Copyright © 2017 Pearson Education, Inc.
Part Four
Compensation
Chapter 12
Pay for Performance and Financial Incentives
Lecture Outline:
Money’s Role in Motivation
Incentive Pay Terminology
Linking Strategy, Performance, and Incentive Pay
Motivation and Incentives
Know Your Employment Law
Individual Employee Incentive and Recognition Programs
Piecework
Merit Pay as an Incentive
Incentives for Professional Employees
Nonfinancial and Recognition-Based Awards
Trends Shaping HR: Digital and Social Media
Improving Performance: HR Tools for Line Managers and Small Businesses
Job Design
Improving Performance: The Strategic Context
Incentives for Salespeople
Salary Plan
Commission Plan
Combination Plan
Maximizing Sales Results
Sales Incentives in Action
Trends Shaping HR: Digital and Social Media
Incentives for Managers and Executives
Strategy and the Executive’s Long-Term and Total Rewards Package
Short-Term Incentives and the Annual Bonus
Improving Performance: HR Practices Around the Globe
Some Other Executive Incentives
Team and Organization-Wide Incentive Plans
How to Design Team Incentives
Evidence-Based HR: Inequities That Undercut Team Incentives
Profit-Sharing Plans
Scanlon Plans
Other Gainsharing Plans
At-Risk Pay Plans
Employee Stock Ownership Plans
Incentive Plans in Practice: Nucor
Employee Engagement Guide for Managers
Chapter 12: Pay for Performance and Financial Incentives 12- 2
Copyright © 2017 Pearson Education, Inc.
Incentives and Engagement
Chapter Review
Where Are We Now..
The main purpose of this chapter is to explain how managers use incentives to motivate
employees. The main topics we’ll discuss are money’s role in motivation, individual employee
incentive and recognition programs, incentives for salespeople, incentives for managers and
executives, team and organization-wide incentive plans and incentives, and employee
engagement.
Interesting Issues:
The owners of a 21-store fast-food franchise in the Midwest knew that their stores’ performance
and profits depended on their employees’ performance. They hoped a new employee incentive
program could boost their employees’ and their stores’ performance. We’ll see that they did.
Learning Objectives:
12-1: Explain how you would apply four motivation theories in formulating an incentive plan.
12-2: Discuss the main incentives for individual employees.
12-3: Discuss the pros and cons of commissions versus straight pay for salespeople.
12-4: Describe the main incentives for managers and executives.
12-5: Name and describe the most popular organization-wide incentive plans.
12-6: Explain how to use incentives to improve employee engagement.
Annotated Outline:
I. Money’s Role in Motivation – Frederick Taylor made three contributions in the late 1800s:
He saw the need for 1) formulating a “fair day’s work,” namely precise output standards for
each job, 2) the scientific management movement, which emphasized improvement of work
through observation and analysis, and 3) using incentives pay to reward employees who
produce over standards.
A. Incentive Pay Terminology – Often managers use two terms
synonymously with incentative plans: Pay-for-performance and Variable
pay. They both tie the employee’s pay to the employee’s performance.
Variable pay is more specific; it is usually an incentive plan that ties pay
to some measure of the firm’s overall profitbaility.
B. Linking Strategy, Performance, and Incentive Pay – compensation experts
argue that managers should understand the motivational bases of incentive
plans when tying workers’ pay to their performance.
C. Motivation and Incentives – the law of individual differences means that
people differ in personality, abilities, values, and needs. They therefore
Chapter 12: Pay for Performance and Financial Incentives 12- 3
Copyright © 2017 Pearson Education, Inc.
react to different incentives in different ways. Several theorists have
contributed relevance to designing incentive plans.
1. Motivators and Frederick Herzberg – hygiene-motivator theory divides
needs into two factors. Hygiene factors include such things as working
conditions, salary, and incentives. Motivators factors include those
factors that make the job more intrinsically motivating, like challenge,
feedback, and recognition.
2. Demotivators and Edward Deci – Deci found that extrinsic rewards
could at times actually detract from a person’s intrinsic motivation.
3. Expectancy Theory and Victor Vroom – the theory suggests that a
person’s motivation to exert some level of effort is a function of three
things: the person’s expectancy (in terms of probability) that his or her
effort will lead to performance; instrumentality, or the perceived
connection (if any) between successful performance and actually
obtaining the rewards; and valence, which represents the perceived
value the person attaches to the reward.
4. Behavior Modification/Reinforcement and B. F. Skinner –
Psychologist B.F. Skinner proposed that to understand behavior, one
must understand the consequences of that behavior. Behavior
modification means changing behavior through rewards or
punishments that are contingent upon performance.
D. Know Your Employment Law
II. Individual Employee Incentive and Recognition Programs
A. Piecework – piecework involves paying the worker a sum (piece rate) for each unit
he/she produces. Straight piecework entails a strict proportionality between results
and rewards regardless of output. With a standard hour plan, the worker gets a
premium equal to the percent by which his/her performance exceeds the standard.
B. Merit Pay as an Incentive – merit pay or a merit raise is any salary increase the firm
awards to an employee based on his/her individual performance. It is different
from a bonus in that it usually becomes part of the employee’s base salary, whereas
a bonus is a one-time payment.
C. Incentives for Professional Employees – professional employees are those whose
work involves the application of learned knowledge to the solution of the
employer’s problems, such as lawyers, doctors, economists, and engineers. Making
incentive pay decisions for professional employees can be challenging because
such employees are usually paid well anyway.
D. Nonfinancial and Recognition-Based Awards – recognition programs usually refer
to formal programs, such as employee-of-the-month programs. Social recognition
programs are more informal manager-employee exchanges, including praise and
approval. Performance feedback is similar but provides quantitative or qualitative
information on performance in order to change the performance or maintain it.
Most employers combine both financial and non-financial incentives to motivate
employees.
E. Trends Shaping HR: Digital and Social Media – there are many reasons to use
Internet sites to manage awards programs. The sites can offer a much broader
Chapter 12: Pay for Performance and Financial Incentives 12- 4
Copyright © 2017 Pearson Education, Inc.
range of products than most employers could catalog and offer by themselves. And
perhaps most importantly, the whole process is expedited, so it’s much easier to
bestow and deliver the awards.
F. Improving Performance: HR Tools for Line Managers and Small Businesses
G. Job Design – research has shown that job design is a primary driver of employee
engagement.
H. Improving Performance: The Strategic Context
III. Incentives for Salespeople
A. Salary Plan – fixed salaries are offered by some firms. Straight salary makes it
simple to switch territories or to reassign salespeople, and it can foster loyalty
among the sales staff. A disadvantage is that it can constrict sales and de-motivate
potentially high-performing salespeople.
B. Commission Plan – salespeople are paid for results, and only for results; thus, such
plans tend to attract high-performing salespeople who see that effort clearly leads
to rewards. But, it may cause them to neglect non-selling duties like servicing small
accounts, cultivating dedicated customers, and pushing hard-to-sell items.
C. Combination Plan – most companies pay salespeople a combination of salary and
commissions, usually with a sizable salary component. Combination plans give
salespeople a floor to their earnings and still provide an incentive for superior
performance. But, they can become complicated, and misunderstandings can result.
D. Maximizing Sales Results – setting effective quotas is an art. In today’s fast-
changing business scene, sales quotas must become more flexible than they have
been in the past. There is a tendency to set commission rates informally, without
considering how much each sale must contribute to covering expenses.
E. Sales Incentives in Action – car salespersons’ compensation ranges from 100%
commission to a small base salary with commission accounting for most of the total
compensation. This approach encourages the salesperson to hold firm on the retail
price, and to push “after sale products” like floor mats and side moldings. There
may also be extra incentives to sell packages such as rustproofing. Commission
plans like these still dominate, but not as much. Many dealerships are substituting
salary plus bonus plans for commissions. This reflects the growing emphasis on
“one price no hassle” pricing.
F. Trends Shaping HR: Digital and Social Media
IV. Incentives for Managers and Executives
A. Strategy and the Executive’s Long-Term and Total Rewards Package –
few HR practices have as profound or obvious an impact on strategic
success as the company’s long-term incentives. In creating the
compensation package, you should: 1) define the strategic context for the
executive compensation program, including the internal and external
issues that face the company, and the firm’s business objectives; 2) shape
each component of the executive compensation package based on your
strategic aims, and then group the components into a balanced plan that
makes sense in terms of these aims; 3) create a stock option plan that gives
the executive compensation package the special character it needs to meet
Chapter 12: Pay for Performance and Financial Incentives 12- 5
Copyright © 2017 Pearson Education, Inc.
the unique needs of the executives, the company, and the firm’s strategy;
4) check the executive compensation plan for compliance with all legal
and regulatory requirements and for tax effectiveness; and 5) install a
process for reviewing and evaluating the executive compensation plan
whenever a major business change occurs.
1. Sarbanes-Oxley – the law affects how employers formulate their
executive incentive programs and injects a higher level of
responsibility into executives’ and board members’ decisions.
B. Short-Term Incentives and The Annual Bonus – is aimed at motivating the
short-term performance of managers and executives.
1. Eligibility usually includes both top and lower-level managers.
2. Fund size refers to the total amount of bonus money the firm makes
available. A nondeductible formula is where employers use a straight
percentage (usually of the company’s net income) to create the short-
term incentive fund. A deductible formula assumes that the fund
should start to accumulate only after the firm has met a specified level
of earnings.
3. The Individual Awards – typically, a target bonus (as well as
maximum amount) is set for each eligible position, and the actual
award reflects the person’s performance.
4. Stock Options – these account for over half of executives’
compensation. A stock option is the right to purchase a specific
number of shares of company stock at a specific price during a specific
period of time; the executive thus hopes to profit by exercising his/her
option to buy the shares in the future but at today’s price.
5. Other Stock Plans – stock appreciation rights permit the recipient to
exercise the stock option (by buying the stock) or to take any
appreciation in the stock price in cash, stock, or some combination of
these. A performance achievement plan awards shares of stock for the
achievement of predetermined financial targets. In a restricted stock
plan, shares are usually awarded without cost to the executive, but
selling the stock is restricted for a specified time period.
6. Ethics and Incentives – simplistic, financial-performance-oriented
incentives, in the absence of strong ethical standards may breed
unethical behavior. The solution is to foster an ethical culture.
C. Improving Performance: HR Practices Around the Globe
D. Other Executive Incentives – companies provide various incentives to
persuade executives to remain with the firm, such as golden parachutes
and loans.
V. Team and Organization-Wide Incentive Plans
A. How to Design Team Incentives – team (or group) incentive plans pay incentives to
the team based on the team’s performance. Occasionally, the employer may want
to pay team members according to some other formula such as based on how well
the best team member does.
Chapter 12: Pay for Performance and Financial Incentives 12- 6
Copyright © 2017 Pearson Education, Inc.
B. Evidence-Based HR: Inequities that Undercut Team Incentives – research
suggests that team incentives are often counterproductive.
C. Profit-Sharing Plans – involve employees receiving a share of the
company’s annual profits. There are several types of profit-sharing plans:
cash plans and deferred profit-sharing plans.
D. Scanlon Plans – this is an incentive plan developed in 1937 by Joseph
Scanlon. The basic features of the plan include: philosophy of
cooperation, identity, competence, involvement system, and sharing of
benefits formula.
E. Other Gainsharing Plans – are incentive plans that engage many or all
employees in a common effort to achieve a company’s productivity
objectives, with any resulting cost-savings gains shared among employees
and the company.
F. At-Risk Pay Plans – put some portion of the employee’s normal pay at
risk (forego it), subject to the firm meeting its financial goals.
G. Employee Stock Ownership Plans (ESOP) – are company-wide plans in
which a firm contributes shares of its own stock (or cash to purchase the
stock) to a trust established to purchase shares of the firm’s stock for
employees.
1. Broad-Based Stock Options – some employers offer these with the
basic of thinking that shared ownership in the company with
employees makes motivational and practical sense.
H. Incentive Plans in Practice: Nucor – Nucor Corp. is the largest steel producer in the
United States. It also has the highest productivity and lowest labor cost per ton.
Employees can earn bonuses of 100% or more of base salary, and all Nucor
employees participate in one of their four performance-based incentive plans
which are: production incentive plan, department manager incentive plan,
professional and clerical bonus plan, and senior officer incentive plan.
VI. Employee Engagement Guide for Managers
A. Incentives and Engagement – although the compensation professionals believed
that total rewards programs can influence employee engagement, many of them
did not specifically include employee engagement as one of the goals of their
compensation plans. They also concluded that the most direct ways to encourage
employee engagement with incentives are 1) to measure the extent to which
supervisors are encouraging their subordinates to be engaged, and 2) to use
incentives to reward supervisors for improving employee engagement. Even more
importantly than the rewards themselves, getting employees involved in
developing the rewards programs was the “gold standard” for building employee
cooperation and commitment.
Chapter Review