Unit 13

VARIABLE COMPENSATION-INDIVIDUAL GROUP

The establishment of equitable and competitive base pay will assist in attracting
personnel to an organization. To achieve the second objective of motivation, the
organization can hold out the possibility of varying compensation, the payment of which
is dependent upon behavior. These monetary motivation appeals can be made to both
individuals and group.

Expectancy Theory and Compensation

If money, or any factor, is to motivate behavior, employees must both desire it and
believe that it will be forthcoming if they behave in the manner prescribe. Thus, the
actual effects of its influence comes from employee assessment of (1) the value of money
in meeting personal needs, and (2) the strength of expectancy that the prescribed
behavior will actually result in the obtainment of the proffered reward. Vroom therefore
suggests the following formula.

Motivational force = valence X expectancy

In determining the degree of valence or value of money to employees, one

requires knowledge of current need levels. Maslow suggests that those persons whose
survival needs are not reasonably well met are likely to place high value upon money as a
means of gratifying physiological requirements. In addition, since people are rarely
exclusive economic in their orientation, employees will have to compare positive
monetary outcomes with all possible losses, such as social rejection if the incentive plan
clashes with primary group norms. Despite its lower order of importance in certain
groups, there is evidence that money is attractive and has real value for large numbers of
organizational employees.

The greatest difficulty in monetary motivation lies in the expectancy portion of

the formula. Employees will subjectively assess likelihood that desired compensation
will actually be forthcoming. This requires consideration of two major items: (1)
personal capacity to perform the prescribed act, and (2) perception that such behavior will
actually be rewarded. Obviously, if the person highly desires money and is offered $ 1
million to high-jump 10 feet, the motivational force is likely to be zero, since this is far
beyond the current world’s record. Supervisors can assist in increasing abilities through
training, increasing confidence in capacities by encouragement and removing
organizational obstacles to employee performance.

Perhaps the greatest difficulty in regard to expectancy is convincing the employee

that management can be trusted to pay off when the prescribed behavior if forthcoming.

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If the incentive scheme is so complicated that accountants have difficulty in
understanding, then expectancy is likely to be low. If superior performance has been
accorded little or only slightly higher pay increase in the past, then the assessment of
instrumentality of monetary rewards is likely to be low. Organizations that use base pay
supplemented by merit-rating schemes to determine periodic pay increases are less likely
to breed high expectancies than those utilizing individual incentive plans. In a study of
varying degrees of expectancy achieved in a firm of 2,000 employees, Schwab
discovered that the perceived individual linkage of money with behavior was highest
among those on individual incentive plans, next highest for those on group incentive, and
lowest for those on hourly pay plans. Supporting the thesis the objectives have higher
valence when attached to performance that requires effort, those on incentive systems
tended to place higher values on money.

Research in this same organization revealed that though employees on incentive

plans were more highly motivated than those on hourly pay, the latter were more satisfied
with the pay actually received. Productivity was highest under the individual piece-rate
system and lowest under the hourly. In separate measures of satisfaction, hourly paid
personnel reported the highest satisfaction with pay received, individual-incentive
employees next highest, and those on group plans reported the greatest dissatisfaction.
Thus, it is suggest that one may have to choose between developing motivated employees
of satisfied employees.

Variable Compensation-Individual

Since the days of scientific management and Federick Taylor, business

organizations have emphasized the use of incentives on an individual, rather than group,
basis. This certainly fitted into the traditional American value of individualism where
each person looks after his or her own best interests. The following four schemes of
administering variable pay will be discussed: (1) general merit and/or seniority
progression, (2) incentive plans for operatives, (3) incentive plans for managers, and (4)
suggestion systems.

Merit/Seniority Progression

The location of the rate range is controlled by job requirements and wage survey
results. Progression through the rate range is dependent on the person. The firm has a
choice of controlling this progression by specifying that it be based on merit, seniority, or
some combination of the two.

Though the primary use of performance appraisal should be in promoting

employees development, many firms also tie the results directly into variable
compensation. Organized labor generally prefers either a single rate for all personnel or a
rate range operated solely on a seniority basis. Various compromises have been
proposed. The first compromise would involve a splitting of each range into two parts
with seniority controlling the lower half, and merit the upper half. In this manner, each
employee is assured of receiving the middle rate, which is often the going rate, merely by

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serving the required amount of time on the job. If one expects to receive more than the
going rate, he or she must be a better-than average employee as demonstrated by
performance ratings.

A second type of compromise is that seniority governs completely the

progression through the rate range in the lower job classes, and merit governs completely
in the higher job classes. In the lower jobs, the employee has less freedom and the job
content controls; in the higher jobs, the person can exert a stronger influence on the
manner in which the job is performed. This philosophy is also demonstrated in the
gradually increasing sizes of rate ranges, which permit a greater percentage of variable
pay in the higher jobs.

A few firms have been experimenting with providing employees with the option
of receiving pay increases in one lump sum. If allotted an increase of $1,200, the
employee can choose to receive it all at once, or at the rate of an extra $100 per month.
The purpose of the lump sum is to dramatize the size of the increase in the hope of
stimulating greater motivation. The usual approach is to treat the lump sum increase as a
loan or salary advance, a portion of which must be returned if the employee leaves the
organization before the year is up. When the lump sum option is offered, approximately
half of all employees elect it. The option has been offered in such firms as Aetna,
American Can, B.F. Goodrich, Timex, and Westinghouse.

Incentive Plans For Operatives

In theory there is no ceiling of compensation under an incentive plan for operative

employees; the worker can earn as much as he or she is physically capable of doing. In
practice, there are often managerial and fellow employee expectations that serve to put a
lid on additional earnings.

In order to establish an incentive pay plan for operatives, two basic items of data
are essentials: (1) the average amount of output that is necessary for adequate job
performance and (2) the fair and equitable amount of money deserved for this average
amount of work. We have already discussed the task of determining base pay for the job.
We now add the task of measuring work performance. In production jobs, time study is
the management technique that typically supplies the answer, for example, 50 units of
product to be produced each hour. Portion of the time study process can be characterized
as scientific, but much of it is simply systematic. One must select an average worker to
study, select a representative sample of his or her work, estimate the speed or pace of
work being observed, allow for interruptions and delays, and add in a percentage of time
to adjust for accumulating fatigue. Many firms report that three-fourths of their
grievances issue from this process of setting a work standard for the individual. In
operative jobs in the sales are, one can use time and duty analyses as well as past
experiences in establishing sales quotas for commission purposes.

It should be noted that non-incentive compensation, that is, payment on the basis
of time expended, is the most commonly used arrangement for operative personnel. The

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percentage of factory workers on incentive plans has steadily declined from 30 percent in
1947 to 18 percent in 1980. The use of time-payment plans is quite common in industries
using automatic and semiautomatic machinery where the worker does not have control of
the process, such as cigarettes, pain, refining, automobiles, chemicals, and so on. On the
other hand, incentive plans cover from 60 to 80 percent of employees in clothing, shoes,
and steel. In clothing and shoes manufacturing the output is identifiable, measurable, and
under the control of the worker. Basic steel is unique in that it is highly mechanized but
pays incentives to 80 percent of the workers. This is caused by the tradition of including
maintenance and service workers in the system. For example, a furnace operator is given
the opportunity to earn 35 percent above base, indirect employees such as maintenance
personnel may earn up to 23 percent, and secondary indirect personnel such as general
labor can earn up to 12 percent. The system recognizes that the individual machine
operator could not possibly perform above standard if not provided consistent support
help by other personnel.

With respect to other personnel, one of a continuing series of surveys indicates

that almost all office employees are paid on the basis of time. On the other hand, variable
compensation is much more widely used for managerial personnel.

Types of plans Because of the ease with which one can manipulate the two
variables, pay and output, there are a multitude of incentive plans that have been
developed. In general, they can be classified into two categories: piece rate and time
bonuses. The most commonly used operative incentive plan is straight piece work.
Thus, if the standard is 50 units per hour, the base rate is $5 per hour, and the employee
produces 600 units in an 8-hour day, then the piece rate is 10 cents each and the total
earnings are $60. If hourly earnings have been guaranteed regardless of output ($40),
incentive earnings in this illustration would account for the extra $20.

Payment plans based on time bonuses are more complicated because there are
three types of time involved: (1) time work, (2) time saved, and (3) standard time. For
example, if during an 8-hour day, one does a series of assignments that add up to a
standard total time value of 12 hours, them time worked equals 8 hours, time saved
equals 4 hours, and standard time produced equals 12 hours. We can award the employee
a bonus based on any one of the three types of time. One illustration of each will be
given.

When standards are poorly set, often based on past experience, the firm may
choose to give a bonus that does not fully compensate for all output. The Halsey Plans
awards a bonus based on the amount of time saved, but only a fraction is awarded since
the standards are loose. Thus if 12 hours’ standard work is accomplished in 8 hours, the
employee receives pay for the hours worked (8 x $5 = $40) plus only 50 percent of the
hours saved (4 x $5 x 50% = $10) for a total of $50. If we should later set accurate
standards, the bonus standards should be moved up to 100 percent, which is identical in
effect to a straight piecework plan.

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 If standards are not only poorly set but management has great fear that employees
my double or triple total earnings, then the Rowan Plan can be used to insure that this
does not happen. An efficiency index is computed by dividing the time saved by the
standard time; for example, 4 hours saved divided by 12 standard hours equals 33.33
percent. This bonus percentage is then multiplied by the value of time worked. Thus the
employee receives pay for hours worked (8 x $5 = 40) plus 33.33 percent of the value of
hours worked (33.33% x $40 = $13.33) for a total of $53.33. There is no way for the
employee to double the pay.

The most liberal incentive plan was designed by Henry L. Gantt, one of the
pioneers of scientific management. The Gantt Task and Bonus Plan pays a fixed bonus
percentage multiplied by the total value of standard time produced should the employee
meet or exceed standard. Thus, if 12 standard hours have been produced during an 8-
hour day, the employee receives not only the value of those hours (12 x $5 = $60) but
also a bonus of 10 percent, for example, of standard time value (10% x $60 = $6) for a
total of $66. If 8 standard hours are not produced, there is no bonus. This plan is used
when standards are demanding and management needs a strong incentive.

The choice of incentive pay plans for operatives is very large, particularly when
firms can devise their own custom plans using the basic elements of output, time saved,
time worked, and standard time. All such plans should be understandable by the
employee and guaranteed against change except in the case of major alterations in
equipment or methods. If possible, standards for all jobs should be of uniform difficulty,
and the spread between normal hourly earnings and average incentive pay should be
sufficient to stimulate above-average effort. Some management estimate the incentive
earnings should be from 30 to 40 percent above straight hourly earnings.

Because of the difficulties of adhering to these characteristics, some firms have

abandoned individual incentives for what is termed “measured day work.” Standards of
performance are retained but employees are paid on a time basis. Comparisons of
performance output with these standards are made for the worker, and pressure,
supervision, challenge, and praise are substituted for money as the incentive. In most
instances, if an employee is definitely and exactly told what is expected, he or she will
make every effort to comply.

Human problems of incentive plans The traditional, official posture of

organized labor is one of opposition to individual incentive pay plans. The union desires
solidarity among members and uniform compensation on the same job is often deemed
prerequisite to this cooperation. At the least, the union will stand guard over the
processes of establishment and administering work standards, ready at any moment to
process a grievance protesting a decision which leads to less pay for its members. In
addition to this more formal problem, there are a number of human relations problems
growing out of incentive systems. Among this are (1) the ratebuster, (2) the reaction to
changes in methods, equipment, and materials, (3) the reaction to lack of uniformity in
tightness of standards, and (4) informal restriction of output. All these problems resolve
around employees fear of management and a desire for security.

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 A ratebuster is an employee who produces far in excess of standard, and
consequently in excess of the production of most of the members of a work group. There
is a feeling among most employees that management will stand for paying only so much
bonus, and that if one or more employees make excessive bonuses, the rates will be cut.
There is great informal pressure upon all employees to conform to the production level of
most of the group. It therefore follows that the employee who does not conform has to
have a strong personality, and often a strong physique, in order to resist these pressures.

The ratebuster is usually ostracized by other workers and operates as if isolated.

The values of additional money have been balanced against the value of group
acceptance, with the decision going to the former. In theory, management should look
with favor upon the ratebuster and pay double and triple wages when they are earned. In
practice, management often prefers not to have a ratebuster, feeling that she or he is a
disruptive influence in the shop; and indeed there have been times when the ratebuster
has been transferred to other jobs in order to smooth relations. But if the standards are
properly established, there is little justification for not paying the production genius all
that is earned.

Related to group pressures on the ratebuster is the general pressure on

management to abandon pay programs that reward a minority of the entire group. A
Midwest paper mill recently abandoned an incentive pay plan that gave some hourly
workers twice yearly bonuses. Allocations were based on supervisors monthly
appraisals, and these were attacked by both employees and their union on the basis of
subjective measurement. After dropping the plan, the plant productivity dropped 20
percent, the turnover rate of top produces doubled, and their level of job satisfaction
decreased. On the other hand, the poorer producers liked their jobs much better. To
increase productivity, supervisors turned to the use of reprimands and threatened job
layoffs.

No firm is ever static and unchanging. Small and large changes in method,
equipment, and materials will be constantly introduced. The worker’s desire for security
and distrust of management call for an explicit policy to the effect that management will
not cut the rate unless there is a substantial change in methods, equipment, and/or
materials. If a change is substantial ( and there is difficulty in defining this word
“substantial”), there should be clear agreement between labor and management that the
work standard can be revised. This revision usually means an increase in total pay for the
employee even though the unit rate is reduced. This compensation can be construed as a
sharing with labor of gains in productivity and a purchase of the employee’s cooperation.

Sometimes a mistake has been made in a time-studied standard. This mistake can
one of two types, the creation of an excessively loose standard or an excessively tight
one. The former error may be discovered if the greater bulk of employees make bonuses
of over 50 percent of regular earnings when only the usual 25 to 30 percent was intended.
The error is frequently undiscovered, however, because of restriction of output by the
employees. Such errors can occur just as often as mistakes of the other type, an

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excessively tight standard. In the latter situation, the employee and the union usually
demand a restudy in the hope of loosening standard.

An even more difficult problem lies in the many small and seemingly
insignificant changes in method, equipment, and materials that occur in most firms.
These changes are initiated by both management and labor, through informal and formal
means. No one change appears to justify a change in the rate, but the cumulative effect
of many changes can be disastrous. Often there is only one remedy: complete restudy of
all jobs under the incentive plan. The accuracy of work standards has a tendency to
deteriorate with the passage of time from the very first day of installation.

A third human problem issues from inconsistencies in the accuracy of standards.

The supervisor has the additional problem of awarding easy and tough jobs on an
equitable basis. If awarded on a systematic basis, such as seniority or taking turns, one
must predict in advance the classification of each job. This often means a balance of its
easiness in relation to how long it will last.

Various factors have been identified as contributing to lack of uniformity in work

standards. Newly studied jobs are likely to have tighter rates while older ones have been
affected by many small changes. Rates set during times of prosperity tend to be looser
than those established during recessions; time study personnel are psychologically
affected by their environment. The smaller the profit margin on an item, the tighter the
rate is likely to be. Jobs that involve higher levels of skill tend to have looser rates since
they cannot be as closely studied as low-skilled tasks. In departments where there is
greater group cohesiveness, which leads to sanctions on the ratebuster and greater
cooperation in informally sharing work and falsifying timecards, standards are likely to
be looser. In departments with higher percentages of union membership the rates are
likely to be looser in recognition of that threat. Strategic, isolation, and dangerous jobs
tend to be favored looser rates. Thus, the causes are limitless and the possibilities for
trouble and problems of administration are great.

In all the above discussion, the concept of restriction of output has been involved.
This is the major defense of employees in the informal battle with management that takes
place through the incentive wage device. Tabulating of the average incentive earnings of
the group can also show this restriction. Instead of a normal distribution of individual
outputs, there is a rapid rise to the informally agreed-upon amount, whatever the
employees fell management will “put up with”; and after that point few, if any, operatives
make bonuses in excess of this level. Those who make above the allowed amount are
ratebusters.

Restriction of output is tangible evidence of the power of social over monetary

desires, but it does not eliminate the value monetary motivation. The entire group is
producing at a level in excess of the amount produced under the formerly administered
time rates. For example, in one corrugated container company, a stable firm operating in
a stable industry, the conversion to incentive pay resulted in increased output for 16 of 18
operations. In comparing the average plant efficiency in the 10 month prior to incentive-

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plan installation (a process consuming 26 months) with that achieved in a 10 month
period afterward, it was calculated that an overall increase of 58 percent was affected
along with an increase in employee earnings of 25 percent. In more dynamic and
uncertain environments, the development of effective incentive schemes is extremely
difficult and often impossible.

Incentive Plans For Managers

Because of the complex and variable nature of most managerial jobs, there is
much room for different levels and qualities of human performance. A study of 84 firms
revealed that 60 percent provide for some type of incentive pay for managers.

The place to begin the design of an executive incentive compensation system is

with the type of behavior desired by the organization. Various business firms are having
difficulties in properly targeting the behavior desired. It has been noted that two of the
most common problems in designing executive incentives are: (1) decoupling the system
from overall industry performance and (2) developing one-dimensional system. In regard
to the former, executives have been rewarded for increasing firm growth 15 percent
within an industry whose average growth is 20 percent. On a relative basis, the executive
is doing less well than others in the same category. With respect to the latter problem,
many plans are excessively narrow. If the reward is based on improving return on assets,
for example, the executive is tempted to lease equipment rather than buy, and to eliminate
investment critical to long-term growth. As emphasized by many critics, one of the basic
difficulties with the American business system is its excessive emphasis upon short-term
results. In recognition of the values of the long-term orientation of the Japanese reward
system, various companies are seeking to develop multiyear system emphasizing long-
range goals.

In targeting the desired behavior, criteria will vary according to levels of

responsibility. For the top executive, the emphasis, should be on entrepreneurial
behavior emphasizing risk taking, with additional compensation being on profits, degree
of market penetration, and new-product development. For lower-level executives, the
emphasis is often on smooth administration and cooperative relationships with others;
bonuses may be based on unit ratings of performance with a fixed percentage of base
salary constituting incentive.

There are a multitude of incentive pay schemes for executive, many of which are
designed in relation to income tax regulations. A few of these are the following:

1. Cash bonuses based on profits or individual performance evaluations are

perhaps the most common type of incentive for executives.

2. The use of stock options where the manager is given the option to purchase
company stock at current prices at some future date have been discouraged by
the Tax Reform Act of 1976. The increases in value through stock
appreciation are now taxed as ordinary income rather than capital gains.

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 3. Stock appreciation rights are similar to stock options, but the manager can
ignore the option to purchase and take a cash bonus equal to the value of the
stock’s appreciation over a span of time.

4. Performance objectives can be set for the executive and rewards allocated
according to degree of achievement. For example, if company earnings grow
by an average of 10 percent over a 5-year period, one might be awarded 500
free shares of stock or the equivalent in cash. For a 9 percent average, the
award might be 400 shares, and so on.

Each of the above plans is geared to stimulate more effective managerial behavior
for the long-run benefit of the organization. With inflation and high individual tax rates,
the popularity of various “perks” or perquisites has increased . Among these are use of
company automobiles, club membership, personal financial planning services, use of
company airplanes, annual physicals at plush health resorts, and major medical insurance
with no deductibles. Many of these are not taxable as income received.

The total amount of compensation for different levels and types of executives will
vary by industry and company size. In a survey of 3,157 manufacturing companies
conducted by the Executive Compensation Service of the American Management
Associations, the chief executive officer typically receives the top money. With this
designated as 100 percent, the corresponding percentage for varying executive jobs in
smaller firms ($2 million to $5 million in sales) were as follows: chief operating officer,
90 percent; executive vice president, 62 percent; top marketing executive, 60 percent; top
manufacturing executive, 54 percent; top financial executive, 51 percent; and top
personnel executive, 34 percent. For larger firms ($200 million to $500 million in sales),
they were: chief operating officer, 81 percent; executive vice president, 60 percent; top
marketing executive, 40 percent; top manufacturing executive, 45 percent; top financial
executive, 48 percent; and top personnel executive, 32 percent. According to one 1978
survey, average compensation for the chief executive officer of a hypothetical $4 billion
company would have included (1) $480,000 in salary and bonus, (2) $120,000 in pension,
insurance, and other benefits and (3) $85,000 in long-term stock-related capital
accumulation for a grand total of $685,000.

Suggestion Systems

The basic purpose of suggestion system is to stimulate creative thinking among

employees. Rather than working harder to obtain higher incentives earnings, the
employee is encouraged to think of ways to do more effectively, reduce waste, and
improve equipment, materials, and produces. In one survey of 288 companies, slightly
over half used suggestion systems on an intermittent or continuous basic. The larger the
enterprise, the more likely that such a system would be undertaken.

The incentive payoff for a usable suggestion is usually about 15 to 20 percent of

the calculated first years savings through its installation. A survey or 1 year by the

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National Association of Suggestion Systems revealed that the number of suggestions
submitted per 100 employees was 40, that management with a consequent average
savings of $499 adopted 31 percent of these. 14 each, and the average award given to
employee was $86.85. In the same year, the highest award was $46,165.

As in the case off all variable compensation plans, there are a number of
administrative problems. Supervisors sometimes resent subordinates making formal
suggestions that might make them look deficient in the eyes of upper management.
Fellow employees may resent the award to a single individual if they feel that the primary
impact of the suggestion is to cause more work to be done by fewer personnel. Staff
specialists are often not excited when the suggestion falls into their particular areas of
expertise. There are also routine problems of administration in setting up suggestion
boxes and establishing the properly staffed review committees to determine the
suggestion’s dollar value. As will be noted later, some firms have abandoned the
concept of individual suggestion systems and have moved to an arrangement where all
employees where all employees share in the savings as a group.

Variable Compensation- Group

Though more accelerated in other countries such as Japan, there is slow steady
movement toward emphasis upon the group in American management. Cooperation and
collaboration are regarded as additional sources of effective action. We shall survey the
following systems of variable compensation for groups, proceeding from narrow to broad
groupings: (1) group piece rate (2) production-sharing plans (3) profit-sharing plans, and
(4) employee stock ownership.

Group Piece Rates

In many production operations, the efforts of a single individual cannot be

differentiated from the group, such as in soap-flake packaging line of four operatives or a
fuel-pump assembly line requiring employees to companies one pump. Compensation to
meet or exceed set standards can be stimulated through a group bonus.

As an illustration, let us assume that three employees are working as a team to

assemble as appliance. For each unit of output, the entire team is allocated $6, and the
standard set by time study is 3 units per hour. If the team produces 30 units in an 8 hour
day, it has generated %180 (6x30). From this amount, the guaranteed wages are
subtracted ($180-144), resulting in a bonus of $36.

There are two philosophies in regard to dividing up of bonus. If one follows the
philosophy of job evaluation and divides according to hourly base rates, A would
receives 8/18 of the bonus ($16), b would get 6/18 ($12), leaving c with 4/18 of the extra
money ($8).

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Production-Sharing Plans

Expectancy theory would suggest that motivational force will be greatest on

individual incentives plans, somewhat weaker on group piecework, and weaker still if the
group is so large that it includes the entire production unit. In essence, these plans
constitute an attempt to share in productivity gains.

Perhaps the most famous production-sharing plan is that known as the Scanlon
Plan. This approach requires the compensation of a normal labor cost per unit of product
produced. If through more cooperation and greater efficiency labor cost can be reduced,
the entire amount saves, or some fractions distributed among the workers in the form of a
bonus. For example it may be determined from past records that labor costs constitute 30
percent of sales. If through cooperative efforts these costs can reduce to 28percent,then 2
percent of sales ids divided among employees on the basis of seniority and /or salary
levels. Lesieur, the heir-apparent to Scanlon, recommends that three-fourths of all
savings be distributed with remaining one-quarter retained by management. Scanlon
claimed that individual incentive plans stimulated cutthroat competition to detriment of
the group, whereas group incentives affected constructive cooperation.

The Scanlon plan is more than a form of monetary compensation. Many authors
classify it as a type of union-management relationship rather than a form of remuneration.
Essential features of the plan are an attitude of labor-management cooperation and system
of processing suggestions. The processing under the Scanlon Plan involves the
establishment of departmental production committees composed of the supervisor and a
union representative. The supervisor and the union representative meet periodically to
discuss individual suggestions and develop general production plans for the department.
Suggestions that are either disapproved or outside the province of the department are
submitted to a plant-wide screening committee that includes that top leadership of both
union and management. There are no individual rewards for accepted suggestions. The
group prospers through the production-savings bonus. The union is highly involved and
encourages suggestions. A contrast of managerial attitude in eight firms that had
abandoned a Scanlon Plan with attitudes in ten firms that had retained their plans
revealed a significant difference. Those abandoning the plan had significantly lower
estimates of employee judgment, dependability, initiative, and alertness.

At the Parker Pen Company, a unionized firm of 1,000 employees, bonuses have
been paid in 142 months out of 168, and range from 5 ½ percent to 20 percent of payroll.
Employees of the latter company have turned in over 25,000 suggestions. In both
instances, the Scanlon Plan replaced an individual incentive system. The number or
written grievances dropped because of management’s greater willingness to listen.
Management was able to stress quality and efficiency in the interests of improving the
return to all workers. General sharing led to improved cooperation from indirect workers
such as tool room employees, maintenance personnel, and materials handlers.

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Employee Profit Sharing

A still broader group of employees would include everyone who works for the
firm. Some claim that relating a top executives performance to the firm profits makes
sense, but a connection between the efforts of a single rank-and –file employee and
company profits is difficult to fathom. Though there are some very large profits-sharing
companies, such as Sears, Roebuck and Company, statistics show that the smaller the
enterprise the more likely the concept will adopted.

Employees profit sharing plans constitutes one of the more glamorous forms of
monetary compensation used in business. The definition of the employee profit sharing
was formulated quite well by International Cooperative Congress in 1897,as follows: an
agreement freely entered into, by which the employees receive a share, fixed in advance,
of profits.” Though the term “profits sharing” is not used precisely by many, a true plan
generally involves a definite commitment on the part of management to pay, over and
over a fair wage, extra compensation that bears a definite percentage relationship to
company profits or declared dividends.

There are two main types of employee profit-sharing plans (1) cash or current
distribution and (2) trust or deferred distribution. Under the current arrangement, benefits
are distributed among participants in cash at least once a year. Deferred type involves a
trust fund, the benefits from which are distributed in the event of death, retirement, or
disability. Some management prefers to place part of the profit share in trust and
distribute the remainder in cash each year.

There are varying estimates of the number of profits-sharing plans actually in

existence the major source of information is the Internal Revenue Service, which
qualifies deferred-sharing trusts for tax exemption purposes. The Service requires that a
qualified plan (1) cover a majority of plant of office employees, (2) stipulate a
management commitment of periodic contributions o the fund based on profits, (3) be
communicated to all covered employees,(4) contain a formula for allocating shares to
employees, and (5)establish a definite method of distribution. A survey of 513
companies utilizing profit sharing revealed that the average company contribution to the
fund amounted to 10 percent of total payroll. Half provided for additional employee
contributions, while almost a fifth permitted some employee involvement in determining
how the fund would be invested.

Profits sharing have received a considerable boost in recent years as various

companies have sought means of promoting greater productivity to meet world
competition. The most recent General Motors- United Auto Workers contract stipulates
that employees will get 10 percent of GM’s United States pretax profit in excess of a sum
of 10 percent of net worth and 5 percent of other assets. Ford also adopted a profit
sharing plan. In dealing with similar problems in the tire industry, contracts have been
signed to establish profit sharing of Uniroyal and Goodrich. One estimates places the
number of profit sharing plans in the United States at 200,000.

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Objectives Of And Objections To Employee Profit Sharing

Employee profit sharing is a highly controversial from of employee remuneration

Its ardent advocates are found in the council of profit sharing industries, an association of
employers founded in the 1940’s. Among the values claimed for the profit sharing are
that it (1) effects an increase of productive efficiency through reducing costs and
increasing output, (2) improves employee morale and reduces labor-management strife.,
(3) provides for employee security in the event of death, retirement. (4) constitutes of a
mechanism of employee economic education., (5) reduces turn over, and(6) improves
public relations a few management also view profit sharing as a means of drawing labor
and management closer together, does inhibiting the development of a labor union. Other
specific objectives can be tied into the mechanics of a plan. For example, one firm
distributes profit shares solely on the basis of attendance, and its absenteeism rate is far
below the industry average. Another distributes shares on the basis of employee savings,
thereby contributing to employee security.

The opponents of employee profit sharing are equally vehement in their

objections. Profit sharing is a type of compensation about which there is much emotion.
One major objection is that such compensation is often a poor incentive to efficiency in
production. In the first place, the extra income bears little relation to individual employee
effort, for many factors besides labor affect profits. It is also difficult to gauge the
varying contributions of individuals. Most plans do not attempt to distinguish among
individuals on the basis of effort and contribution. Thus the incentive value is reduced. In
the second place, the extra compensation is not paid soon after the employee effort is
made. Cash plans pay yearly, and companies utilizing deferred distribution issue reports
of account balances employee profit sharing, therefore, hardly qualifies as an incentive
wage plan. A second objection is that such plans often prove to be morale depressant
rather stimulant. Employees often regard a reasonably steady profit share as a part of
regular income. When there is no profit share to be paid, they are greatly upset and
frequently ask for abolition of the system accompanied by a raise in base pay. If the
employees cannot or do not distinguish between the regular wage and profit share, the
company is assuming great risk and receiving little or no return.

Concerning the value of increasing employee security, opponents of profit

sharing maintain that a properly constituted pension plan will more adequate will meet
the objective security of employees. Under a pension plan, the benefit is a known amount
and the company contributes enough money to produce this amount of pension. Under a
deferred-profit-sharing trust, the contribution is variable, depending on profits and the
resulting declines in stock and bonds markets have sharply reduced the value the
participants accounts. Sears, which has been only deferred profit sharing for retirement
income, has recently added a non contributory pension plan for its 230,000 hourly
employees. Burlington Industries has also added a new pension program and guaranteed
that all profit sharing accounts will earn at least as much as pass book savings account.
Polaroid Corporation allows employees to make their own decisions as to how their
accounts are to be invested.

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 Probably the most telling argument against employee profit sharing is its high
discontinuance rate. This discontinuances are caused by such factors as employee apathy
to the profit appeal, lack of profits, insufficient shares, union opposition, and the
unintelligent administration. Employee profit sharing can work, but it is an extremely
difficult of remuneration to administer effectively, and therefore often constitutes greater
incentives to management than it does to employees.

The Framework Of Employee Profit Sharing

One of the first items to established under a profit sharing plan is that of
specifying the nature and amount of the company contribution to the profit fund. It must
be decided (1) whether the share shall be a percentage of profits or wage dividend based
on the stock dividend declared by the board directors. (2) whether the percentage shall be
fixed or on a sliding scale based on the amount of profits (3) whether the percentage shall
be computed before of after dividends to stockholders, taxes, and amounts to be
reinvested in the firm. (4) what shall be the amount of the profit to be shared. One study
showed that profits contributed under current distribution plans constituted 16-25 percent
of the profits before taxes and that under deferred distribution arrangements they
amounted 7-15 percent. A percentage is applied to the employees total yearly income to
determine his or her wage dividend.

A second part of framework of profit sharing is the determination of the personal

eligible for participation in the plans. The usual stipulation is a certain amount of
seniority. Current distribution plans usually specify a period of one year or less, while
deferred plans require from two to five years. Current distribution plans tends to
emphasize the objective of the production incentive while plans of the deferred plans
security. Also of importance is deciding how this participating employees shall share in
the profit sharing funds. Two basis are widely used, earning and service.

Another common approach is to credit each employee with one point for certain
amount of salary, and with another point for each of year of service. Thus, one employee
may have 30 points from salary and 20 points from service for a total of 50. The total
number of all employees is divided into profit-sharing amount. The individual’s share is
then determined by multiplying the value of one point by the total of 50. Other basis of
distribution that are sometimes used are merit rating, attendance, savings, and an equal
sharing.

A very few plans have provided for loss sharing as well as profit sharing. The few
companies that have provided for scheduled cuts in wages geared to losses have never
enforced these provisions. It is significant to note that all these companies have
abandoned the practice of employee profit sharing is so difficult to administer effectively
that it is safe to say that the firm that entertains the thought of loss sharing might just as
well forget about this type of compensation.

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Administration of Employee Profit-Sharing Plans

The successful operation of employee profit sharing is difficult to effect. By

successful operation is meant a situation in which profits are shared and company derives
a known return in production, cooperation, turnover, ,morale, or the like. Many firms go
through the mechanics of computing and distributing profit shares, but receive little
returns. Proper administration is essentially a problem of an employee education. A
person must be convinced that the base wage is fare in relation to the going rate, and that
any shares paid are over and above this rate. One must see the relation efforts and the
success of enterprise, must learn to accept profits as variable and the absence of the
profits as challenge to increased efforts. At the least, one should learn not to be shocked
or disgruntled by variations.
In general, successful administration of employee profit sharing plans
encompasses the following activities and policies:

1. The sharing of profits should be accompanied by a feeling of employee-

employer partnership. Tangible evidences of this feeling can be given by such
activities as the joint administration of the plan, joint labor-management shop
committees which consult on operating problems, the distribution of
meaningful and understandable financial information, the establishment of an
employee stock-ownership plan, the permitting of employee inspection of
company books, and the distribution of information concerning production,
shipments, receipts, etc.

2. An effective employee of educational plan concerning the nature of profits

and profit sharing plan is necessary if any cooperation is to be expected. This
involves some teaching of basic economics. It also involves continuous
education concerning the significant events affecting profits and profits
sharing. All types of media of communication should be utilized, such as
individual status reports, group meetings, letters from the company president,
social occasions to dramatize the plan, and supervisory the contacts.

3. The non profit year should be provided for in advance. Management should
not allow itself or its employees to be surprised by the sudden decline or
absence of profits and the profit share. The following is represented not as a
formula for avoiding trouble during the nonprofit year but rather as a series of
suggestions that have been found helpful in minimizing trouble at this time.

a. If a company is especially fearful of possible adverse effects during

non profit periods, it should the deferred-distribution type of plan.

b. The conditioning of employees to the possibility of the profitless years

in advance by education concerning the nature and functioning of
profits under economic system, tends to result in more desirable
employee reactions.

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 c. If a company is desirous of stimulating of employee cooperation and
performance during the profitless period each should adopt current
distribution type. Where as the deferred type seems to stimulate little
reactions during the non profit period, the current type usually effects
some result. It should be recognized, however that the chances for loss
are almost as great as the opportunities for gain.

d. The larger the average individual profit share paid to the employee
during profitable periods, the more favorable will the reaction of
employees during the non profit periods.

e. It is essential to keep the profit share and regular wage distinctly

separate in the eyes of employees.

f. The more education of employees that is undertaken on a continuous

basis, the less there is during a nonprofit period.

g. The adoption of some type of partnership attitude and program tends

to induce more favorable employee reactions during the non profit
periods.

4. It should be recognize that labor organizations and employee profit sharing

plans are not necessarily in compatible. Through the traditional attitude of
organized labor has been antagonistic, apparently this approach is currently
being modified. There is no legal requirement that the management bargain
over a profit sharing plan as there is in the cases of pensions and employees
stuck ownership plans.

One study suggests that employee profit sharing plans may be used by companies
to forestall organization of employees by labor unions. In a study of a 5-year period, one
half of the representation elections held where sampled. In this it was found that 759
elections were in the plants of having profit sharing plans. Unions won 336 and lost 423,
for a winning of 44.3 percent. This compares with a 59.8 percent victory ratio for unions
in all other elections held during this 5-year period. After adjustments for such variables
as size of company, geographic location, industry, in the particular unions involves, the
difference in wins was determined to statistically significant.

The primary conclusion of the above discussion is that management should not
fall for the glamorous appeal of employee profit sharing and embark upon such a venture
thoughtlessly. Profit sharing should not even be considered unless percent relationships
between labor and management are reasonably good. It can make something better out of
something good, but it is quite ineffective in situations of poor management relations.

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Employee Stock Ownership

Perhaps the weakest connection between employee efforts and anticipated

monetary returns is found in stock ownership plans. Whether a stock increases in value or
not is dependent not only on the company’s efforts but vagaries of the stock market as
well. Employees stock ownership plans had their beginning in this country around the
turn of the century. Approximately 20% of the firms listed on the stock exchange have
some type of purchase plan. Such plans are more common among major insurance
companies, commercial banks, gas and electric companies, and those with over one half
billion dollar in sales.

The typical employee ownership plan provides a mechanism through which

certain eligible employees may purchase the stock of the company at reduced rate.
Through a few firms offer the stock at the market rate, most cut the price 10-20 percent.
A second typical feature is that provision is made for installment buying. The employee
authorizes a payroll deduction, and stock is periodically purchase for her or him in the
market by company. Most companies prefer to deal in their regular issues. A fourth
feature of some plants is the granting of stock option-a right to purchase a certain amount
of stock in the future at a stated price. The stock option feature is more widely used in
executive compensation plans than it is with the rank in file.

The recent innovation in this field is the employee stock ownership plan (ESOP)
developed by Louis Kelso. With approval and encouragement of the federal government,
firms are allowed to set up an ESOP trust through which they can obtain capital at
roughly half the usual cost. The trust borrows money from a bank of insurance company
in order to purchase the company’s newly issued stock. It pledges the stock as collateral
and firms guarantees the loan. Each year, the firm makes tax, deductible contributions to
the qualified ESOP trust which the trustees used to pay off the loan. As the is paid for, it
is released and allocated to employee accounts. The plan non contributory on the
employee. Through many view the ESOP as a low cost capital formation device it is
promoted by the government as a means of broadening corporate ownership among
employees.

Whereas Ford and General Motors utilized profit sharing as a means of

stimulating greater cooperation, the federal government pressured Chrysler to set up an
ESOP as a part of process of keeping the firms in existence . Chrysler employees give up
$162 million in wages and benefits accepted new stock contributed to an ESOP that will
amount to a 15% interest in the firm. Other undertaking program on a voluntary basis
include Exxon, American Telephone Corporation, Atlantic Richfield, and Mobil Oil.

What does the company hope to gain from the creation of an employee stock
ownership plan? One of the commonly cited objectives is to promote mutuality of
interests. The employee is encouraged to consider the view point of the company as a
stock holder. He or she is also led to read company literature received as a part owner,
which would probably be ignored as an employee. Other possible values are the
promotion of thrift and security, the creation of an added incentive to work productively

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and cooperative, and the creation of an additional source of an investment capital. The
employees of Armeo Steel Corporation, for example, own 5% of that firms outstanding
stock. It was acquired through employee contribution of from 5-8 percent of salary or
wages received, supplemented by a company contribution of 50 cents on the dollar saved.
Stock are held in trust until employees withdraw from the plan or terminate with the
company. Over 80 percent of Armco personnel participate in this thrift-stock purchase
arrangement.

The high discontinuance rate of this plans during periods of economic difficulty
has led many to be highly suspicious of the values of employee stock ownership. The
objection of placing too many eggs in one basket is often cited. The employee is ask to
invest savings as well as talent in one company, with a consequent lack of investment
diversification. Instead of promoting morale, this plans at times seem to contribute to its
deterioration. Stock prices fluctuate, and the employee can see nothing from the daily
operation to justify such fluctuation. As long prices go up, morale is good; when they go
down, the employee is likely to blame the company---the intermediary who produce the
for her /him. There seems to be an implied obligation for protection. For this reason,
some firms have a plan feature that guarantees a certain purchase price. The unhappy
situation of the 1930’s, when employees where still paying stock purchase at inflated
prices prior to the stock market cash, is one to be avoided. For firms with ESOP whose
stocks are listed there is a danger that will not be insufficiently strong financial condition
to guarantee purchase of the stock at the employee’s retirement. Some have moved to list
on the stock engage just because of their purchase liability.

Employee ownership of stock also resembles profit sharing in that the key to
effective administration is education of the employee participant. One must understand
the nature of stock, dividends, and the stock market. This education requisite is both a
duty and an opportunity for the company. Stock ownership, like profit sharing provides a
basis for approaching the employee with the company information.

Summary

Variable compensation programs are designed to elicit from the individual group
specified types of behavior that are regarded as contributing to organizational
effectiveness. Money can be powerful motivator but the design of such motivational
program is fraught with difficulties.

In general, motivation force will equal the value of money to the person
multiplied by the degree of expectancy that it will be forthcoming if the desired act is
performed. Assessment of expectancy is affected by self-determination of capacity to
perform and by degree of trust in management that money will actually be allocated.

Linkages between effort and performance, payoff, must exist if the variable plan
is to be effective. Linkages are best perceived when plans apply to individuals, such as
salary adjustments, incentive pay based on output, bonuses for individual suggestions or

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systems. Each of these has managerial problems, such as the subjective nature
performance measurement, and the precise alignment of payoff with desired behavior.

Increasingly, managements are accepting the ideas that groups as well as

individuals can be motivated more effectively. In general, the smaller group, the clearer
the linkage between effort and performance. The group pieces rate is an incentive system
with better perceived linkage than production-sharing, profit-sharing, or employee stock-
ownership plans. The accent in group plans is primarily upon cooperation toward a
mutual objective. In production sharing, cost sharing are shared. In profit sharing the
employee prospers if the entire firm does well. An even more indirect effect is
exemplified by employee stock ownership. If the enterprise prospers, its stock values are
likely to increase, provided something else does not happened to affect the stock market
or the economy as a whole. Both individual competition and group cooperation are
potential sources of organizational effectiveness.

BRIEF CASE: Present your analysis using the case analysis format, and answer the
questions following the case.

In the steel industry, a group of employees was assigned to the task of strapping
several thin sheets of steel to forms packages for shipment. Though the average
performance of the group under a time-payment system had been at an index of 70, a
time study by management had placed normal performance at an index of 90. an
incentive pay system was established on the basis of 90 equaling standard performance.
Weeks went by, but the employees continued to received time wages since their
performance still averaged 70. as a result, management took the following steps:
1. They checked with other steel companies and found that an index of 90 was
prevalent.
2. They did an all-they time study, reanalyzed the figures, and concluded that 90
was fair.
3. On the assumption that poor work methods were being followed, they hired
special instructors to teach the employees proper methods.
4. They took pictures of correct motions, enlarged them, and posted them on the
walls in the work area.
Despite the above, the employees continued to produce at a rate of 70. as another
step, management sent a newly hired time study engineer to the work area. Though
dressed in suit and tie he proceeded to get on hands and knees measuring the dimensions
of the work area. When one of the employees could contain his curiosity no longer, he
asked the stranger what he was doing. The time study engineer replied, “ Oh, I’m
measuring to see if we can locate an automatic steel strapping machine in this area. “

Questions:
1. What do you think the probable reaction of the employees will be to the act of the
new time study engineer?
2. What other alternatives would you suggest for management to implement?

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