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Pay-for -performance

Prepared by:
Why Incentives?

• People join a firm because of Pay

• People stay in a firm (or leave) because of Pay

• Employees more readily agree to develop job skills because of


• Employees perform better on their jobs because of Pay

Designing a pay-for-performance
• The effectiveness of a pay model depends upon three things- efficiency,
equity and compliance.

1. Efficiency: it involves three general areas of concern.

(i) Strategy:
• Does the pay-for-performance plan support corporate objectives?
• The plan should link well with HR strategy and objectives.
• The reward should not be on the basis of status quo.
• Finally, management has to address the most difficult question like- How
much of an increase makes a difference? How does it take to motivate an
(ii) Structure:
• Structure of the organization should be sufficiently decentralized to allow different
operating units to create flexible variations on a general pay for performance plan.
• Different operating units may have different competences and different
competitive advantages, so the organization should not have a rigid pay-for-
performance system that detracts from these advantages.

(iii) Standards:
• The key to designing a pay-for-performance system rests on standards:
• Objectives
• Measures
• Eligibility
• Funding
2. Equity/Fairness :
• The second design objective is to ensure that the system is fair to
employees. Two types of fairness are concerns of employees:
• Distributive justice: Fairness in the amount that is distributed to the
employees. Managers have little influence over the size of employee’s pay
check. It is influenced more by external market conditions, pay policy
decisions of organization and occupational choices.
• Procedural justice: Fairness of the procedure used to determine the
amount of reward employee receives. Managers have control over this
type and the organizations that use fair procedures and supervisors are
perceived as more trustworthy and command higher levels of
• A key element in fairness is communication regarding what is expected
from employees.
3. Compliance:
The pay for performance system should comply with existing laws as a good
reward system enhances the reputation of the firm.
Types of Pay-for-performance

1) Shop-floor incentive: Shop-floor incentive schemes are based

on the principle of payment-by-performance(PBR).

• F. W. Taylor(1911), stated that the object of shop-floor incentive scheme was to

reward the input of labor within closely-defined tasks and by so doing, to stimulate
people to work at a faster pace and increase their output.

• This is in accordance with the instrumentalist view of motivation which is closely

associated with ‘Taylorism’.

• The view that employees will only work harder if they get more money still
dominates thinking about shop-floor incentive schemes, although the advent of
high technology in the shape of computer-integrated manufacture has meant that
what were formerly skilled craft workers have now become technicians.
2) Sales force incentive:

• Any company with a consumer-facing (or, indeed, a business-to-business) aspect

will constantly be looking to increase their sales figures.
• Targets are set for sales people, but there is frequently little incentive to push
beyond these targets once an employee is drawing a salary.
• Developing effective incentive schemes to encourage your sales people to
perform to the best of their abilities is an important aspect of running a successful
consumer facing business.
• The major benefits here are two-fold; in the first instance your turnover obviously
increases as your sales go up. Secondly, a good sales incentive scheme that goes
beyond the regular bonus structure will be a vital tool for keeping hold of your
most talented, in demand sales staff.
3) Exécutive pay

•Executive pay is financial compensation received by an officer of a firm, often

as a mixture of salary, bonuses, shares of and/or call options on the company
stock, etc.

• Over the past three decades, executive pay has risen dramatically beyond the
rising levels of an average worker's wage. Executive pay is an important part
of corporate governance, and is often determined by a company's board of
4) Team based Pay

• It is one of the incentive plans which has lot of attributes to be a failure

reports many companies.
• First, team comes in many varieties such as, full-time teams(work group
organized as a team), part-time teams(that cut across functional
departments) and full-time teams which are temporary. With so many
varieties. It is hard to have a consistent type of compensation plan.
• A second problem with rewarding teams is called the “level problem”.
• Third problem is the complexity of a plan which varies from organization
to organization.
• Company makes sure that all its team pay comes from performance
measures under the control of the team but there are uncontrolled
elements factored into the process of setting performance standards.
• Team-based pay plans simply are not communicated which is the factor in
compensation success or failure.
Types of team based Pay
• Profit-sharing

• Gain-sharing

• Employees Stock Ownership Plan(ESOP)

(a) Profit-sharing plan
• Profit sharing, when used as a special term, refers to
various incentive plans introduced by businesses that
provide direct or indirect payments to employees that
depend on company's profitability in addition to
employees' regular salary and bonuses.
• The profit sharing plans are based on
predetermined economic sharing rules that define the
split of gains between the company as a principal and
the employee as an agent.
• For example, suppose the profits are x, which might be a
random variable. Before knowing the profits, the
principal and agent might agree on a sharing rule
s(x). Here, the agent will receive s(x) and the principal
will receive the residual gain x-s(x).
b) Gain-sharing plan:
• Gain-sharing is best described as a system of
management in which an organization seeks higher
levels of performance through the involvement and
participation of its people.
• As performance improves, employees share financially in
the gain. It is a team approach; generally all the
employees at a site or operation are included.
• Gain-sharing measures are typically based on
operational measures i.e., productivity, spending,
quality, customer service.
• Gain-sharing applies to all types of business that require
employee collaboration and is found in manufacturing,
health care, distribution, and service, as well as the
public sector and non-profit organizations.
(c) Employee Stock
Ownership Plan(ESOP):

• Some companies believe that employees can be linked

to the success or failure of the company through ESOP.

• Companies like PepsiCo, Lincoln Electric, Coca-Cola and

others goals to increase employee involvement in the
organization which may increase the performance.

• ESOPs don’t make sense as an incentive since the effects

are generally long-term.