chapter 21 rewarding performance cost accounting traditions and innovations barfield, raiborn,...
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Chapter 21
Rewarding Performance
Cost AccountingTraditions and Innovations
Barfield, Raiborn, Kinney
Learning Objectives (1 of 2)
• Explain the relationship between compensation and maximization of stockholder wealth
• List the different ways of rewarding performance
• Describe the movement toward rewarding group, as well as individual, performance
• List the positive and negative consequences of incentive pay programs
Learning Objectives (2 of 2)
• Explain why incentive programs may involve shares of, or options for, common stock
• Describe the importance of nonmonetary rewards in motivating managers
• Clarify how taxes affect compensation plan design
• Describe the role of ethics when designing a compensation package
• Identify expatriate compensation issues
Rewarding Performance
Compensation Strategy
• Unites goals and strategies, performance measurements, and rewards
• Board of directors and top management determine compensation strategy
• Compensation committee– Establishes compensation strategy– Sets compensation policies/guidelines
Is this aconflict
ofinterest?
Set strategic goals
Identify critical success factors, set operational targets and compensation strategy
Identify performance measures
Set performance rewards
Employee or employee group performs tasksMeasure/monitor performance
Determine rewards
Plan-Performance-Reward Model
Traditional Compensation Strategy
• Top managers– salary and significant financial incentives
• Middle managers– salary and raises based on performance
• Workers– wages and small bonuses
Contemporary Strategy
• Incentive-based compensation to all employees
• Based on group or individual performance
• Encourages – higher level of employee performance and
loyalty– lower overall costs
Pay-for-Performance Plans• Correlation with organization goals
– Maximization of shareholder wealth
• Appropriate time horizon– Long-run perspective– Reward with stock or stock options
• Subunit mission• Age of employee• Balance of group and individual benefits• Management ownership
Setting Performance Measures• Degree of control over performance output
Minimize risk to worker of random effects
worker specific, short-run measures
upper less specific, longer-time horizon,
management organization longevity measures
Setting Performance Measures
• Incentives relative to organization levelworker weighted toward monetary and
short-term measures
upper weighted toward nonmonetary
management and long-term measures
Worker Compensation
• Choice of plan affected by:– Competitive focus– Organizational culture– Local laws– Union affiliation– Political consideration
Pay Plan
• Periodic compensation – function of time at work, not tasks accomplished– affected by seniority, skill, education level– no link between performance and reward
Performance-Based Pay Plans
• Merit pay
• Contingent pay
• Piece rate
These do not consider overall organizational success
Profit Sharing• Contingent on organizational success• Current and/or deferred incentives in form of cash
or stock• Allocated among employees based on
– personal performance measures– seniority– team performance– managerial judgment– specified formulas
Profit Sharing
Stock Options• Employee can purchase shares of company
stock at a set price during a specific time period
• More valuable as company stock price increases
Stock Appreciation Rights• Employee may receive cash, stock, or a
combination of cash and stock
• Amount based on company stock price at a future date
• More valuable as company stock price increases
Employee Stock Ownership Plan (ESOP)
• Profit-sharing compensation invested in company stock
• More valuable as company stock price increases
Nonfinancial Incentives
• Recognition of efforts
• Participation in decision making
GoodJob
Managerial Compensation• Monetary• Perquisites - Perks
– vacations– free child care– free parking– personal assistants or private secretaries– health care– recreational club memberships– office with a view– flexible work hours
Not-for-Profit and Governmental
• Time-based pay plans; not a strong link between pay and performance
• 90% of government workers support plans that would link pay and performance
• Only 20% of not-for-profits provide bonus plans for top executives
Possible Tax Treatments of Compensation Elements
• Full and immediate taxation
• Tax deferral - pay tax at a future date
• Tax exempt - pay no tax
Taxation of Fringe Benefits
• Employer-provided accident and health insurance– deductible by employer– not taxable to employee
• Cafeteria benefit plans– both nontaxable and taxable benefits
Benefits
Deferred Compensation
• Profit-sharing, pension, and various stock-based plans including ESOPs
• Company receives an immediate deduction
• Employee is not taxed until distributions made (tax deferred)
Ethical Considerations
• Organizational governance
• Role of capital markets– Takeover, raiders, and golden parachutes
• Compensation differentials
Global Compensation
• Expatriate compensation
• Domestic base salary and fringe benefits plus adjustments for– cost of living - housing, education, security– currency fluctuations– tax implications– retirement benefits in home currency
Questions
• What are some different ways of rewarding performance?
• Why do many incentive programs involve shares of, or options for, common stock?
• What are some ethical issues to consider when designing a compensation package?
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