Dessler HRM 12e ch 012 pay for performmance and financial incentives

Part I: Introduction Managing Human Resources Today Managing Equal Opportunity and Diversity Mergers, Acquisitions, and Strategic Human Resource ManagementPart II: Staffing the OrganizationPersonnel Planning and Recruiting Selecting Employees Training and Developing EmployeesPart III: Appraising and Compensating EmployeesPerformance Management and Appraisal Compensating EmployeesPart IV: Employee and Labor RelationsEthics, Employee Rights, and Fair Treatment at Work Working with Unions and Resolving Disputes Improving Occupational Safety, Health, and SecurityPart V: Special Issues in Human Resource Management Managing Human Resources in Entrepreneurial Firms Managing HR Globally Measuring and Improving HR Management’s Results

Chapter 12

Pay for Performance and Financial

Incentives

WHERE WE ARE NOW…

1 Explain how you would apply five motivation theories in

formulating an incentive plan.

straight pay incentives for salespeople.

executives.

variable pay plans.

LEARNING OUTCOMES

Motivation, Performance, and Pay

• Incentives

 Financial rewards paid to workers whose production exceeds a predetermined standard

 Popularized scientific management and the use of financial

incentives in the late 1800s

 Systematic soldiering

 Fair day’s work

 Understanding the motivational

bases of incentive plans

The Hierarchy of Needs

 Physiological (food, water, warmth)

 Security (a secure income, knowing one has a job)

 Social (friendships and camaraderie)

 Self-esteem (respect)

 Self-actualization (becoming a whole person)

 People are motivated first to satisfy each lower-order need

and then, in sequence, each of the higher-level needs

Herzberg’s Hygiene–Motivator Theory

• Hygienes (extrinsic job factors)

 Satisfy lower-level needs

 Inadequate working conditions, salary, and incentive pay can cause dissatisfaction and prevent satisfaction

• Motivators (intrinsic job factors)

 Satisfy higher-level needs

 Job enrichment (challenging job, feedback, and recognition)

addresses higher-level (achievement, self-actualization) needs

 The best way to motivate someone is to organize the job so that doing it provides feedback and challenge that helps satisfy the person’s higher-level needs

Demotivators and Edward Deci

• Intrinsically motivated behaviors are motivated by the

individual’s underlying need for competence and

self-determination

 Offering an extrinsic reward for an intrinsically-motivated act

can conflict with the acting individual’s internal sense of

responsibility

 Some behaviors are best motivated by job challenge and

recognition, others by financial rewards

Victor Vroom’s Expectancy Theory

• Motivation is a function of:

 Expectancy: the belief that effort will lead to performance

 Instrumentality: the connection between performance and

the appropriate reward

 Valence: the value the person places on the reward

• Motivation = (E x I x V)

 If any factor (E, I, or V) is zero, then there is no motivation

to work toward the reward

 Employee confidence building and training, accurate

appraisals, and knowledge of workers’ desired rewards can

increase employee motivation

Behavior Modification /

Reinforcement Theory

• B F Skinner’s Principles

 To understand behavior one must understand

the consequences of that behavior

 Behavior that leads to a positive consequence (reward)

tends to be repeated, while behavior that leads to a

negative consequence (punishment) tends not to be

repeated

 Behavior can be changed by providing properly scheduled

rewards (or punishments)

Incentive Pay Terminology

 Ties employee’s pay to the employee’s performance

 Is an incentive plan that ties a group or team’s pay to some

measure of the firm’s (or the facility’s) overall profitability

 Example: profit-sharing plans

 May include incentive plans for individual employees

Employee Incentives and the Law

 Bonuses included in overtime calculations:

 Those promised to newly hired employees

 Those provided for in union contracts or other agreements

 Those announced to induce employees to work more productively, steadily, rapidly, or efficiently or to induce them

to remain with the firm

 Bonuses excluded from overtime calculations:

 Christmas and gift bonuses not based on hours worked

 Bonuses so substantial that employees don’t consider them

a part of their wages

 Purely discretionary bonuses in which the employer retains discretion over how much, if anything, to pay

Types of Employee Incentive Plans

Individual Employee Incentive and Recognition Programs

Team/Group-based Variable Pay Programs

Pay-for-Performance

Plans

Individual Incentive Plans

 The worker is paid a sum (“piece rate”)

for each unit he or she produces

 Straight piecework

 Standard hour plan

Pros and Cons of Piecework

and powerful incentives

in standards or work processes

affecting output

an overriding output focus

• Possibility of violating minimum

wage standards

incentives either cannot be earned

Individual Incentive Plans (cont’d)

 Is a permanent cumulative salary increase the firm awards

to an individual employee based on his or her individual

performance

 Can detract from performance if awarded across the board

 Becomes permanent ongoing reward for past performance

 Give annual lump-sum merit raises that do not make the

raise part of an employee’s base salary

 Tie merit awards to both individual and organizational

performance

TABLE 12–1 Merit Award Determination Matrix (an Example)

To determine the dollar value of each employee’s incentive award: (1) multiply the

employee’s annual, straight-time wage or salary as of June 30 times his or her maximum incentive award and (2) multiply the resultant product by the appropriate percentage figure from this table.

Example: if an employee had an annual salary of $20,000 on June 30 and a maximum

incentive award of 7% and if her performance and the organization’s performance were

Company Performance (Weight = 0.50)

Incentives for Professional Employees

 Are those whose work involves the application

of learned knowledge to the solution of the

employer’s problems

 Lawyers, doctors, economists, and engineers

 Bonuses, stock options and grants, profit sharing

 Better vacations, more flexible work hours

 Improved pension plans

 Equipment for home offices

Nonfinancial and Recognition Awards

 Recognition has a positive impact on performance,

either alone or in conjunction with financial rewards

 Day-to-day recognition from supervisors, peers, and

team members is important

 Social recognition

 Performance-based recognition

 Performance feedback

FIGURE 12–1 Social Recognition and Related Positive

Reinforcement Managers Can Use

• Challenging work assignments

• Freedom to choose own work

activity

• Having fun built into work

• More of preferred task

• Role as boss’s stand-in when he

Online and IT-Supported Awards

 Enterprise incentive management (EIM)

 Software that automates planning, calculation, modeling, and management of incentive compensation plans

 Enabling companies to align their employees with corporate strategy and goals

 Programs offered by online incentives firms that

improve and expedite the awards process

 Broader range of awards

 More immediate rewards

Incentives for Salespeople

 Pay is a percentage of sales results

 Keeps sales costs proportionate to sales revenues

 May cause a neglect of nonselling duties

 Can create wide variation in salesperson’s income

 Likelihood of sales success may be linked to external factors rather than to salesperson’s performance

 Can increase turnover of salespeople

Incentives for Salespeople (cont’d)

 Pay is a combination of salary and

commissions, usually with a sizable

salary component

 Plan gives salespeople a floor

(safety net) to their earnings

 Salary component covers

company-specified service activities

 Plans tend to become complicated,

and misunderstandings can result

Specialized Commission Plans

 Commissions are paid but a draw on future

earnings helps the salesperson to get through

low sales periods

 Pay is mostly based on commissions

 Small bonuses (“spiffs”) are paid for directed

activities like selling add-ons or slow-moving

items

Maximizing Sales Force Results: Setting Sales Quotas

• Should quotas be locked in for a period of time?

• Have quotas been communicated to the sales force

within one month of the start of the period?

• Does the sales force know exactly how its quotas are set?

• Do you combine bottom-up information (like account forecasts)

with top-down requirements (like the company business plan)?

• Do 60% to 70% of the sales force generally hit their quota?

• Do high performers hit their targets consistently?

• Do low performers show improvement over time?

• Are quotas stable through the performance period?

• Are returns and debookings reasonably low?

• Has your firm generally avoided compensation-related lawsuits?

• Is 10% of the sales force achieving higher performance than previously?

Incentives for Managers and Executives

 Base salary (cash)

 Short-term incentives (bonuses)

 Long-term incentives (e.g., stock options)

 Makes executives and the board of directors

personally liable for violating their fiduciary

responsibilities to their shareholders

 Requires the CEO and CFO to repay bonuses,

incentives, or equity-based compensation

received following issuance of a financial

statement that the firm must restate

Short- and Long-Term Incentives

 Plans intended to motivate short-term performance

of managers and tied to company profitability

 Issues in awarding bonuses

 Eligibility basis

 Fund size basis

 Individual performance award

 Long-term incentives

 Stock options

 Performance shares

 Indexed options

 Premium price options

 Stock appreciation rights

TABLE 12–2 Multiplier Approach to Determining Annual Bonus

Company’s Performance (Based on Sales Targets, Weight = 0.50)

Note: To determine the dollar amount of a manager’s award, multiply the maximum possible

(target) bonus by the appropriate factor in the matrix.

Creating an Executive Compensation Plan

compensation program.

the manager on achieving the firm’s strategic goals.

compliance with all legal and regulatory

requirements and for tax effectiveness.

the executive compensation plan whenever

a major business change occurs.

Team/Group Incentive Plans

 Incentives are based on team’s performance

 Set individual work standards

 Set work standards for each team member

and then calculate each member’s output

 Members are paid based on one of three formulas:

 All receive the same pay earned by the highest producer

 All receive the same pay earned by the lowest producer

 All receive the same pay equal to the average pay earned by the group

Pros and Cons of Team Incentives

• Pros

 Reinforces team planning and problem solving

 Helps ensure collaboration

 Encourages a sense of cooperation

 Encourages rapid training of new members

 Pay is not proportionate to an individual’s effort

 Rewards “free riders”

Organizationwide Incentive Plans

 Current profit-sharing (cash) plans

 Employees receive cash shares of the firm’s profits

at regular intervals

 Deferred profit-sharing plans

 A predetermined portion of profits based on the employee’s contribution to the firm’s profits is placed in each employee’s retirement account under a trustee’s supervision

 Employees’ income taxes on the distributions are deferred, often until the employee retires

Gainsharing Plans

Philosophy of

cooperation

Involvement system Identity

Scanlon Plan Components

Competence

Benefits sharing formula

Implementing a Gainsharing Plan

the employees’ share of the gains.

At-Risk Variable Pay Plans

weekly pay at risk

their goals, they earn incentives

 If they fail to meet their goals, they

forego some of the pay they would

normally have earned.

Organizationwide Incentive Plans (cont’d)

 A firm annually contributes its own stock—or cash

(with a limit of 15% of compensation) to be used to

purchase the stock—to a trust established for the

employees

 The trust holds the stock in individual employee

accounts and distributes it to employees upon

separation from the firm if the employee has worked

long enough to earn ownership of the stock

Advantages of ESOPs

 Can take a tax deduction equal to the fair market value

of the shares transferred to the ESOP trustee

 Gets an income tax deduction for dividends paid

on ESOP-owned stock

 Can borrow against ESOP in trust and then repay

the loan in pretax rather than after-tax dollars

 Develop a sense of ownership in and commitment to the firm

 Do not pay taxes on ESOP earnings until they receive

a distribution

 Can place assets into an ESOP trust which will allow them to

Implementing an Effective Incentive Plan

2 Link the incentive with your strategy.

5 Be scientific in analyzing the effects of the plan.

Why Incentive Plans Fail

• “Pay is not a motivator.”

TABLE 12–3 Express Auto Compensation System

1 Sales force Persuade buyer to

purchase a car

Very small salary (minimum wage) with commissions Commission rate increases with every 20 cars sold per month.

2 Finance office Help close the sale;

persuade customer to use company finance plan.

Salary, plus bonus for each $10,000 financed with the company

3 Detailing Inspect cars delivered

from factory, clean, and make minor adjustments

Piecework paid on the number of cars detailed per day

4 Mechanics Provide factory warranty

service, maintenance, and repair

Small hourly wage, plus bonus based on (1) number of cars completed per day and (2) finishing each car faster than the standard estimated time to repair

Minimum wage

K E Y T E R M S

financial incentives

fair day’s work

scientific management movement

standard hour plan

merit pay (merit raise) annual bonus

stock option golden parachutes team (or group) incentive plan organizationwide incentive plans profit-sharing plan

Scanlon plan gainsharing plan at-risk variable pay plans employee stock ownership plan (ESOP)

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