Incentive PayCompensation Management

Chapter No.04By:- Israr K. Raja

Preston University, Islamabad, Pakistan.

Learning Objectives

• Incentive Pay Vs Traditional Pay Systems

• Plans rewarding Individual Behaviour• Types of Plans reward Group behavior• Corporate Incentive Plans• Designing of Incentive pay Plans

Incentive Pay

Incentive Pay

• Known as variable pay. • Rewards employees for partially or

completely attaining a predetermined work objective.

• - one-time rewards given to employees for completely or partially achieving a predetermined work objective

Components of Incentive Pay

• Compensation fluctuates according to a pre-established formula, individual or group goals, and company earnings- Augments base pay, appears as a one-time payment- Controls costs- Motivates employees

Incentive Pay Assumptions

• 1. Individual employees and work teams differ in how much they contribute to the company

• 2. The company overall performance depends to a large degree on the performance of individuals and groups within the company

• 3. A company needs to reward employees on the basis of their relative performance in order to attract, retain, and motivate high performers

Incentive Pay Vs Traditional Pay Systems

Traditional Pay• Supports command and control

management and traditional job hierarchies.

• Driven by duties and responsibilities in job description; focuses on tasks.

• Highly structured design with little room for flexibility.

• Tightly controlled communication, "need to know" basis only.

Incentive Pay• Designed with business

objectives and strategic plan.• Motivates and rewards

critical behaviors; focuses on contribution.

• Flexible design adapts to changes in business priorities.

• Openly communicates shared vision, performance expectations and success.

Contrasting Incentive Pay with Traditional PayTraditional Pay

• Fixed hourly rate• Fixed salary

Incentive Pay• Pay based on

performance• Individual plans• Group plans• Companywide

plans

Types of Incentive Plans

• 1. Individual- Incentive Plans• 2. Group- Incentive Plans• 3. Company-Incentive Plans

Individual Incentive Plans

• Reward employees whose work is performed independently, and for meeting work-related standards

• Piecework plans can be used here to, but typically are used for their production employees

Types on Individual Plans

• Piecework Plans• Management Incentive Plans• Behavior Encouragement Plans• Referral Plans

Piecework Plans

• Reward workers for every item produced over a designated production standard- uses objective and subjective criteria- quantity and/or quality goals

Piecework Plans Advantages

• Incentive Effect: workers willingness to work hard to produce more

• Sorting Effect: workers choice to stay versus leave for another job

Piecework Plans Disadvantages

• May promote inflexibility• Unrealistic standards may hamper

employee motivation• Setting performance standards is time

consuming• Factors beyond employees control may

affect outcomes• May promote undesirable behaviors

Management Incentive Plans

• Award bonuses to managers when they meet or exceed objectives based on sales, profit, production, or other measures for their division ex.) increasing market share

• Management incentive plans focus on achieving complex, multiple objectives (MBO)

Behavior Encouragement Plans

• Employees receive payments for specific behavioral accomplishments- safety records- attendance

Referral Plans

• Employees receive bonuses for recruitment of highly qualified employees

Advantages and Disadvantages of

Individual Incentive Plans

• Advantages:- Promotes link between pay and performance- Equitable pay enables companies to retain best performers

• Disadvantages:- Employee may not be able to control factors that affect performance- Loses motivational effect when goals are too high or too low

Group Incentive Plans

• Reward employees for their collective performance, rather than for each employee's individual performance

• Emphasize importance between and within teams

• Encourage team members to have predetermined team objects

Group Incentive Performance Measures

• Customer satisfaction• Labor cost savings• Materials cost savings• Reduction in accidents• Services cost savings

Types of Group Incentive Plans

• Team-Based or Small-Group Based incentive Plans

• Gain Sharing

Team-Based or Small-Group Based incentive Plans

• A small group of employees shares a financial reward when a specific objective is met.

• Rewards allocated 3 ways..1. Equal Incentive payments to all team members2. Different payments to team members based on their contributions to the goal3. Different payments determined by a ratio of each team members base pay to the total base pay of the group

Types of “Teams” for Team Incentive Plans

• 1. Work (process) teams: refer to organizational units that perform the work of the organization on an ongoing basisex.) customer service teams, assembly teams on production lines

• 2. Project teams: consist of a group of people assigned to complete a one-time projectex.) a team of engineers working on the construction of a bridge

• 3. Parallel teams (task forces): include employees assigned to work on a specific task in addition to normal work duties

Gain Sharing

• Group incentive systems that give employees a financial reward based on improved company performance in areas such as increased productivity, lowering costs, and improving safety** emphasizes employee involvement and giving suggestions

Components of Gain Sharing Programs

• 1. Leadership Philosophy: progressive, involving a cooperative organizational climate

• 2. Employee involvement through suggestions and problem solving ideas

• 3. Bonuses awarded when productivity exceeds productivity targets

Types of Gain Sharing Plans

• 1. Scanlon Plan2. Rucker Plan3. Improshare

Scanlon Plan

• Emphasis on teamwork:- Employee involvement in teamwork to reduce costs

Two tiered cost savings suggestion system1. Production level committees2. Company wide screening committees- Monetary rewards for productivity improvements......**based on a ratio of labor costs and sales value of production (SVOP)SVOP= the sum of sales revenue + the value of goods in inventory*Smaller Scanlon Ratio= labor costs/SVOP* want ratio to be smaller...less labor cost.....

Rucker Plan

• Emphasizes employee involvement and monetary incentives

- Uses a value-added formula to measure productivity : difference between the value of the sales price and value of materials used to make the product- Larger Rucker ratio indicates that the value added is greater than the total employment costs

Improshare

• Defined as "Improved Productivity through Sharing"- measures productivity physically rather than on dollar savings- incentive to finish products with fewer labor hours**main focus is on labor-hour ratio- Unlike Scanlon and Rucker Plans, employee participation is not a feature- workers receive bonuses on a weekly basis- includes a buy-back provision

Advantages and Disadvantages of Group Incentives Plans

• Advantages:- companies can more easily develop performance measures for group plans than individual plans (fewer groups than individuals)- greater group cohesion (achieving common goal)

• Disadvantages:- May lead to higher employee turnover because of the free-rider effect: some employees may make fewer contributions to the group because they posses lower ability, skills, or experience than other group members- Members may feel uncomfortable with the fact that other members performance influences their compensation level

Company-Wide Incentive Plans

• Rewards employees when company meets performance standards

• Two types: profit sharing plans and employee stock options

Company-Wide Performance Measures

• company profits• cost attainment• market share• sales revenue

Types of Companywide Incentive Plans

• Profit Sharing Plans• Employee Stock Option Plans

Profit Sharing Plans

• Current profit-sharing plans- award cash to employees typically on a quarterly or annual basis as part of core compensation

• Deferred profit-sharing plans- place cash awards in trust accounts for employees retirement

Profit-Sharing Formulas

• Fixed first-dollar-of profits- based on specific percentage or pre- or post- tax annual profits

• Graduated first-dollar-of profits- percentages increases as pre- or post- tax annual profits increase

• Profitability threshold formula- profits must exceed a minimum level

Distribution Methods

• Equal Payments:- same for all employees

• Proportional payments based on annual salary:- presumes higher salaries equate to more contributions to the group and profits

• Proportional payments based on contribution to profits:- hard to quantify individual employee contribution- not widely used

Advantages and Disadvantages of

Profit-Sharing Plans• Advantages

- enable employees to share in companies profitsallow companies greater financial flexibility

• Disadvantages- can undermine the economic security of employees- may fail to motivate employees if they do not see a direct link between their efforts and corporate profits- may lead to turnover of productive employees, if rewards are small

Employee Stock Option Plans

• Company grants employees the right to purchase company stock- to own the stock, employees must exercise the stock option rights by purchasing stock at designated price after a specified period of time - incentivizes employees to be more productivity, with expectation that stock value will increase over time- employees make money by selling stock for more than purchase price

Employee Stock Option Plans

• Company Stock• Represents total equity of a company• Company Stock Shares• Represents equity segments of equal value

- equity interest increases positively with the number of stock shares• Employee Stock Ownership Plans (ESOPs)• Place company stock in trust account for employees

- similar to deferred profit sharing• Stock Compensation Plans• Represent an important type of deferred compensation for executives

Deferred Compensation is suppose to...

• - Create a sense of ownership- Align the interest of the executive with the interest of the owners or shareholders of the company long term

Incentive Pay Considerations

• - Based on individual or group performance?

• - Acceptable level of risk employees willing to accept?

• - Complementing or Replace traditional pay?

• - Performance criteria evaluated should be quantifiable and accessible?

• - Appropriate time horizon?

Time Horizon

• Short-term versus Long-term1. "Rule-of-thumb" is that short-term is five years or fewer2. Incentives for lower-level employees are:a)usually short-termb) goals are within the control of the employees3. incentives for professionals and executives are generally long-term