Pay for Performance and Financial Incentives essay

The use of financial incentives?financial rewards paid to workers whose production exceeds some predetermined standard?is not new; it was popularized by Frederick Taylor in late ass’s. Taylor had become concerned with the tendency of employees to work at the slowest pace possible and produce at the minimum acceptable level. But the workers had energy for other things.

Taylor wanted to harness this energy during the workday to achieve huge productivity gains C today, this includes fixed and variable insemination plans. Fixed pay: independent of the performance level of the individual, group, or org base pay and other forms Of relatively consistent compensation (allowances) that help income stability. Variable: links pay with productivity, profitability, or some measure of org performance. Employers increase variable pay while holding salary increases or fixed compensation at modest levels. Facilitates MGM. F total compensation by keeping base pay inflation controlled. Top performers must get top pay to secure their commitment to the org C] accurate performance appraisal or measurable outcomes is a precondition of effective pay-for-performance plans org spend roughly 1 1 % of total pay-related spending on variable pay-related expenses. > 84% of Canadian employers have one or more types of variable pay plans in place. Cash bonuses/incentives are the most common form of short-term incentives, used 87% of organizations that have short-term incentive plans in place.

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Line of sight: extent to which a worker can relate his daily work to the achievement of overall corporate goals. Workers must understand corporate strategy and how their work is important to achievement of strategic objectives C] important for effective variable pay plans Goal of APP programs is to treat workers like partners; think of business goals as their own Types of Incentive Plans Individual incentive plans give income over base salary to individuals who meet specific standard.

Informal incentives may be awarded to individuals for accomplishments that are not readily measured by a standard (ex: exemplary customer service) Group incentive programs provide payments over base salary to team members when the group collectively meets a specified standard for performance, productivity, ‘other work-related behavior Org-wide incentive plans provide monetary incentives to all workers Of the org profit sharing plans that provide workers with a share Of the org profits in a specified period shanghaiing programs reward workers for improvements in org productivity non-monetary recognition programs motivate workers through praise/expressions of appreciation incentive must appeal to the individual receiving it appeal is affected by demographic factors INCENTIVES FOR OPERATIONS Piecework plans piecework: system of pay based on # of items processed by each worker in a unit of time oldest incentive plan, most commonly used evolving a workable piece-rate plan requires job evaluation & mind Austria engineering job evaluation enables firms to assign an hourly wage rate to the job industrial engineers develop the production standard (crucial issue in piece-rate planning) production standards are stated in terms of a standard number of minutes/unit or units/hour after employment standards legislation, most employers had to guarantee a minimum wage straight piecework plan: a set payment for each piece produced/processed in a factory/shop C piecework usually implies strict proportionality between result rewards, regardless of output level sharing productivity gains between worker and employer means worker doesn’t get full credit for all production above normal Advantages of a piece-rate plan simple to calculate easily understood by employees appear equitable in principle incentive value can be powerful since rewards are directly tied to performance Disadvantages of a piece-rate plan Bad reputation among many employees, based on some employers’ habits of arbitrarily raising production standards whenever they found their workers earning “excessive” wages. Stated in monetary terms (like $0. 50 per piece) D hen a new job evaluation results in a new hourly wage rate, the piece rate must also be revised; this can be a big clerical chore. Subtle: Since the piece rate is quoted on a per-piece basis, in workers’ minds, standards become tied inseparably to the amount of money earned. When an attempt is made to revise production standards it meets considerable worker resistance, even if the revision is fully justified. Industrial-engineered specificity of piecework plans = biggest disadvantage Tailor-made for relatively specialized jobs in which employees do the same narrow set of tasks many times a day L] acidity?preoccupied with producing # of units needed and less concerned with meeting quality standards or switching jobs (doing so could reduce productivity) Employees tend to be trained to perform only a limited number of tasks. Attempts to introduce new technology more likely to fail D require major adjustments to engineered standards and negotiations with employees. Equipment tends not to be as well maintained, focuses is on maximizing each machine’s output. Some firms drop piecework plans and to substitute team-based incentive plans, like shanghaiing Guaranteed piecework plan: the minimum hourly wage plus incentive for each piece reduced above a set number of pieces per hour (so you get paid $1 0/h even if you don’t meet the standard of 15 pieces, or instance. But for every piece exceeding 15, you get $0. More) differential piece-rate plan: worker is paid basic hourly rate + an extra % of his base rate for production exceeding the standard per hour or per Dacca similar to piecework payment but is based on a % premium C assumes that you have a guaranteed base rate if you produced 25% more than the standard for that hour (or whatever time period), you get 1. 25 * (base pay rate per hour) * (# hours worked) most advantages similar to the piecework plan; simple to compute/understand has most of the advantages of the piecework plan and is fairly simple to compute/ understand expressed in units of time instead of in monetary terms (like the standard piece-rate system). 0 less tendency by workers to link their production standard with their pay. Clerical job of recompiling piece rates whenever hourly wage rates are re-evaluated is avoided.

Workforce Diversity: targeting Incentives for Life Stage when developing incentive programs, consider the demographics of workforce understanding each employee’s life stage helps determine most effective incentive approach results in a workforce that is satisfied, engaged, and more likely to perform better/stay with firm traditionalists (1922-45): flexible schedules, health and fitness rewards, entertainment rewards that they wouldn’t buy or themselves (computers, cell phones) boomers (1946-1964): recognition, appreciation, travel rewards, luxury, health related awards Gene X (1965-80): gadgets, high-tech rewards, state of the art technology, work-life balance (extra vacancy days, onsite childcare), flexibility (want family/friends) Gene Y (191-2000): relationship enhancers, home entertainment items, dining experiences, personalized rewards where they can choose colors and accessories, charitable rewards, etc. Motivation is highly personal Team or Group Incentive Plans Team or group incentive plan: a production standard is set for a specific work group and its members are paid incentives if the group exceeds the production standard. There are several ways to implement team/group incentive plans. 1) Set work standards for each member and maintain a count of the output of each member. Members are then paid based on one of three formulas: A.

All members receive the pay earned by the highest producer; B. Al members receive the pay earned by the lowest producer; or C. All members receive payment equal to the average pay earned by the group. 2) Set a production standard based on the final output of the group as a whole; all members receive the same pay, based on the piece rate for the group’s job. N based on either the piece rate or standard hour plan, but the latter is more prevalent. 3) Choose a measurable definition of group performance/ productivity that the group can control. O total labor hours per final product C] piecework’s engineered standards are not required here Advantages: Team/

Group incentive plans make sense because: 1) Sometimes, several jobs are interrelated one worker’s performance reflects his co-workers 2) Team plans reinforce group planning and problem solving 3) Helps ensure that collaboration takes placed reduce jealousy, make group members indebted to one another (as they would be to the group), and encourage cooperation. 4) Less bickering among group members over who has “tight’ production standards 5) facilitates on-the-job training, since each member wants to get new members trained ASAP Disadvantage = each workers rewards are no longer based solely on his own effort. To the extent hat the person does not see his effort leading to the desired reward, a group plan may be less effective at motivating employees than an individual plan is.

More effective with communication about plan specifics, strong worker involvement in plan’s design and implementation, and when members perceive the plan as fair INCENTIVES FOR SENIOR MANAGERS AND EXECS Most employers award their senior managers and execs a bonus/incentive because of the role they play in determining divisional and corporate profitability Short-Term Incentives: The Annual Bonus of firms in Canada with variable pay plans provide an annual bonus: unlike salaries, which rarely decline with reduced performance, SST incentive bonuses can easily result in an increase or decrease 70% in total pay relative to the previous year. Three basic issues should be considered when awarding short-term incentives: 1) Eligibility is usually decided in one of three ways. ) key position: a job-by-job review to identify the key jobs (typically only line jobs) that have a measurable impact on profitability. B) set a salary-level cut- off point; all employees earning over that threshold amount are automatically eligible for consideration for SST incentives CLC simplest approach. The size of the bonus is usually greater for top-level execs. Average bonuses range from 10-80%. C) salary grade: refinement of the salary cut-off approach; assumes that all employees at a certain grade or above should be eligible for the SST incentive program. 2) How Much to Pay Out (Fund Size): total amount of bonus $ available; several formulas to do this. A) non-deductible formula: straight % (usually of company’s net income) creates the fund. ) deductible formula: assumption that the SST incentive fund should begin to accumulate only after the firm has met a specified level of earnings. There are no hard- and-fast rules about what an ideal payout size would be, and some firms do not even have a formula for developing the bonus fund. OR, reserve a min. Amount of the profits (ex: 1 0%) for shareholders’ investments, then establish a fund for bonuses (ex: 20% of corporate operating profit before taxes in excess of the rest) 3) Determining Individual Awards: sometimes, the amount is determined on a discretionary basis (usually by the boss), but typically a target bonus is set for each eligible position and adjustments are then made for greater or less than targeted performance CLC A Max. Mount may be set.

Rate each manager’s performance C compute preliminary bonus estimates L sum = estimates for total $S to be spent on SST incentives 0 compare with bonus fund available If necessary, the individual estimates are then adjusted Will managers receive bonuses based on individual/team/corp. performance? In a profit-sharing plan, each person gets a bonus based on company’s results, regardless of effort. With a true individual incentive, the manager’s individual performance is rewarded. Top-level exec bonuses are generally tied to overall corporate results (divisional results if he is in charge f a major division) C] assuming corporate results reflect individual performance. Moving down the chain of command, corporate profits = less accurate gauge Of a managed contribution. For supervisors, individual performance is a more logical determinant of his bonus. Abbey that managerial and exec-level bonuses should be tied to both org and individual performance CLC simplest way is split-award method: breaks the bonus into two separate bonuses, one based on individual effort and one based on the org performance. Drawback?pays too much to the marginal performer, who still gets that company-based bonus. C] use the multiplier method: bonus should be a product of individual and corporate performance. When either is very poor, the product is zero. Outstanding performers should get larger awards people that the company cannot afford to lose. Marginal performers should never receive awards that are average, and poor performers should get nothing.

The S saved on those people should be given to above-average performers. Eng-Term Incentives LET incentives: intended to motivate and reward top MGM for the firm’s LET growth and prosperity and to inject a LET perspective into exec decisions. If only SST criteria are used, a manager could increase profitability in one year but in turn reduce profits over the next 2-3 years. D focus on SST returns at the expense of LET increase in share price. Economic recession in late 2008 resulted in increasing regulatory focus on this type of compensation. LET also encourage execs to stay by giving them the opportunity to accumulate capital (company shares) based on the firm’s LET success.

Long-term Capital accumulation programs: LET incentives are most often received for senior execs Have recently begun to be extended to employees at lower organizational levels. 0% of Canadian private sector org provide LET incentives. & very few for public sector employees. Common: stock options, performance share unit plans, restricted share unit plans, and deferred share unit plans. C popularity of these plans changes over time because of economic conditions, internal company financial pressures, changing attitudes toward long-term incentives, tax law 1) Stock Options: most popular LET incentive in Canada, but its use is decreasing. A stock option is the right to purchase a specific # of shares of company stock at a specific price at some point in future.

Often a vesting (waiting) period ensures that the employee as contributed to any increase in stock price, which also aligns the stock option with the goal of LET retention of talent. Exec thus hopes to profit by exercising his option to buy the shares in the future, at today’s price. Assumption: the price of the stock will go up (so thou can sell it in the future at market price) D The difference earned is treated as a taxable benefit. Often, the employee benefits since they only have to pay capital gains tax on 50% of the gain. From the employer’s perspective, capital gains from cash incentive plans and stock purchase plans are taxed at full income inclusion levels. Thus, stock option plans = cash windfall with no downside risk but unlimited upside potential.

Bad: stock price depends on things outside the exec’s control, such as economic conditions and investor sentiment D declining market can mean share prices don’t riseњ concern today to the extent that the exec can affect stock market / firm’s growth, the stock option = incentive. Stock options have traditionally been treated as a tool to attract and retain highly skilled workers. Trend in stock options as LET incentives: they are being used for non-managers/nosecones C] companies make good the promise of letting employees share in the company’s success Proposals have been made to require that stock options be shown as an expense on financial statements because so many options dilutes share values for shareholders D distorted impression of the true value of a company.

Canada Pension plan Investment Board: Stock options are a less effective/efficient form of compensation than direct share ownership in aligning the interests of directors with those of shareholders; it does not motivate the exec to enhance long-term corporate performance. Stock-based compensation is superior to option-based compensation plans for 3 broad reasons: 1 . Alignment of worker interest with shareholders (across a wide range of future share prices) 2. Efficient compensation (in terms of the perceived value received by the executive); and 3. It alters the capital structure in a more predictable way (less potential dilution and more straightforward accounting treatment) 2) Plans Providing Share “Units”: new approach instead of stock has become common.

Execs are granted a specified # of units whose value is equal to (and fluctuates with) a company’s share price, subject to certain conditions. A performance share unit plan provides units subject to the achievement of predetermined financial targets, such as growth in PEPS (often multilayer period). If the performance goals are met, then the value of the units is paid to the exec in cash/stock. 3) In a restricted share unit plan, units are promised to the exec but will be forfeited if an exec leaves the company before a vesting period (typically 3 years). But if the exec is still there, the full value of the units based on the current stock price is payable in cash/stock. ) Deferred share unit plan, units are promised to the exec; only payable when he leaves the company. Relating Strategy to Executive Compensation: should lead to more effectiveness. Few HER practices have as much connection to strategy as does how the company crafts its LET incentives. Few strategies can be accomplished in 1-2 years њ so LET signals that are sent to execs regarding the things that will/won’t be rewarded affect whether/not strategy is implemented effectively. Ex: strategy to boost sales by expanding abroad might suggest linking incentives to increased sales abroad. A cost- reduction strategy might link incentives to improved profit margins. insemination experts suggest defining the strategic context for the exec compensation plan before creating the compensation package itself, as allows: 1 . Define the internal & external issues that face the company/ objectives 2. Based on the strategic aims, shape each component of the exec compensation package and then group the Components into a balanced whole. Include a stock option plan so the exec compensation package meets the unique needs of the execs and the company. 3. Check the exec compensation plan for compliance with all legal resets & tax effectiveness. 4. Install a process for reviewing/evaluating the plan whenever a major business change occurs. Sales compensation plans rely on incentives (sales commissions) C] this varies by industry. SST prevalent approach ? combination of salary and commissions to compensate salespeople. Widespread use of incentives for salespeople is due to three factors: tradition, the unsupervised nature of sales work, & assumption that incentives are needed to motivate salespeople INCENTIVES FOR SALESPEOPLE Salary Plan In a salary plan, salespeople are paid a fixed salary C] maybe occasional incentives (bonuses, etc). Works well when the main sales objective is prospecting (finding new clients) or when the salesperson is mostly involved in account servicing (developing and executing product training programs for distributors sales force or participating in national and local trade shows. Good for industries that sell technical products ex: aerospace and transportation equipment Salespeople know in advance what their income will be employer also has fixed, predictable sales force expenses simple to switch territories or quotas or to reassign salespeople high degree Of loyalty among the sales staff LET perspective is encouraged by straight salary compensation disadvantage it does not depend on results њ often tied to seniority D denominating Commission Plan Commission plans pay salespeople in direct proportion to their sales?they ay only for results. Advantages. 1) Salespeople have the greatest possible incentive D There is a tendency to attract high-performing salespeople who see that effort will clearly lead to rewards. ) Sales costs are proportional to sales (vs.. Being FCC) CLC company’s selling investment is reduced. 3) easy to understand and compute. Drawbacks 1) Salespeople focus on making a sale and on high-volume items; neglecting customer service 2) Wide variances in income between salespeople can lead to a feeling that the plan is inequitable. 3) Salespeople are encouraged to neglect other duties, like servicing small accounts. 4) Pay is often excessive in mom times and very low in recessions. Paying salespeople a commission that’s 100% of pay resulted in the highest turnover of salesperson. Turnover= much lower when salespeople are paid a combination of a base salary plus commissions.

C although 100% commissions can drive higher sales, without a financial safety net it can also undermine the desire Of salespeople to stay. The effects of a commission pay plan could also depend on personality extroversion was positively associated with higher performance (% of existing members renewing their memberships & # of new members paying membership fees) only when the salespeople were explicitly awarded for accomplishing these tasks CLC extroversion did not always lead to higher sales; Combination Plan Moving away from straight commission or fixed salary to combination plans for salespeople. Advantages of both straight salary and straight commission plans and also disadvantages C] earnings & allows compensation for admit work vs.. Ay be a compromise & confusing to calculate Salespeople have a floor to their earnings Company can direct salespeople’s activities by detailing what services the salary is being paid for, while the commission component provides a built-in incentive for superior performance. Alarm component is not tied to performance C employer is trading away some incentive value. Combination plans can get complicated, and misunderstandings can result. Not a problem with a simple “salary plus commission” plan, but most plans are not so simple. “Commission plus drawing account” plan: salesperson is paid basically on commissions but can draw on future earnings to get through low sales periods. Commission plus bonus” plan: salespeople are paid primarily on the basis of commissions, but they are also given a small bonus for directed activities, like selling slow- moving items. Complexities of the typical ambition plan. Ex: the following 3-step formula is applied: Step 1: Sales volume < $1 8 000 a month; Base salary + 7% Of gross profits + 0. 5% of gross sales Step 2: Sales volume $18 000-$25 000 a month; Base salary + 9% gross profits + 0. 5% gross sales Step 3: Sales volume >$25 000 a month; Base salary + 10% of gross profits + 0. 5% of gross sales In all cases, base salary is paid every two weeks, while the earned %s are paid monthly. Setting sales goals or targets is complex and requires careful planning and analysis. There may be various special awards.

Trips and high-tech items are commonly used as sales prizes. Sales Compensation in the E-commerce Era Traditional product-based sales compensation focuses on the amount of product sold. In Internet age, team positions the company with prospects, make sales, and service accounts. All sales members deepen customer relationshipsњ this new approach is because, for customers who know what they want, rapid low-cost purchases can be made over the Internet. Face-to- face sales are now reserved for high-volume customers and higher-margin services. Sales incentive plans now must encourage the sales force to focus on the customer Focus: integrate with e-commerce, and support rapid change.

Cross-selling incentives (multiple sales of different product lines to same customer) are important, along with incentives for relationship MGM. And customer satisfaction. Experts suggest setting sales salaries at 50-75% of total expected compensation,+ incentives. A part of the incentive should be tied to team results to encourage sharing, hand- offs,& peer pressure. INCENTIVES FOR OTHER MANAGERS AND PROFESSIONALS Merit pay/raise: any salary increase awarded to an employee based on individual performance. Different from a bonus in that it usually represents a continuing increment (bonus ? one time) Term “merit pay/raise” is more often used with respect to white-collar employees, and particularly professional, office, and clerical employees.

Advocates: only pay/rewards tied directly to performance can motivate improved performance; awarding identical pay raises to all workers (regardless of effort) may detract from performance Detractors present good reasons why merit pay can backfire. 1) merit pay plan depends on the validity of performance appraisal system (what if system is unfair) 2) Supervisors tend to minimize differences in employee performance when computing merit raises. They give most employees similar raises, either because of a reluctance to alienate some employees or a desire to help everyone with the cost of living. 3) Most employees think they’re above-average; below-average merit increase can be demoralizing. 4) Some believe that merit pay pits employees against each other and harms team spirit. Consensus of opinion is that merit pay can and does improve performance. Success depends on validity of performance appraisal system Traditional merit pay plans have two basic characteristics: (1) Merit increases are usually granted at a designated time of the year as a higher base salary (raise) (2) usually based exclusively on individual performance, although many profits may affect the total SUm available for merit raises [l occasionally tied to both individual. Org performance Sometimes, merit raises are awarded in a single lump sum once a year, without changing base salary. Incentives for Professional Employees Professional employees: their work involves the application of learned knowledge to the solution of the employer’s problems leavers, doctors, economists, and engineers. Pay decisions regarding professional employees involve unique problems. ) for most professionals, money has been less important as an incentive than for other employees. C professionals tend to e paid well anyway AND they are already driven by the desire to produce high-caliber work and receive peer-recognition 2) Professionals still want financial incentives firms with the most productive research and development groups have incentive pay plans for their professionals, usually bonuses that represent a relatively small portion of their total pay (increases not that motivating) 3) The time cycle of the professionals’ incentive plans is usually> layer D long time spent in designing, developing, and marketing a new product.

Professionals need many non-salary items in order to do their best. Not only incentives better equipment/facilities, supportive management style, support for professional journal publications.