CHAPTER 10

Recognizing Employee Contributions with Pay

Week 13
Incentive Pay
• Incentive pay is compensation that is linked to individual,
team and organizational performance.

• This form of compensation is specifically designed to energize,

direct, or maintain employees’ behavior.

• Incentive pay is influential because the amount paid is linked to

certain predefined behaviors or outcomes.

• Usually, these payments are in addition to wages and salaries.

Incentive Pay (continued)
• Incentive Pay is important because it:

Motivates the employees to try harder and get more

creative.

Helps to recruit and retain high quality employees.

Effective Incentive Plans
• Effective incentive plans fulfil the following requirements:

 Performance measures are linked to the organization’s goals.

 Employees believe they can meet performance standards.

 The organization gives employees the resources they need to meet

their goals.

 Employees value the rewards given (expectancy theory).

 Employees believe the reward system is fair (equity theory).

 The pay plan takes into account that employees may ignore any goals
that are not rewarded.
 Types of Incentive Pay Plans

Individual Incentives Group Incentives

• Piecework rate plans • Gainsharing
• Standard hour plans • Group bonuses
• Merit pay system • Team awards
• Individual bonuses
• Sales commissions

Organizational Incentives
• Profit Sharing
• Stock ownership
Pay for Individual Performance

Piecework rate plans

Standard hour plans

Merit pay system

Individual bonuses

Sales commissions
Pay for Individual Performance:
Piecework Rates

Straight Differential
Piecework Rate Piecework Rate Piecework Rate
Plan Plan
• A wage based • Wages are • Employees are
on the amount determined by paid one piece-
workers multiplying the rate for units
produce. number of units produced up to a
produced by the standard output
piece rate for one and a higher
unit. piece-rate wage
for units produced
over the standard.
Differential Piecework Rate Plan - Example

• Assume that the standard quota for a worker is set at 300 units
per day and the standard piece rate is 14 cents per unit.

• However, for all units over the standard, the employee receives
20 cents per unit.

• Under this plan, a worker who produces 400 units in one day
would get:

(300 * 14 cents) + (100 * 20 cents) = $62

Pay for Individual Performance:
Standard Hour Plans and Merit Pay
Standard Hour Plan
• An incentive plan that pays
workers extra for work done in
less than a preset “standard
time.”
• These plans are much like
piecework plans.
• They encourage employees to
work as fast as they can, but not
necessarily to care about quality
or customer service.
Merit Pay System
• A system of linking pay
increases to employees’
performance ratings.
• Managers use a merit pay grid
to assign merit increases to
employees.
• The system gives the lowest
paid best performers the
biggest pay increases.
Managers determine pay raise amounts by two factors jointly: employee’s performance
ratings and the position of employee’s base pay rates within the pay range.
Problems with Merit Pay
• Merit pay has several drawbacks, which need to be
considered:

It can quickly become expensive

Employees might perceive the merit pay plan to be unfair

This incentive plan discourages teamwork

Pay for Individual Performance:
Performance Bonuses
• Bonus is a one-time payment that does not become part of the
employee’s base pay.

• Bonuses are less costly to the employer than a merit pay raise
because they are not rolled into employee’s base wages.

• On the contrary, the employee must re-earn them during each

performance period.

• Bonuses can also be used to reward employees for contributing

new ideas and developing new skills.
Performance Bonuses (continued)
• Bonuses are linked to certain predefined behaviors to
encourage employees to exhibit those behaviors.

• Bonuses tend to vary with employees’ performance and

company’s financial position.
Pay for Individual Performance:
Sales Commissions
• A variation on piece rates and bonuses is the payment of

commissions.

• Commission refers to incentive pay calculated as a

percentage of sales.
Types of Sales Commission Plans
• Salary-Only Plan

• Straight Commission Plan

• Salary-Plus-Commission Plan
Types of Sales Commission Plans – (continued)

• Salary-Only Plan

 All compensation is paid as a base wage with no incentives.

 The salary only approach is useful when an organization

emphasizes serving and retaining existing accounts over

generating new sales and accounts.

 This approach is frequently used to protect the income of new

sales representatives for a period of time while they are building up

their sales clientele.
Types of Sales Commission Plans –
(continued)
• Straight Commission Plan

Under this system, salespeople earn only commissions.

The advantage of this system is that the salesperson must sell to

earn.
The disadvantage is that it offers no security for the sales staff.

This insecurity can be offset by using a draw system.

Types of Sales Commission Plans – (continued)

• Salary-Plus-Commission Plan
Combines the stability of a salary with the performance
aspect of a commission.

Salary component enables a company to attract high quality

employees and allows the company to direct its employees
towards non-selling tasks (e.g., further training) that do not
lead directly to commissions.

The commission component serves as the employees’

share in the gains they generated for the company.
Pay for Group Performance
• Employers may address the drawbacks of individual

incentives by including group incentives in the

organization’s compensation plan.

• To win group incentives, employees must cooperate and

share knowledge so that the entire group can meet its

performance targets.
Common Group Incentives

Gainsharing

Group Bonuses

Team Awards
Group Incentives - Gainsharing
• Gainsharing is a group incentive program that measures

improvements in productivity and effectiveness and

distributes a portion of each gain to employees.

• A popular form of gainsharing is the Scanlon plan,

developed in the 1930s by Joseph N. Scanlon.

 Finding the Gain
in a Scanlon Plan

Scanlon Plan – a
gainsharing
program in which
employees
receive a bonus if
the ratio of labor
costs to the sales
value of
production
(SVOP) is below
a set standard.
Pay for Group Performance:
Group Bonuses and Team Awards
Group Bonuses
• Bonuses for group
performance tend to be for
smaller work groups.
• These bonuses reward the
members of a group for
attaining a specific goal,
usually measured in terms of
physical output.
Team Awards
• Similar to group bonuses, but
are more likely to use a
broader range of
performance measures:
 Cost savings
 Successful completion of a
project
 Meeting deadlines
Group members that meet a sales goal or
a product development team that meets
a deadline or successfully launches a
product may be rewarded with a bonus
for group performance.
 Types of Incentive Pay Plans

Individual Incentives Group Incentives

• Piecework rate plans • Gainsharing
• Standard hour plans • Group bonuses
• Merit pay system • Team awards
• Individual bonuses
• Sales commissions

Organizational Incentives
• Profit Sharing
• Stock ownership
Pay for Organizational Performance
• Two important ways organizations measure their performance are in terms of
their profits and their stock price.

• In a competitive marketplace, profits result when an organization is efficiently

providing products that customers want at a price, they are willing to pay.

• Stock is the owners’ investment in a corporation; when the stock price is

rising, the value of that investment is growing.

• Many organizations offer incentive pay tied to these organizational

performance measures.

• The expectation is that employees will focus on what is best for the
organization.
Types of Pay for Organizational
Performance
Pay for Organizational Performance:
Profit Sharing
• Profit sharing is a reward system that distributes some

portion of organizational profits to employees.

• Profit sharing plans offer several advantages:

 Encourage employees to “think like owners”.

 Increase productivity and organizational performance.

 Help in recruiting, motivating and retaining employees.

Profit Sharing – (continued)
• In some profit-sharing plans, employees receive portions of the
profits at the end of the year.

• In others, profits are deferred, placed in a fund and made

available to employees on retirement or on their leaving the
organization.

• Companies usually distribute profits in one of the following

ways:
Equal payments to all employees.
Proportional payments to employees based on annual salary.
Proportional payments to employees based on their
contributions to profits.
Pay for Organizational Performance:
Stock Options

• Stock Options - A plan that gives employees the opportunity

or option to purchase a fixed number of shares of company
stock at a specified price for a limited period of time.
 If market price of the stock is above the specified option

price, employees can purchase the stock and sell it for a

profit.

 If the market price of the stock is below the specified option

price, the stock option is “underwater” and is worthless to

employees.
Stock Options – An Example
• Suppose a company’s employees received options to purchase stock
at $10 per share in 2021 and the stock price reaches $30 per share in
2022.

• Employees have the option of purchasing stock (‘exercising their

stock options’) at $10 per share in 2022.

• If they want to, they can sell their stock for the market price of $30
thereby, receiving a gain of $20 for each share of stock.

• However, if the stock price goes down to $8 per share in the year
2022, there will be no financial gain and employees will not bother to
exercise the options.
Pay for Organizational Performance:
Employee Stock Ownership Plans
• Employee Stock Ownership Plan (ESOP) – an arrangement
in which the organization distributes shares of stock to all its
employees by placing it in a trust, which is managed on
employees’ behalf.

• The earnings of the trust are exempt from income tax!

• Employees receive regular reports on the value of their stock,

and when they leave the organization, they may sell the stock
to the organization or on the open market.
Processes That Make Incentives Work
Participation in Decisions
• Employee participation in pay-
related decisions can be part of
a general move toward
employee empowerment.
• Employee participation can
contribute to the success of an
incentive plan.
Communication
• Communication demonstrates to
employees that the pay plan is
fair.
• When employees understand
the requirements of the incentive
pay plan, the plan is more likely
to influence their behavior as
desired.
• Important when the pay plan is
being changed.
Incentive Pay for Executives
• Since, executives have a much stronger influence over

the organization’s performance than other employees do,

incentive pay for executives warrants special attention.

• An executive is typically someone in the top two levels of

an organization such as, Chief Executive Officer (CEO),

President, Senior Vice President etc.
Components of Executive Compensation Packages

Copyright © 2005 Thomson Business & Professional Publishing. All rights

13–35
Components of Executive Compensation Packages
– (continued)

• Executive Salaries – In some organizations, salaries often

make up 90% or more of total compensation, while in others
salaries may constitute half of the total package.

• Executive Benefits – Executives receive both regular and

supplemental benefits.
 Regular benefits include traditional retirement, health insurance
and vacation plans.
 An example of a supplementary benefit is company-paid financial
planning for executives.
Components of Executive Compensation Packages
– (continued)

• Executive Perquisites (Perks) – These are special benefits –

usually non-cash items – for executives. Examples include
company cars, health club & country club memberships,
first class air travel, use of private jets etc.

• Annual Executive Incentives and Bonuses – This includes

bonuses based on the year’s profits, return on investment,
or other measures related to the organization’s goals.

• Long-Term Incentives - Include stock options and stock

purchase plans.
Common Executive Compensation Issues

Copyright © 2005 Thomson Business & Professional Publishing. All rights

reserved.
13–38
 CEO and Worker Pay

Country CEO Pay Worker Pay CEO / Worker Ratio

USA $12,259,894 $34,645 354

Germany $5,912,781 $40,223 147

United Kingdom $3,758,412 $44,743 84

Japan $2,354,581 $35,143 67

Incentive Pay for Executives:
Ethical Issues

• Incentive pay for executives lays the groundwork for significant

ethical issues.

• Specifically, when an organization links executive pay to its stock

performance, executives may be tempted to inflate the stock price

in order to enjoy bonuses and valuable stock options.

• A related issue when executive pay includes stock or stock

options is insider trading.

Balanced Scorecard for Executives