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CHAPTERS 11CHAPTERS 11

Rewarding Performance

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Chapter ObjectivesChapter Objectives

Develop pay-for-performance plans Develop pay-for-performance plans that are appropriate for different that are appropriate for different levels in an organizationlevels in an organization

Identify the potential benefits and Identify the potential benefits and drawbacks of different pay-for-drawbacks of different pay-for-performance systems and choose the performance systems and choose the plan that is most appropriate for a plan that is most appropriate for a particular firmparticular firm

Design an executive compensation Design an executive compensation package that motivates executives to package that motivates executives to make decisions that are in the firm’s make decisions that are in the firm’s best interestsbest interests

Weigh the pros and cons of different Weigh the pros and cons of different compensation methods for sales compensation methods for sales personnel and create an incentive personnel and create an incentive plan that is consistent with the firm’s plan that is consistent with the firm’s marketing strategymarketing strategy

Review Key Terms Employee stock ownership plans

(ESOPs) Gainsharing Incentives Pay-for-performance Profit-sharing

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Motivation, Performance, and PayMotivation, Performance, and Pay

IncentivesFinancial rewards paid to workers whose production

exceeds a predetermined standard

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Individual DifferencesIndividual Differences

Law of Individual DifferencesThe fact that people differ in personality, abilities,

values, and needs.Different people react to different incentives in

different ways.Managers should be aware of employee needs and

fine-tune the incentives offered to meets their needs.Money is not the only motivator.

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Needs and MotivationNeeds and Motivation

Abraham Maslow’s Hierarchy of NeedsFive increasingly higher-level needs:

physiological (food, water, sex) security (a safe environment) social (relationships with others) self-esteem (a sense of personal worth) self-actualization (becoming the desired self)

Lower level needs must be satisfied before higher level needs can be addressed or become of interest to the individual.

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Needs and MotivationNeeds and Motivation

Herzberg’s Hygiene–Motivator theory Hygienes (extrinsic job factors)

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

Motivators (intrinsic job factors) 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 helps satisfy the person’s higher-level needs.

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Instrumentality and RewardsInstrumentality and Rewards

Vroom’s Expectancy Theory A person’s motivation to exert some level of effort is a

function of three things: Expectancy: 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.

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Pay-for-performance: The ChallengesPay-for-performance: The Challenges

The “The “do only what you get paid fordo only what you get paid for” syndrome” syndrome Unethical BehaviorsUnethical Behaviors Negative effects on the spirit of cooperationNegative effects on the spirit of cooperation Lack of controlLack of control Difficulties in measuring performanceDifficulties in measuring performance Psychological contractsPsychological contracts The credibility gapThe credibility gap Job dissatisfaction and stressJob dissatisfaction and stress Potential reduction of intrinsic drivesPotential reduction of intrinsic drives

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Meeting the Challenges of Pay-for-performance Meeting the Challenges of Pay-for-performance SystemsSystems

Link pay and performance appropriatelyLink pay and performance appropriatelyStraight piecework: A fixed sum is paid for each

unit the worker produces under an established piece rate standard. An incentive may be paid for exceeding the piece rate standard.

Standard hour plan: The worker gets a premium equal to the percent by which his or her work performance exceeds the established standard.

Use pay-for-performance as part of a broader Use pay-for-performance as part of a broader HRM systemHRM system

Build employee trustBuild employee trust

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Meeting the Challenges of Pay-for-performance Meeting the Challenges of Pay-for-performance SystemsSystems

Promote the belief that performance makes a Promote the belief that performance makes a differencedifference

Use multiple layers of rewardsUse multiple layers of rewards Increase employee involvementIncrease employee involvement Stress the Importance of Acting EthicallyStress the Importance of Acting Ethically Use motivation and non-financial incentivesUse motivation and non-financial incentives

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Employee Preferences for Non-cash Employee Preferences for Non-cash IncentivesIncentives

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans

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Types of Incentive PlansTypes of Incentive Plans

Individual incentive/recognition programs

Sales compensation programs

Team/group-based variable pay programs

Organization-wide incentive programs

Executive incentive compensation programs

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Individual-based plans Individual-based plans

Individual-based plansIndividual-based plans Merit payMerit pay Bonus programsBonus programs Lump-sum paymentsLump-sum payments

Advantages Advantages Rewarded performance is likely to be repeated – expectancy theory Financial incentives can shape an individual's goals Help the firm achieve individual equity Fit in with an individualistic culture

DisadvantagesDisadvantages May promote single-mindedness Employees do not believe pay and performance are linked They may work against achieving quality goals, and they may promote

inflexibility.

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Individual-Based Plans Individual-Based Plans

Conditions under which individual-based plans Conditions under which individual-based plans are most likely to succeedare most likely to succeed When the contributions of individual employees can When the contributions of individual employees can

be accurately isolatedbe accurately isolated When the job demands autonomyWhen the job demands autonomy When cooperation is less critical to successful When cooperation is less critical to successful

performance or when competition is to be encouraged performance or when competition is to be encouraged

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Sales Compensation Programs Sales Compensation Programs

Salary plan Straight salaries

Best for: prospecting (finding new clients), account servicing, training customer’s sales force, or participating in national and local trade shows.

Commission plan Pay is only a percentage of sales

Keeps sales costs proportionate to sales revenues. May cause a neglect of non-selling duties. Can create wide variation in salesperson’s income. Likelihood of sales success may linked to external factors rather than to

salesperson’s performance. Can increase turnover of salespeople.

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Sales Compensation Programs Sales Compensation Programs

Combination plan 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.

Commission-plus-drawing-account plan Commissions are paid but a draw on future earnings helps the salesperson

to get through low sales periods. Commission-plus-bonus plan

Pay is mostly based on commissions. Small bonuses are paid for directed activities like selling slow-moving

items.

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Team-based PlansTeam-based Plans

Team-based plans attempt to support other efforts to increase the flexibility of the work force within a firm.

These plans normally reward all team members equally based on group outcomes.

Advantages Foster group cohesiveness Facilitate performance measurement

Disadvantages Possible lack of fit with individualistic cultural values Free-riding effect Social pressures to limit performance Difficulties in identifying meaningful groups Inter-group competition leading to a decline in overall performance.

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Team-based PlansTeam-based Plans

Conditions under which team-based plans are most Conditions under which team-based plans are most likely to succeed-likely to succeed-

When work tasks are so intertwined it is difficult to single When work tasks are so intertwined it is difficult to single out who did whatout who did what

When the firm’s organization facilitates the implementation When the firm’s organization facilitates the implementation of team-based incentivesof team-based incentives

When the objective is to foster entrepreneurship in self-When the objective is to foster entrepreneurship in self-managed work groupsmanaged work groups

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Advantages and DisadvantagesAdvantages and Disadvantages

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Plant-wide PlansPlant-wide Plans

Plant-wide plans Generally referred to as gainsharing programs because they return a portion of the

company's cost savings to the workers, usually in the form of a lump-sum bonus. Conditions to be consideredConditions to be considered

Firm sizeFirm size TechnologyTechnology Historical performanceHistorical performance Corporate cultureCorporate culture Stability of the product marketStability of the product market

Three major types: Scanlon Plan

Rewards labor savings, most appropriate for companies that have a "high touch labor" content

Rucker Plan Most appropriate for organizations that want to improve other variables, such as scrap

reduction or energy consumption, in addition to labor. Improshare

easiest of the gainsharing plans to understand and install

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Plant-wide PlansPlant-wide Plans

Advantages eliciting active employee input increasing the level of cooperation fewer measurement difficulties improved quality

Disadvantages protection of low performersproblems with the criteria used to trigger rewardsmanagement-labor conflict

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Corporate-wide Plans Corporate-wide Plans

Corporate-wide Plans macro type of incentive program and is based on the entire corporation's performance

Differences between Corporate-wide Plan and Gainsharing no attempt is made to reward workers for productivity improvements they are very mechanistic they may used to fund retirement programs although there are exceptions

Profit-sharing plans Cash plans

Employees receive cash shares of the firm’s profits at regular intervals. The Lincoln incentive system

Profits are distributed to employees based on their individual merit rating. Deferred profit-sharing plans

A predetermined portion of profits is placed in each employee’s account under a trustee’s supervision. Employee stock ownership plans (ESOPs)

A corporation 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.

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Corporate-wide Plans Corporate-wide Plans

Advantages Advantages Financial flexibility for the firm Increased employee commitmentTax advantages

DisadvantagesDisadvantages Risk for employeesLimited effect on productivityLong-run financial difficulties.

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Types of Pay-for-performance PlansTypes of Pay-for-performance Plans Corporate-wide PlansCorporate-wide Plans

Conditions favoring corporate-wide plansConditions favoring corporate-wide plans Firm sizeFirm size Interdependence of different parts of the Interdependence of different parts of the

businessbusiness Market conditionsMarket conditions The presence of other incentivesThe presence of other incentives

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Designing Pay-for-performance PlansDesigning Pay-for-performance Plans Managers andManagers and Executives Executives

Annual bonus

Plans that are designed to motivate short-term performance of managers and are tied to company profitability.

Eligibility basis: job level, base salary, and impact on profitability

Fund size basis : nondeductible formula (net income) or deductible formula (profitability)

Individual awards: personal performance/contribution

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Designing Pay-for-performance PlansDesigning Pay-for-performance Plans Managers andManagers and Executives Executives

Stock optionThe right to purchase a specific number of shares of

company stock at a specific price during a specific period of time.

Nonqualified stock option

Indexed option

Premium priced option

Options have no value (go “underwater”) if the price of the stock drops below the option’s strike price (the option’s stock purchase price).

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Designing Pay-for-performance PlansDesigning Pay-for-performance Plans Managers andManagers and Executives Executives

Other plans Guaranteed loans to directors

Loans provided to buy company stock. A highly risky and now frowned upon practice Key employee program

Golden parachutes Payments companies make to departing executives in connection with a

change in ownership or control of a company.

Performance plans Plans whose payment or value is contingent on financial performance

measured against objectives set at the start of a multi-year period

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Designing Pay-for-performance PlansDesigning Pay-for-performance Plans Managers andManagers and Executives Executives

Creating an Executive Compensation Plan Define the strategic context for the executive compensation

program. Shape each component of the package to focus the manager on

achieve the firm’s strategic goals. Create a stock option plan to meet the needs of the executives

and the company and its strategy. Check the executive compensation plan for compliance with

all legal and regulatory requirements and for tax effectiveness. Install a process for reviewing and evaluating the executive

compensation plan whenever a major business change occurs.

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Key Strategic Pay QuestionsKey Strategic Pay Questions

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Why Incentive Plans FailWhy Incentive Plans Fail

Performance pay can’t replace good management.

You get what you pay for.

“Pay is not a motivator.”

Rewards punish.

Rewards rupture relationships.

Rewards can have unintended consequences.

Rewards may undermine responsiveness.

Rewards undermine intrinsic motivation.

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Implementing Effective Incentive PlansImplementing Effective Incentive Plans

Ask: Is effort clearly instrumental in obtaining the reward?

Link the incentive with your strategy. Make sure effort and rewards are directly related. Make the plan easy for employees to understand. Set effective standards. View the standard as a contract with your employees. Get employees’ support for the plan. Use good measurement systems. Emphasize long-term as well as short-term success. Adopt a comprehensive, commitment-oriented approach.

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HR Activities that Build CommitmentHR Activities that Build Commitment

Clarifying and communicating the goals and mission of the organization.

Guaranteeing organizational justice.

Creating a sense of community by emphasizing teamwork and encouraging employees to interact.

Supporting employee development by emphasizing promotion from within, developmental activities, and career-enhancing activities.

Generally committing to “people-first values.”