Chapter 11 – Rewarding Performance
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CHAPTER 11
Rewarding Performance
Objectives:
After reading this chapter, you should be able to
1. Understand the determinants of effective reward systems.
2. Identify the critical variables related to the selection of the most appropriate reward
systems.
3. Describe the evidence on the effectiveness of different types of reward systems.
4. Know the relative advantages and disadvantages of the various approaches to reward
effective performance.
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CHAPTER 11 – CHAPTER SUMMARY
I. Overview
A. Critical to obtain ROI on employee compensation
B. Strong trend to implement pay for performance systems
C. Research indicates PFP systems tied to strategic goals are HPWC
D. PFP systems put some portion of employee pay at risk
E. Organizations must understand potential difficulties and limitations of PFP systems
F. Cheating is a primordial economic act
G. Option backdating
H. 600% rise in CEO pay largely due to PFP components of pay packages
I. PFP plans can be a key to success
II. Does PFP Work?
A. What is being rewarded
B. Short term measures must correlate with long-term measures
C. Individual and situational contingencies need to be considered
D. PFP can be successful when:
1. Tailored to particular work situations
2. Linked to long term strategic objectives
1. Probability of effort leading to reward
2. Probability of receiving the reward
3. Value of the outcome
C. Unions becoming more receptive to PFP systems
D. Consider impact on team culture
E. Increased pay should be tied to those aspects that are critical to the organization
F. The PFP systems should be compatible with the strategic goals
G. Employee must be capable of controlling & increasing output/quality
H. Reward criteria are critical
I. Worker involvement in PFP design is important
IV. What Are the Main Problems with PFP Programs? Figure 11-4
A. Poor perceived connection between performance and pay
B. Expensive to develop and maintain
C. Lack of objective, countable results
D. Employees perceive that performance is not accurately measured.
E. Union resistance
F. The performance rewarded is not related to the firm’s long term objectives.
G. Supervisors do not take it seriously
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V. What Are the Legal Implications of PFP?
A. Subject to same redress as non-PFP compensation
B. Title VII and EPA litigation
C. Situational constraints can foster sense of inequity
D. “Disparate Impact” theory can be used
VI. How Do You Select a PFP System?
A. Who should be included in a PFP system?
1. Systems should be developed with specific groups and conditions in mind
2. Most companies have different systems for different jobs or departments
3. PFP system should involve as many employees as possible
4. American’s prefer individual PFP systems
B. How Will Performance Be Measured?
1. Criteria selected must be compatible with short and long-term strategic
objectives
2. Performance should be measured to maximize reliability & validity
C. What are the rewards in an incentive system?
1. Cash, percentage increase in base pay, and non-cash prizes most common
2. Stock ownership, stock options
a) 2005 requirement to expense options reduced their usage
b) Problems with options-backdating, re-pricing
D. A Discrepancy between Research and Practice
1. Trend to use bonus-based PFP not permanently tied to base pay
2. Performance-based pay should not be tied to base pay-use bonus-based system
3. Long-term costs are more easily controlled and linked to current performance
E. Should you use individual, group, or company-level PFP?
1. Measure and reward individual performance if possible
2. Cooperation and team work are encouraged by a group or unit based system
F. When should team-based PFP be used?
1. HRM systems focus on the results of the team
a) High achievers may go elsewhere to have individual accomplishments
recognized
2. The pool of rewards is not fixed
3. “Free–riders” increase with group size
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VII. Individual PFP Plans: Merit Pay and Incentive Systems
A. What are Merit Pay Plans?
1. Merit pay plans call for distribution of pay based on appraisal of worker’s
performance
2. The most common PFP system
3. Employees want link between performance and pay
4. Fundamental problem is accurately measuring performance
5. Raters can be trained to be more accurate
6. Can lead to high turnover among best performers
7. Avoid forced-distribution
B. What Is Incentive Pay?
1. Based on units produced & provides closest link between individual effort and
pay
2. Piece-rate system
a) Standards set for level of work done in specific amount of time
b) Set a fair rate of pay using internal or external measures
c) Divide the base wage by the standard
d) International Piece-Rate Pay:
i) Complies with minimum wage requirements of respective countries
ii) Controversy due to low level of these rates
e) Differential piece rate addresses production variability
f) Pay only for quality pieces
g) Can be combined with bonus pay
h) Effective when work is repetitive, controllable and no need for cooperation
i) Need to involve employees
3. Standard hourly rate
a) The production standard is based in time units
b) Rate may vary with the output (Halsey plan)
C. What Are Sales Incentive Plans?
1. Sales incentive plans can increase sales over time
2. Important to consider all performance dimensions
3. Commission Plans pay directly on sales data
4. Draw-plus commission sales person can borrow against commission account
5. Commissions can be paid in rewards other than cash e.g. stock
6. Commission plus salary
7. Sales bonuses
D. What Are Bonuses?
1. One-time payments not permanently tied to salary
2. Tend to be more effective than base-pay adjustments
3. May be individual or group performance
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VIII. What Are Group Incentive Plans?
A. Group plans are best when cooperation and teamwork are essential
B. Require special consideration
1. Potential for free-rider effect
2. Strong group norms can inhibit output
3. Need to meet FLSA requirements
C. What Is Profit Sharing?
1. Based on a percentage of company profits
2. Employee payments typically linked to a ratio related to their pay
3. Way to align goals of management and employees
a) More likely to exert maximum effort and share information
4. Group size impacts employee perception of fairness
5. Perception of connection between employee effort and profitability key to
success
D. What Is Gain Sharing?
1. Worker involvement, cooperation and trust are critical
2. Process of sharing financial benefits, earned from reducing cost or increasing
productivity, with workers
3. Usually paid out monthly
4. What Are the Four Approaches to Gain Sharing?
a) Scanlon plan
i) Most Common plan
ii) Rewards for suggestions
iii) Screening committees review suggestions
iv) Incentive for labor cost savings
b) Rucker plan
i) Calculation includes value of supplies, materials, services and labor
ii) Incentive to save on all inputs
iii) More difficult plan to understand and explain
c) IMPROSHARE plan
i) Specifies standard number of hours to produce a base production
level
ii) Rewards all employees equally
iii) Gains can be seen over 3 year period before plateau
iv) Easy to administer and understand
d) Winsharing
i) Combines gain sharing with profit sharing
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ii) Takes market demand into consideration
iii) Group performance measures used independent of profit measures
5. Bottom Line on Gain Sharing?
a) Benefits include increased productivity and quality
b) Cooperation between unions & management, employee participation &
realistic expectations essential
c) Advantages of IMPROSHARE plan over Scanlon and Rucker plans
i) Easier to comprehend, more control over production, and not require
management to reveal sensitive information
d) Advantages of Scanlon and Rucker plans over IMPROSHARE plan
i) Workers share in financial risks, and Scanlon allows more integration
with problem-solving process
E. What Are Employee Stock Option Plans?
1. Employee Stock Ownership Plans (ESOPs)
a) Retirement plan in which the company contributes its stock to the plan for
the benefit of the company’s employees,
b) Employees never buy or hold the stock directly; this is different from
employee stock option plans
2. Employee stock Option plan
a) Employee has the right to buy a specific number of the company’s shares at
a fixed price within a certain period of time
3. Works best when combined with employee involvement and problem solving
4. Implications:
a) May be perceived as more equitable than profit or gain sharing
b) May generate less motivation because value connected to market conditions
c) If value less than perceived performance then can result in feelings of
inequity
IX. Managerial and Executive Incentive Pay
A. Executive incentives are supposedly linked to net income, return on investment, or
total dividends paid
1. Total compensation packages rose 28% in 2010
2. Increase was due mainly to increases in incentive vs. base pay
3. Tying executive compensation to earnings has coincided with dramatic increase
in earnings restatements
4. Plans continue to favor short vs. long term results
Chapter 11 – Rewarding Performance
B. Are There Documented Negative Consequence to Widening Pay Dispersion?
1. Little research has shown a relationship between this gap and subsequent
performance decrements or high turnover
2. Maybe more acute if it occurs in high tech firms
3. Tends to diminish communication, increase status gaps, and foster aggressive
competition for the top post
C. Should You Use Short- or Long-Term Measures of Performance?
1. Lower-level managers typically have incentives based on short-term measures
2. Executives have both short- and long-term performance incentives
3. Rewards are usually in the form of lump sum bonuses
4. Stock option reward plans
a) Enable execs to purchase stocks over a specified time period at a fixed price
b) Based on the notion that executives would profit when shareholders profited
c) Provided an incentive to adjust performance goals and the price and timing
of grants
d) Not proven effective at incenting outstanding performance
e) Stock appreciation rights (SARs) enable execs to call the option and receive
the difference between the fixed and market prices of the stock in cash
f) Restricted stock plans give shares as a bonus with some restrictions (e.g.,
remaining with the firm for a period of time)
g) Performance share plans award units based on long- and short-term
measures
h) Units are later translated into stock awards
i) Stock plans can be paid into retirement accounts
j) Clawback provisions
D. What about the Corporate Board Room?
1. Rarely linked to corporate performance
2. Boards provide very little corporate governance and oversight
3. Research indicates that higher corporate performance results if the board of
directors is paid strictly with stock
4. Is increased shareholder power the answer
X. How Do Companies Keep Entrepreneurs and Promote Intrapreneurs?
A. Fund employee ventures by using innovative compensation schemes
B. Special award programs for major accomplishments
XI. What Are the Managerial Implications for PFP programs?
A. A well-designed PFP system should lead to:
1. Lower costs
2. Higher profits
3. Higher motivation (of individuals or groups)
a) Involve employees for better results
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B. A mix of plans often has the best results
C. Three strategic positions for more effective PFP systems (Figure 11–7)
1. Pay the person
2. Translate business strategy into measure that can be used for reward system
3. Individualize the reward system
D. Sound measurement is key to successful plans
E. All important work dimensions should be rewarded
F. Measurement ambiguity results in conflict
G. Close monitoring is required
E. Compensation should reflect a mix of programs that support individual, group and
organizational level performance
Chapter 11 – Rewarding Performance
F. CHAPTER 11 – IMPORTANT TERMS
Backdating – Adjusting the dates when stock options are granted. If the stock price goes up,
“backdating” can increase compensation. It can also be illegal
Behavioral Encouragement Plan – payment for specific accomplishments such as safety
compliance or attendance
Commission plans – payments to sales staff based on a measurement of sales
Differential rate – Two outcomes related to pay: one for performing below standard and other
for meeting or exceeding the standard (Taylor).
Draw-plus Commission system – intended to protect sales staff from highly variable
Gain sharing – Group incentive system based on improved performance, not profit, with
rewards given out frequently rather than annually. Plans typically involve a form of employee
suggestion system.
Halsey Plan – divided the savings of performing a task in less than the standard time between
the workers and the employer.
Improshare – Uses standard hours rather than labor costs to determine incentive pay.
Engineering studies or past performance data are used to specify the standard number of hours
required to produce a base production level. Savings in hours result in reward allocation to
workers.
Incentive plans – Rely on countable results as basis for setting PFP rate. Incentive pay usually
based on units produced
Merit pay plan – addition to an employee’s base pay that earned thru employee performance
as measured through performance appraisal
Performance Appraisal Discomfort Scale (PADS) – a means to measure the extent to which a
person feels uncomfortable giving negative feedback
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Performance share plans – award units, that are later translated into stock awards, based on
short- and long-term measures
Piece-rate system – Worker is paid per unit of production
Production variability – can disrupt the flow of products to customers if employees forgo extra
effort for piece rate pay if they are too tired, ill, etc. but work hard on days when feeling fine or
need extra money.
plan defines productivity ratio as the value added to production by labor divided by labor cost.
Scanlon Plan – Uses a formula to determine the employee’s share of cost savings (W+S/SVOP).
High level of participation through labor-management committees.
Standard hourly rate – Production standard used for incentive pay is expressed in time units.
Stock appreciation rights – Does not involve buying stock. Having been awarded rights to a
based on financial performance in excess of goals
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CHAPTER 11 – DISCUSSION QUESTIONS
1. Deming and other quality experts think PFP is a bad idea. What do you think?
The accurate measurement of performance is the major stumbling block in pay for performance
(PFP) efforts. The Deming view maintains that performance appraisal fosters competition among
individual workers and diverts attention away from systems related to the quality of the product
or service. PFP may only create more problems within the entire system (increase system
2. Why is trust so important for PFP systems?
Openness and trust are necessary if employees are to accept the standards and believe in the
equity of the rewards of a PFP system. Employees must believe that their added effort will
3. When is a group-based PFP system better than an individual system?
Group plans are the most useful when tasks are so interrelated/interdependent that it is difficult
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4. Some experts argue that a corporation’s board of directors should be paid only with
stock options. What do you think?
Since the boards that were compensated only with stock were less likely to overpay their CEOs
and reported superior corporate performance, it makes sense to pay them with stock. U.S. CEO
5. How would you go about combining individual and group-based PFP systems?
Employees who exceed the standard expectations of the job could be given a lump-sum bonus
based on the company’s performance while still participating in a profit sharing or gainsharing
6. Some experts believe that if you have to use performance appraisals as the main source of
data for a PFP system, you shouldn’t bother with the PFP system. What do you think?
The performance appraisal system and the evaluators of performance are mainly responsible for
establishing a clear link between employee performance and pay. There are a host of problems
associated with the use of performance appraisals. The fundamental problem is with measuring
performance, a problem compounded in service industries in which individual performance is
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7. Under what conditions (if any) should a company install a forced-distribution rating
system for PFP?
8. Conduct research on executive compensation contracts. Determine to what extent
“clawback” or “give–back” provisions are part of the contract. Describe such a program
and how the “clawback” works.