Chapter 12: Incentive Plans and Executive Compensation
is designed to give employees significant stock ownership in their employers.
Establishing an ESOP creates several advantages. The major one is that the firm can
receive favorable tax treatment on the earnings earmarked for use in the ESOP.
Another is that an ESOP gives employees a “piece of the action” so that they can
C. Metrics for Variable Pay Plans
Firms in the United States are spending significant amounts on variable pay plans as
incentives. 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 used, depending on the nature of the plan and the goals set for it.
Figure 12-8 shows some examples of different metrics that can be used to evaluate
variable pay plans.
V. Sales Compensation
The compensation paid to employees involved with sales frequently is partly or entirely
tied to individual sales performance. Salespeople who sell more products and services
Chapter 12: Incentive Plans and Executive Compensation
A. Types of Sales Compensation Plans
Sales compensation plans can be of three general types—salary only, straight
commission, and salary-plus-commission or bonuses.
Salary Only
Some companies pay salespeople only a salary. The salary-only approach is useful
when an organization emphasizes serving and retaining existing accounts over
generating new sales and accounts. This approach is frequently used to protect the
income of new sales representatives for a period of time while they are building up
their clientele.
Straight Commission
A widely used individual incentive system in sales jobs is the commission, which is
compensation computed as a percentage of sales in units or dollars. Commissions are
integrated into the pay given to sales workers in three common ways—straight
commission, salary-plus-commission, and bonuses.
Salary-Plus-Commission or Bonuses
Chapter 12: Incentive Plans and Executive Compensation
B. Sales Compensation Management Perspectives
Sales incentives work well, especially when they are tied to the broad strategic
initiatives of the organization and its specific marketing and sales strategies. However,
as economic and competitive changes have become more complex and shifted in nature,
employers in many industries have faced challenges in their sales.
Administering Sales Compensation Programs
The last few years have seen sales compensation plans with different design features.
Many of them are multitiered and can be very complex. Selling over the Internet
brings additional challenges to incentive compensation as well.
C. Sales Performance Metrics
Successfully using variable sales compensation requires establishing clear performance
criteria and measures. Figure 12-9 shows some of the possible sales metrics. Generally,
Considering Effectiveness of Sales Plans
Many sales compensation plans are not seen as effective by either salespeople or
managers and executives. One problem that can occur is constantly making too many
Chapter 12: Incentive Plans and Executive Compensation
VI. Executive Compensation
Executive compensation is handled differently than other employees’ pay in most public
companies, privately held companies, and even tax-exempt organizations. The amounts
CEO’s receive are usually more than business unit heads with similar responsibilities in
A. Executive Compensation Controversy
At the heart of most executive compensation plans is the idea that executives should be
rewarded if the organization grows in profitability and value over a period of years.
Chapter 12: Incentive Plans and Executive Compensation
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 over others. However, incentive plans have usually been
designed in ways to minimize the impact of such attempts at effecting executive pay.
“Say on Pay”
Clawbacks
The “clawbacks” provision in Dodds-Frank allows a company to recover any
C. Elements of Executive Compensation
Because many executives are in high tax brackets, and their compensation often is
provided in ways that offer significant tax savings, their total compensation packages
Executive Salaries
Salaries of executives vary by the type of job, size of organization, the industry, and
Chapter 12: Incentive Plans and Executive Compensation
Executive Benefits
Many executives are covered by regular benefits plans that are also available to
nonexecutive employees, including retirement, health insurance, and vacation plans.
In addition, executives may receive supplemental benefits that other employees do
not receive.
Executive Perquisites (Perks)
Annual Executive Bonuses
Annual bonuses for senior managers and executives can be determined in several
ways. One way is to use a discretionary system whereby the CEO and the board of
Long-Term Incentives (LTI)
Executive performance-based incentives should tie executive compensation to the
long-term growth and success of the organization. However, whether these
Chapter 12: Incentive Plans and Executive Compensation
usually linked to achieving specific performance criteria. Other types of stock
options include phantom stock, performance shares, and other specialized technical
forms.
Exit Packages and Golden Parachutes
While severance payments and pension payments may not ordinarily cause
D. Global Executive Compensation
The expansion of global business by firms based in both the United States and other
countries has raised executive compensation issues. Numerous executives have
responsibilities for operations throughout the world, and they are compensated for those
expanded responsibilities. However, senior executives in the United States continue to
earn higher salaries than similar executives in other countries.
E. “Reasonableness” of Executive Compensation
The notion of providing monetary incentives that are tied to improved performance of
the company makes sense to most people. However, in the United States, there is an
Measuring Executive Compensation
Of all the executive compensation issues that have been raised, the one that is
Chapter 12: Incentive Plans and Executive Compensation
discussed most frequently is whether executive compensation levels, especially for
CEOs, are sufficiently linked to organizational performance. The reason for giving
compensation in the form of incentives is that it is thought to be effective in
Measurement of executive performance varies from one employer to another. Some
executive compensation packages use a short-term focus of one year, which may lead
to large rewards for executive performance in a given year even though corporate
performance over a multiyear period is mediocre, especially if the yearly measures
Executive Compensation and Boards of Directors
In most organizations, the board of directors is the major policy-setting entity and
must approve executive compensation packages. Corporate directors receive
compensation for board and committee meetings and other activities. The
compensation committee usually is a subgroup of the board of directors that is
Chapter 12: Incentive Plans and Executive Compensation
One major concern voiced by many critics is that the base pay and bonuses of CEOs
are often set by the members of board compensation committees, many of whom are
CEOs or executives of other companies with similar compensation packages. Also,
the compensation advisors and consultants to the CEOs often collect large fees, and
critics charge that those fees distort the objectivity of the advice given.
Critical Thinking Challenges
Discuss why variable pay-for-performance plans have become popular and what elements
are needed to make them successful.
To be successful, pay-for-performance plans should have the following general
characteristics:
• Consistent with organization culture
• Sufficient financial resources available
• Linked to organizational objectives
Chapter 12: Incentive Plans and Executive Compensation
1. Give examples of individual incentives used by an organization in which you were
employed, and then describe why those plans were or were not successful.
Discussion of this question might focus on whether students felt the named incentive
systems succeeded. Another factor to consider in discussing incentive systems is the
extent to which a system reflects the effort necessary to achieve an incentive payment.
In describing why the plans were successful or unsuccessful, students might include
these eight conditions for successful pay plans:
• Consistent with organization culture
• Sufficient financial resources available
• Linked to organizational objectives
2. Describe the nature and components of, and the issues currently facing, executive
compensation in various U.S. industries.
Students will probably include many of the issues that are discussed in the text—links
Chapter 12: Incentive Plans and Executive Compensation
compensation and follow all appropriate legislation and regulations.
3. Suppose you have been asked to lead a taskforce to develop a sales incentive plan at
your firm. The taskforce is to generate a list of strategies and issues to be evaluated by
websites, identify and develop preliminary material for the taskforce.
The taskforce should understand the different types of sales incentive plans and the
advantages and disadvantages of each.
Salary-plus-commission or bonuses is the most frequently used form of sales
compensation. This plan combines the stability of a salary with the performance aspect
of a commission. A common split is 80%–20% or 70% salary to 30% commission,
although the split varies by industry and can be based on numerous other factors.
4. Your insurance company needs to update the sales incentive program for its
sales/marketing representatives. Because of the growth in the volume and diversity of
the products being sold, the existing system of having one incentive program for all
sales marketers no longer meets the needs of the company. To maximize sales in each
of the product lines, the system needs to provide an incentive and reward system to
Chapter 12: Incentive Plans and Executive Compensation
encourage employees to focus on their specific product lines while also cross–
marketing the company’s portfolio of other products. To identify the key facets of a
A. Would a compensation program that offered only commission work for your
company? Why or why not?
Students’ answers will vary. The text provides information about straight
B. What other incentives would assist the company in motivating the sales staff?
Students might recommend other incentives such as special gifts or travel for top
Case
Best Buy Pays Big Bucks for CEO
1. Was Joly overpaid?
Student answers will vary. Some students may answer that Joly is overpaid as they
2. What factors probably led to this pay package?
Students’ answers may vary. Some students may say that the extravagant pay package
3. If you were able to vote on this pay package (“say on pay”), how would you vote and
Chapter 12: Incentive Plans and Executive Compensation
why?
Student answers will vary. Some students may vote in favor of the project as they may
Supplemental Cases
Cash Is Good, Card Is Bad
Questions
1. Evaluate the use of this type of incentive and why the manager is experiencing
problems with it.
The store manager decided to institute a 2% commission on cash sales only. Because
of the 4% service charge made by credit charge card plans on all charge sales, Arlow’s
2. If an incentive program is to be used, what type of system would you recommend?
Why?
Student answers will vary. Some students may answer that employees should be given
Comments
Chapter 12: Incentive Plans and Executive Compensation
The incentive scheme described in the case has resulted in problems. By placing emphasis
on how the sale is paid for, instead of on the sale itself, the manager has generated counter-
productive results. The incentive is not directly tied to the results that the manager wants—
Incentive Plans for Fun and Travel
This case discusses incentive plans that stimulate employee interest and motivate them to
1. Why might the use of incentives in the form of gift certificates be better than just
providing cash to employees?
Often cash is spent to pay bills or just used without any remembrance of what was
bought with the money. Cash is often just combined with cash in the employee’s
2. What are some advantages and disadvantages of a sales incentive program in which
the top performers receive a trip or other large reward, while other sales individuals
receive lesser or different types of rewards?
The main advantage of a sales incentive program where the top performers receive a
Chapter 12: Incentive Plans and Executive Compensation
Sodexo Incentives
This case shows how a large firm uses recognition and awards. (For the case, go to
1. Based on the Sodexo example, discuss the importance of widespread incentives in
improving both the culture and employee retention efforts in a firm.
The importance of wide-spread incentives in affecting the culture and employee
retention efforts in a firm is evident at Sodexo. This is especially true for a large
2. How might having employees receive recognition and incentives at a national level
impact the performance of their coworkers and colleagues?
Students’ answers may vary, but seeing one’s working colleagues getting national
recognition may inspire some employees to also try to perform at a higher level to get