10–34

 Executive Compensation Reform (cont’d)
• Possible Future Reform Measures
 Sophisticated formulas that peg executive
compensation to organizational benchmarks other
than stock price to align pay more closely with
performance.
 Corporate policy changes governing how
compensation committees structure executive pay
packages.
 Restraints on stock options making it harder for
executives to cash out and receive windfall cash
sums.

© 2007 Thomson/South-Western. All rights reserved. 10–35

 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.

© 2007 Thomson/South-Western. All rights reserved. 10–36

 Group Incentive Plans (cont’d)
• 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.
 Scanlon
 Rucker
 Improshare

© 2007 Thomson/South-Western. All rights reserved. 10–37

 Figure 10–4 The Pros and Cons of Team Incentive Plans

PROS
• Team incentives support group planning and problem
solving, thereby building a team culture.
• The contributions of individual employees depend on group
cooperation.
• Unlike incentive plans based solely on output, team
incentives can broaden the scope of the contribution that
employees are motivated to make.
• Team bonuses tend to reduce employee jealousies and
complaints over “tight” or “loose” individual standards.
• Team incentives encourage cross-training and the acquiring
of new interpersonal competencies.

© 2007 Thomson/South-Western. All rights reserved. 10–38

 Figure 10–4 The Pros and Cons of Team Incentive Plans (cont’d)

CONS
• Individual team members may perceive that “their” efforts
contribute little to team success or to the attainment of the
incentive bonus.
• Intergroup social problems—pressure to limit performance
(for example, team members are afraid one individual may
make the others look bad) and the “free-ride” effect (one
individual puts in less effort than others but shares equally
in team rewards)—may arise.
• Complex payout formulas can be difficult for team members
to understand.

© 2007 Thomson/South-Western. All rights reserved. 10–39

 Employee Bonus and Gainsharing Plans

Rewards
Rewards come
come from Rewards come from employee participation in
from employee
employee participation
participation in
in
Scanlon
ScanlonPlan
Plan improving productivity and reducing costs.
improving productivity and reducing costs.

Rucker
RuckerPlan
Plan Shared
Sharedrewards
rewardscome
comefrom
fromthe
thedifference
differencebetween
between
(SOP)
(SOP) labor costs and sales value of production.
labor costs and sales value of production.

Gainsharing
Gainsharingbased
basedon
onincreases
increasesininproductivity
productivityof
of
Improshare
Improshare the
thestandard
standardhour
houroutput
outputof
ofwork
workteams.
teams.

© 2007 Thomson/South-Western. All rights reserved. 10–40

 Figure 10–5 Scanlon Plan Suggestion Process

© 2007 Thomson/South-Western. All rights reserved. 10–41

 Highlights in HRM 5
Lessons Learned: Designing Effective Gainsharing
Programs
• Enlist total managerial support for the gainsharing effort.
• When developing new programs, include representatives from all
groups affected by the gainsharing effort—labor, management,
employees.
• Prevent political games in which involved parties are more
interested in preserving their self-interests than in supporting the
group effort.
• Bonus payout formulas must be seen as fair, must be easy for
employees to calculate, must offer payouts on a frequent basis, and
must be large enough to encourage future employee effort.
• Establish effective, fair, and precise measurement standards.
• Be certain that employees are predisposed to a gainsharing reward
system.
• Launch the plan during a favorable business period.
© 2007 Thomson/South-Western. All rights reserved. 10–42
 Enterprise Incentive 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.
 Challenges:
 Agreement over division of profits between company
and employees.
 Possibility of no payout due to financial condition of
company.

© 2007 Thomson/South-Western. All rights reserved. 10–43

 Enterprise Incentive Plans (cont’d)
• 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.

© 2007 Thomson/South-Western. All rights reserved. 10–44

 Enterprise Incentive Plans (cont’d)
• 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.

© 2007 Thomson/South-Western. All rights reserved. 10–45

 Employee Stock Ownership Plans

Rewards
Rewards and
and Risks
Risks of
of ESOPS
ESOPS

Advantages
Advantages Disadvantages
Disadvantages
Retirement
Retirement benefits
benefits Liquidity
Liquidityand
andvalue
value
Pride
Prideof
ofownership
ownership Single
Single funding
fundingbasis
basis
Deferred
Deferredtaxes
taxes Not
Notinsured
insured

© 2007 Thomson/South-Western. All rights reserved. 10–46

 Key Terms
• bonus • profit sharing
• combined salary and • Rucker Plan
commission plan • Scanlon Plan
• differential piece rate • spot bonus
• employee stock • standard hour plan
ownership plans (ESOPs) • straight commission plan
• gainsharing plans
• straight piecework
• Improshare • straight salary plan
• lump-sum merit program • team incentive plan
• merit guidelines • variable pay
• perquisites

© 2007 Thomson/South-Western. All rights reserved. 10–47