Performance Incentives

Akanksha Jaiswal, PhD

15/01/2022
 Good news amidst COVID times….

• Infosys will roll out salary increase and

promotions across all levels effective 1
January 2021 as the company forecasts
higher growth in the year ahead

• CEO Salil Parekh announced that the

company will pay a special bonus in
December and 100% variable pay for Q2.
https://cio.economictimes.indiatimes.com/news/corporate-news/infosys-to-roll-out-salary-increase-
from-january-2021-to-pay-special-bonus-in-december-quarter/78673400
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 Deliberate…..
• Should a good employee be paid more than a poor one?
• If YES, how should performance be measured?
• What should be the differential reward?
• Should the employee with more years of experience be paid more
than the one with less experience?
• If YES, what is the trade-off between seniority and performance in
assigning pay raises?
• What are the legitimate factors to consider in the reward equation?
• Should the manager’s relative be paid more because he is family?
• Does paying for performance result in higher performance?
How do we design a pay system so that individuals are rewarded
according to their value to the organization?
COVID-19 and 24th March 2020 15/01/2022 3
 Context for today’s class….
• Different people performing the same job may
add different value to the organization.
• Design of HR practices strongly impacts
employees’ perception of the company and
corporate performance, thereof.
• If performance appraisal system is acceptable to
employees, it builds long-term trust.
• Compensation should be designed to increase the
likelihood that employees demonstrate
competencies that will help the organization
achieve its strategic objectives.
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The big picture…..

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 What behaviors does
compensation need to reinforce?
Attract
talent

Behaviours
organizations
Motivate Develop
are interested
in

Retain
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 Performance Measurement Relationship to
Compensation Strategy –
When incentives work and when they don’t

Companies are best able to get employees to adjust, be flexible,

and committed when a broader array of rewards, rather than just
money, is part of the compensation package! 15/01/2022 7
Cascading Link between Organization
Strategy and Employee Behavior

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What motivates people?

3. How does
1. What’s
it help deliver
important to
desired
the person?
behaviors?

2. How does the

organization offer it?

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 1. What’s important to the person?
• Maslow’s and Herzberg’s theories
• People have needs, such as physiological, security, and
self-esteem, that influence behavior.
• If organizations offer rewards that satisfy these needs
employees will behave in desired ways.
• Flexible compensation wherein employees choose
from a menu of pay and benefit choices.
• Who best knows what satisfies needs? The employee!
So let employees choose, within limits, what they want
in their reward package.
• Ex: Intellect Design Arena
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2. How does the organization offer it?
• Companies provide rewards in exchange for desired employee
behaviors
• Expectancy theory – people cognitively evaluate what behaviors
are possible in relation to the value of rewards offered in
exchange.

• Equity theory – people are highly concerned about the fairness

of the exchange process (ratio between what is expected and
what is received).
• Agency theory - Employer and employee seek the most favorable
exchange and act opportunistically if given a chance (“get by”
with doing as little as possible to satisfy the contract)
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3.How does it help deliver desired behaviors?
• Goal-setting theory - Goals are expected to flow from the desired
behaviors.
• How do goals increase performance?
• Specific goals provide internal stimulus as compared to “do your
best”.
• Difficult goals (when accepted by the employee) direct focus on
the task, avoid distractions, discover strengths, develop strategies,
and are persistent.
• Feedback helps identify the gap between the expected and
observed performance.
• Self-determination theory - Employees are motivated not only by
reward systems and pay grades (extrinsic motivators,) but also by
intrinsic motivators (sense of autonomy, competence, purpose, and
engagement) 15/01/2022 12
Pay-for-performance

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What is a pay-for-performance plan?
• Traditionally, pay = entitlement
• Shift from the “equal pay for same job” mindset to “pay that
varies with individual/ organizational performance”.
• Short-term incentive plans
• Long-term incentive plans
• Individual incentive plans
• Group incentive plans

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 Popularity of variable pay
• Pressure on firms to cut costs and/or increase productivity.
Well-designed variable-pay plans motivate employees to
perform better and help in cutting costs.
• Variable pay is, by definition, a variable cost. No/poor profits
mean no extra pay beyond base pay.

• Today’s fast-paced business environment, new technologies,

new work processes, and new work relationships require
workers to be agile.
• Thus, compensation experts design reward systems so that
workers will be able and willing—to move quickly into new
jobs and new ways of performing old jobs.
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 When paying doesn’t pay off…..

https://www.youtube.com/watch?v=5JB6PZrgZjw&t=4s

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 PAY-FOR-
PERFORMANCE PLANS

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 Merit pay

• Increase in base pay (called merit increase) to how highly employees are rated
on their performance evaluation.
• Performance rating (1-5) determines the increase in the base pay.
• Cons:
• Expensive and doesn’t achieve the goal of improving performance
• Lower satisfaction among top performers.
• Reward difference is not very large for every increment in performance, so
employees think “Why bother?”
• Sorting effect: People who don’t want to have their pay tied to
performance don’t accept jobs at such companies or leave when pay for
performance is implemented.
• Sorting leaves a residual workforce that is more responsive to merit rewards. 18

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 Lump-Sum Bonuses
• Based on employee performance, they receive an end-of-year
bonus that does not build into base pay.
• Employees must earn this increase every year, so it is viewed as
less of an entitlement than merit pay.
• Less expensive than merit pay over the long run
• No surprise that employees aren’t fond of lump-sum bonuses

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Kotak, Zee, Urbanclap, Voltas
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 Individual Spot Awards
• Awarded for exceptional performance, often on special
projects or for performance that exceeds expectations
• Formal mechanism for this recognition including
guidelines on the ‘size’ of the award
• Very popular in organizations. Eg: Mahle GmbH
• Found to be moderately-highly effective

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 Individual Incentive Plans
• Promise of pay for pre-established level of performance
• Individual incentive plans increase performance substantially
• Cell (1) oldest and most popular individual incentive plan - pay a
specified amount for each piece/unit produced
• Easily understood by employees
Short Long
cycle cycle

22

15/01/2022
 Individual Incentive Plans
• Cell (2) Standard hour plan: incentive rate is based on
completion of a task in some expected time period.
• For long-cycle tasks, it is possible that only one task or
some portion of it may be completed in a day.
• So, incentives are based on whether the employee
completed the task in the designated time period.
• More practical than straight piecework plans for long-
cycle operations and jobs that are non-repetitive and
require numerous skills for completion.
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Individual Incentive Plans
• Cell (3) variable incentive as a function of production level (short cycle)
• Taylor plan: 2 piecework rates:
• When employee exceeds the published standard for a given time period, the rate is
set higher than the regular wage incentive level
• For production below standard, rate is lower than the regular wage
• Merrick plan: 3 piecework rates

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Individual Incentive Plans
• Cell (4) variable incentives linked to a standard time period/unit of
production (long cycle tasks)
• Halsey 50–50: If task is completed in < standard time, the savings
are shared split (50-50) between employee and employer.
• Rowan plan: Standard time to complete a task = 10 hours but it is
completed in 7 hours, then employee receives 30% bonus above the
hourly wage for each of the 3 hours. If done in 6 hours, 40%
bonus.
• Gantt plan: Standard time for a task is purposely set at a level
requiring high effort to complete.
• Employee who fails to complete the task in the standard time is
guaranteed a pre-established wage.
• If task is completed in <= standard time, earnings are pegged at 120% of
the time saved.
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 Example 1 – BFSI Sector India
• Types of incentives:
• On-roll employees
• Pay package 16 lac + 4 lac incentive (yearly once)
• Performance rating (1-4 where 1 is excellent, 1→ 100%, 2→ 60%,
3→ 40%, 4 → 0 incentive)
• Rating by immediate supervisor based on structure given by HR
• 10% get 1 rating while more than 60% get 3 rating
• Off-roll employees (support staff)
• Incentive slabs
• 3 files →Rs 500/file
• 6 files → Rs 1000/file
• > 11 files → Rs 3000/file
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Individual Incentive Plans

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TEAM INCENTIVE PLANS

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 Gain-Sharing Plans
• Engages employees in a common effort to achieve a
company’s productivity objectives
• Any resulting cost-savings gains are shared among employees
and the company
• Focus is on cost reduction (e.g., reduce scrap, labor costs,
material, tool purchase, rework costs)
• Sorting effect - good employees want to be rewarded for their
individual performance → gain-sharing may lead to turnover.

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 Profit-sharing plans
• All employees receive a share of the firm’s annual profits.
• Current profit-sharing - employees get a share in the employer’s profits
quarterly or annually.
• Deferred profit-sharing - employer puts cash awards into trust accounts
for the employees’ retirement.
• Productivity was much higher in plans where payouts were in
the same year than deferred
• Downside: Most employees don’t feel their jobs have a direct
impact on profits, hence, don’t get motivated.

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 Earnings-at-Risk Plans
• Success-sharing plan – base pay is constant and variable
pay adds on during successful years.
• If the company does well, employees receive a predetermined
amount of variable pay
• If poor, no variable pay but base pay is secure
• Risk-sharing plan - base pay is reduced by some amount
• Reduces satisfaction and increases turnover

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 Some basis for team incentives
• Team performance standards based on:
• Productivity improvements (38 percent of plans)
• Customer satisfaction (37 percent)
• Financial performance (34 percent)
• Quality of goods and services (28 percent)
• Ex: Kraft Foods uses a combination of financial measures
(income from operations and cash flow), success in developing
managers, building diversity, adding to market share.

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Problems with team incentive plans
• Variety
• Full-time teams (work group organized as a team)
• Part-time teams (cutting across functional departments)
• Full-time temporary teams (eg: ease the transition into a JV)
• Level
• If I am 1 in a 500 member team, why should I try hard?
• Small teams hoard top performers/unwilling to accept new people
• Teams have different performance objectives so it is difficult to compare
when assigning rewards. Inevitably, complaints arise!
• Complex
• Plans are too complex for teams/individuals to understand
• Free-riding
• Have clear performance standards/SMART goals
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 How are team incentive plans useful?
• Group-based plans, particularly gain-sharing
plans, cause organizations to evolve into
learning organizations.
• Employees are encouraged to suggest how
to do things better in the company
• Organizations evolve from 1st-order
learning (maintenance of existing ways of
doing things) to 2nd-order learning (break
out of existing patterns and explore
different ways of thinking and behaving)

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Team incentive plans

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Corporate examples

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 PAY-FOR-
PERFORMANCE PLANS

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 Long-term incentive plans
• Variable pay plans where the time horizon is longer than a year
• Employee Stock Ownership Plans (ESOPs): increase employee
involvement in the organization to influence performance
• ESOPs don’t make sense as an incentive as the effects are generally
long-term.
• How much of an impact will my performance today have on the stock
price at the time I exercise my option?
• Does my working harder mean more for me?

• We can’t predict very well what makes stock prices rise and this is
the central ingredient in the reward component of ESOPs.
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 Combination plans

• It’s not uncommon for companies to use both individual and group
incentives.
• The goal is to both motivate individual behavior and to ensure that
employees work together.
• Start with standard individual (e.g., performance appraisal, quantity of
output) and group measures (e.g., profit, operating income)
• Variable pay level depends on how well individuals perform and how
well the company (or division/strategic business unit) does on its
macro (e.g., profit) measures.
• 75–25 split plan - 75% is based on how well the individual does and
25% is dependent on corporate performance.
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Total Reward System

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 Example 2

• One of today’s biggest success stories is the merger

of individual incentives with efforts to reduce health-
care costs.
• For example, American Express implemented a
“Walk this Way” program that paid $200 towards
healthcare premiums to any employee who walked
2.5 miles every day.

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 Example 3

•Marketing team incentive

•$100/sales qualified lead
•Eg: 16 leads last year: 100*16
•Sales team incentive
•$200 per opportunity
•Eg: Out of 16 leads, 8 turned into opportunities
last year: 200*8
•If a lead + opportunity = 100+200 = 300$ incentive
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akanksha.jaiswal@liba.edu

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