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Chapter 8
Variable Pay, Executive Compensation, and Benefits
Chapter Overview
This chapter deals with variable pay (individual incentives, group/team incentives,
organizational incentives), and executive compensation.
An increasing number of employers feel traditional pay systems fail to link pay with
performance. However, to develop a successful pay-for-performance plan the
organization must address the following:
Does the plan $t the organization?
Does the plan reward appropriate actions?
Is the plan administered properly?
Also, the results of the variable pay plans should be measured to determine how
successful the programs are.
The three types of variable pay plans include individual, group/team, and
organizational incentives. The chapter next presents a more detailed discussion of
these types of incentives. Individual incentives encourage workers to achieve
individualized goals. Typical individual incentive plans include piece-rate systems,
and bonuses. Following the discussion of individual incentive plans, group/team-
based variable pay plans are examined. Coverage is given to designing group/team
incentive plans, group/team incentive challenges, types of group/team incentives
(group/team results and gainsharing).
The chapter next looks at organizational incentives such as profit sharing and
employee stock plans such as employee stock ownership plans (ESOPs).
The chapter then moves to a discussion of executive compensation. identification of
the various elements of executive compensation such as salaries, benefit, perks,
annual incentives and bonuses, and long-term performance incentives are
presented.
Employee benefits represent one of the most significant HR issues facing employers. This chapter
presents an overview of the most significant issues associated with benefits and describes benefits offered
under five classifications—security, health care, retirement, financial, family-oriented, and time off.
The chapter presents a discussion of strategic benefit issues such as the role of benefits as competitive
advantage, and the issues around benefits design, administration, technology, measurement, cost control
and benefits communication. Then the general types of benefits that are government mandated and the
voluntary benefits are covered. Security benefits are then discussed. This includes workers compensation,
unemployment, and severance pay.
As the nation’s work force grows older, retirement-related benefits take on added importance. Social
Security and pension plans are covered with descriptions of defined-benefit pension plans, defined-
contribution pension plans, cash balance pension plans, and individual retirement options. Next the legal
requirements for retirement benefits are presented with discussions on ERISA, and retirement benefits
and age discrimination.
The chapter next discusses health care benefits. Employers, usually through insurance, provide a variety
of health-care and medical benefits. Increasing costs, especially those for health insurance, have caused
employers to seek ways of containing health care benefits costs. Specific approaches include passing on a
portion of the costs to employees through copayments and employee contributions, offering managed care
options, and using Consumer-Driven Health (CDH) plans, and providing health-care preventive and
wellness efforts. Health-care legislation such as COBRA and HIPAA are also discussed.
Financial benefits including insurance, financial services, and education assistance are then described and
the chapter ends with a discussion of family-oriented benefits and time-off benefits.
Chapter Outline
I. Variable Pay: Incentive for Performance
Variable pay is compensation that is tied to performance. Pay for performance is often used
The philosophical foundation of variable pay rests on three basic assumptions:
Some people or groups contribute more to organizational success than do others.
Some people perform better and are more productive than are others.
A. Successful Variable Pay
Employers adopt variable pay for many reasons, including the following:
Link strategic business goals and employee performance
Enhance organizational results and reward employees financially for their contributions
Achieve HR objectives, such as increasing retention, reducing turnover, recognizing succession
Reduce fixed costs
Combating Variable Pay Complexity
One factor that can clearly lead to failure of a variable pay plan is having an incentive plan that is
too complex for employees and management to understand.
B. Global Variable Pay
Variable pay is expanding in global firms and in other countries. Also, laws and regulations differ from
C. Three Categories of Variable Pay
Variable pay plans can be classified into three categories—individual, group/team, and organizational.
Individual incentives are given to reward the effort and performance of individuals. Group/team
incentives are given when an organization rewards an entire group/team for its performance.
II. Individual Incentives
Individual incentive systems tie personal effort to additional rewards for the individual employee.
Conditions necessary to use individual incentive plans are that:
Individual performance must be identifiable.
A. Piece-Rate Systems
The most basic individual incentive systems are piece-rate systems. Under a straight piece-rate
system, wages are determined by multiplying the number of units produced (such as garments sewn or
B. Bonuses
Employees may receive additional compensation in the form of a bonus, which is a one-time payment
that does not become part of their base pay. A bonus can recognize performance by an employee, a
team, or the organization as a whole. A very large all-or-nothing bonus is called a massive kinked
III. Group/Team Incentives
The use of groups/teams in organizations has implications for incentive compensation. Team incentives
can take the form of cash bonuses for the team or items other than money, such as merchandise or trips.
A. Design of Group/Team Variable Pay
In designing group/team variable pay, organizations must consider several issues. The main concerns
Distribution of Group/Team Incentives
The two primary ways for distributing those rewards are:
Same-size reward for each member
Different-size reward for each member
Employers can vary rewards given to team members depending on factors such as individual
contribution to group/team results, current pay, years of experience, or skill levels of jobs
Timing of Group/Team Incentives
Firms may specify pay outs to be monthly, quarterly, semiannually, or annually, although the most
Who Makes Decisions about Group/Team Incentive Amounts?
Some group/team incentive programs allow members themselves to make decisions about how to
B. Group/Team Incentive Challenges
The difference between rewarding team members equally and rewarding them equitably triggers many
of the problems associated with group/team incentives. Rewards distributed in equal amounts to all
C. Types of Group/Team Incentives
Group/team reward systems can use different ways of compensating the group. The two most common
Group/Team Results
Results to be measured may include group production, cost savings, or quality improvement. Those
Gainsharing
The system of sharing greater-than-expected gains in profits and/or productivity with employees is
gainsharing. Also called teamsharing or goalsharing, the focus is to increase “discretionary
To develop and implement a gainsharing or goalsharing plan, management identifies the ways in
IV. Organizational Incentives
An organizational incentive system compensates all employees according to how well the organization as
a whole performs during the year. Two common organizational variable pay systems are profit sharing
and employee stock plans.
A. Profit Sharing
As the name implies, profit sharing distributes some portion of organizational profits to employees.
The primary objectives of these plans can include the following:
Increase organizational performance
Attract or retain employees
Typically, the percentage of the profits distributed to employees is set by the end of the year before
distribution, although both timing and payment levels are considerations that might be determined
Drawbacks of Profit-Sharing Plans
There are a number of drawbacks associated with profit-sharing. First, employees must trust that
management will accurately disclose financial and profit information. Second, profits may vary a
B. Employee Stock Plans
Organizational incentive plans can use stock ownership in the organization to reward employees. The
A stock option plan gives employees the right to purchase a fixed number of shares of company stock
Employee Stock Ownership Plans
Firms in many industries have an employee stock-ownership plan (ESOP), which is designed to
give employees significant stock ownership in their employers. One advantage of establishing an
C. Metrics for Variable Pay Plans
With incentive expenditures increasing each year, it is crucial that the results of variable pay plans be
measured to determine the success of the programs. Various metrics can be evaluated, depending on
V. Executive Compensation
Executive compensation is usually handled differently than employee. Executives (particularly CEOs) can
A. Executive Compensation Controversy
Executive compensation should include an element of risk for the executive. Executive pay is often
B. Changes in the Context of Executive Compensation
The U.S. government has historically involved itself in executive compensation only by requiring
more disclosure of compensation from companies, and changing the tax code to favor some payments
“Say on Pay”
A provision of the Dodds-Frank Act took a proactive approach. Publically listed companies now
Clawbacks
The “clawbacks” provision in Dodds-Frank allows a company to recover any incentive-based pay
that was paid out during the prior three years if it would not have been paid under restated financial
C. Elements of Executive Compensation
Executives’ total compensation packages consist of much more than just their base pay. Many
executives are covered by regular benefits plans that are also available to nonexecutive employees,
and some may receive supplemental benefits that other employees do not receive. Perquisites
VI. Employee Benefits and HR Strategy
A benefit is a tangible indirect reward provided to an employee or group of employees for organizational
A. Benefits as a Competitive Advantage
Benefits can be used to create and maintain a competitive advantage for the organization. While they
represent a significant cost, benefits are an important factor in employee commitment and retention.
B. Tax-Favored Status of Benefits
Providing employee benefits rather than wages can be advantageous for employees. Most benefits
C. Global Benefits
There are significant differences in benefits across the globe. In many countries, retirement, health,
The amount of paid leave and vacation time also vary significantly around the globe. Paid-time-off for
childbirth and medical disability are generous in Scandinavian and European countries and they
VII. Managing Benefits
Benefit programs must be designed, administered, measured, and communicated. To maximize the impact
A. Benefits Design
Organizations design benefit plans with a goal of providing value for employees while remaining cost-
effective for the company. Many key decisions must be made as part of benefits design.
Flexible Benefits
A flexible benefits plan allows employees to select the benefits they prefer from options
One problem with flexibility in benefit choice is that employees may choose an inappropriate
benefits package. Another problem can be adverse selection by employees, whereby only higher-
Part-Time Employee Benefits
Another key design issue is whether or not to provide benefits to part-time employees. Many
employers do not provide part-time employee benefits, except some paid time off. Part-time
Domestic Partner Benefits
Under some state laws, same-sex domestic partners may be entitled to coverage on company
medical insurance plans and to be recognized under retirement plans as a surviving spouse. In
Older Workers Benefit Needs
Hiring and retaining older workers can be an important strategy for an organization seeking high-
VIII. Benefits Administration, Technology, and Communication
Legal compliance, recordkeeping, enrollment and participation issues result in a significant administrative
responsibility for organizations. Many organizations offer an open enrollment period once a year. Open
Outsourcing Benefits Administration
One significant trend is the outsourcing of benefits administration. Third party administrators
Technology and Employee Self-Service
The spread of HR technology, particularly web-based and mobile systems, has significantly
changed the benefits administration burden on HR staff. Internet and computer-based systems are
Self-service allows employees to change their benefits choices, track their benefits balances, and
A. Benefits Measurement
Numerous HR metrics can be used to evaluate whether benefits are providing the expected results in
terms of employee retention and satisfaction. Other metrics are used to measure the return on the
B. Benefits Cost Control
Since benefits costs have risen significantly in the past several years, particularly for health care,
employers are focusing more attention on measuring and controlling them, even reducing or dropping
benefits offered to employees. Another common means of benefits cost control is cost sharing, which
C. Benefits Communication
Employees generally do not know much about the values and costs associated with the benefits
provided by employers. This is in large measure due to ineffective communication by the company.
Benefits Statements
Some companies give individual employees a personal statement that translates benefits into dollar
D. Types of Benefits
A wide range of benefits are offered by employers. Some are mandated by laws and government
regulations, while others are offered voluntarily by employers as part of their HR strategies. Figure 8-3
Employers voluntarily offer a variety of benefits to help them compete for and retain employees. As
jobs become more flexible and varied, both workers and employers recognize that choices among
