PAY–FOR-PERFORMANCE:
INCENTIVE REWARDS
This chapter acquaints students with the different types of financial incentive plans that have
been developed to motivate each category of employees within an organization. More important,
it seeks to make students aware of the criteria for a successful incentive plan and how effective
CHAPTER LEARNING OUTCOMES
1
10
0
c
ch
ha
ap
pt
te
er
r
Know how to implement incentive programs.
LEARNING OUTCOME 1
Differentiate how gains may be shared with employees under the
Scanlon and Improshare gainsharing systems.
LECTURE OUTLINE
I. STRATEGIC REASONS FOR INCENTIVE PLANS
• Incentive plans, also called variable pay plans, have grown significantly over the
past years. Incentive pay programs emphasize a shared focus on organizational
objectives by allowing employees to earn increased compensation beyond merit pay
A. Incentive Plans as Links to Organizational Objectives
• Organizations implement incentive plans for a number of reasons. Traditional
reasons include a desire to lower labor costs and be more competitive, or
because of slow technological advances. In today’s competitive environment,
Chapter 10: Pay-for-Performance: Incentive Rewards 129
• Figure 10.2 in the textbook lists the advantages of incentive pay programs.
B. Requirements for a Successful Incentive Plan
• Studies show that one of the main factors for success of an incentive plan is
employees’ acceptance of the plan. Employee acceptance can be heightened by
employee involvement in the design and administration of the program.
II. SETTING PERFORMANCE MEASURES
• A major factor to the success of an incentive pay program is measurement.
Measurement focuses on what is important to the organization and measurement
communicates to employees where their efforts should be directed. While many
aspects of organizational performance can be measured, most incentive pay programs
seek improvements in product or service quality, increased productivity, or lower
costs.
III. ADMINISTERING INCENTIVE PLANS
• Some organizations have implemented incentive programs only to have the plans fail
completely or achieve only limited success. Failures are often traced to poor
administration of the plan and/or rushing into a program without careful planning.
130 Part 4: Implementing Compensation and Security
• The textbook lists important points to follow for the effective administration of
incentive programs.
IV. INDIVIDUAL INCENTIVE PLANS
• Various incentive plans exist for individual employees. Organizations will design a
program based on unique organizational characteristics and the needs of employees.
A. Piecework
• The simplest piecework plan is straight piecework, in which pay is based on the
number of units produced times the rate assigned to the unit. Under a
differential piece rate plan, when an employee’s production exceeds a standard
amount, a higher rate is earned for all units produced.
• Ask students what they believe are the advantages to a piecework incentive plan.
1. Computing the Piece Rate—An example is given in the textbook for
2. Piecework: The Drawbacks
• As an incentive pay plan, piecework has a large potential for satisfying an
employee’s desire to earn more money. Unfortunately, piecework incentive
plans are not as prevalent as one might imagine. The reason lies with some
inherent problems with piecework plans. Problems include the following: It is
Chapter 10: Pay-for-Performance: Incentive Rewards 131
B. Standard Hour Plan
The standard hour plan is an incentive pay plan based on the time it takes to
C. Bonuses
• A bonus is an incentive payment that is supplemental to the employee’s wage.
D. Merit Pay
• Merit pay plans are possibly the most popular form of incentive pay for
managerial employees.
• Merit raises have a motivational effect on employees only when the raises are
1. Problems with Merit Raises
• Ask students if they are given merit raises for their job performance. Ask if
they recognize any problems with this pay system.
E. Incentive Awards and Recognition
• When employers wish to recognize high performing employees or employees
who make special contributions to the organization, they can make available non-
cash incentive awards.
132 Part 4: Implementing Compensation and Security
• These awards might include theater or sports tickets, clothing or jewelry,
merchandise awards, or weekend vacations.
F. Sales Incentives
• Because of the competitive nature of sales jobs, special incentive pay plans have
been developed for sales employees. These plans take into account the high
motivation these individuals must maintain and the independence inherent in their
jobs.
• Motivation is particularly important for sales employees in the field who must
exercise a high degree of self-discipline.
1. Unique Needs of Sales Incentive Plans
• Salespeople can be asked to perform a wide variety of individual tasks. For
example, they can service existing accounts, promote new products, and
2. Types of Sales Incentive Plans
There are four basic types of sales incentive plans: (a) straight salary,
(b) straight commission, (c) combination of salary and commission, and (d) sales
plus bonus plan.
a. Straight Salary Plan
• By paying salespeople a salary, the organization can compensate them for
performing duties not related to sales volume, such as customer service,
Chapter 10: Pay-for-Performance: Incentive Rewards 133
b. Straight Commission Plan
• Under a straight commission structure, compensation is a percentage of
sales. This provides maximum incentive to increase sales performance and
c. Combined Salary and Commission Plan
• This plan mixes both salary and commission and is widely used. The
percentage of commission to salary is called “leverage.” This type of
incentive plan offers several advantages:
(1) A good mix of leverage can create the most advantages of both types
d. Salary Plus Bonus Plan
• This plan pays an established salary plus a bonus for achieving targeted
V. GROUP INCENTIVE PLANS
• The hallmark of group incentive plans is that they encourage employees to work in a
cooperative rather than individualistic environment. Cooperation is particularly
important when the work of employees is interrelated or employees need to support each
other in the completion of their tasks.
A. Team Compensation
• Team incentive plans reward team members with an incentive reward when
agreed-on performance standards are met or exceeded.
134 Part 4: Implementing Compensation and Security
• When establishing team compensation, managers will follow a three-step
approach:
1. Set performance standards upon which incentive payments are given.
B. Gainsharing Incentive Plans
• The desire for improved productivity and total–quality management is the
motive for implementing gainsharing plans.
• Gainsharing plans can cover hourly, management, and executive employees.
These plans allow covered employees to receive special compensation for
1. The Scanlon Plan
• The Scanlon Plan operates through a formal structure of committees
composed of hourly and management employees. Employees communicate
their ideas and opinions for improved efficiency through these committees.
Chapter 10: Pay-for-Performance: Incentive Rewards 135
2. Improshare—When using Improshare, an organization pays a bonus based on
the overall productivity of the work group. The basis of measurement is the
3. Lessons from the Scanlon Plan and Improshare—For these plans to be a
success, management must treat employees as adults and allow them to become
VI. ENTERPRISE INCENTIVE PLANS
• One distinguishing characteristic of enterprise incentive plans is that all employees in the
organization participate in the incentive plan’s payout. The incentive bonus is based on
the success of the organization over an extended period of time. The underlying
philosophy of enterprise incentive plans is to create a feeling of ownership in the
organization, thereby fostering teamwork and cooperation among organizational
members.
A. Profit-Sharing Plans
• Plans that use profit sharing pay employees—on a current or deferred basis—
some amount of money based on organizational profits. Their purpose is to give
jobs and performance.
1. Variations in Profit-Sharing Plans
• Profit-sharing plans differ according to (1) the percentage of profits shared
with employees, and (2) the amount of shared profits each employee is to
2. Weaknesses of Profit-Sharing Plans
136 Part 4: Implementing Compensation and Security
• Weaknesses include (1) low profits resulting from factors over which
B. Stock Options
• The philosophy behind stock ownership is that by owning shares of company
stock employees will be committed to achieve organizational goals and be more
C. Employee Stock Ownership Plans (ESOPs)
There are two main types of employee stock ownership plans (ESOPs)—a stock
bonus plan and a leveraged plan. Both programs establish an ESOP trust that
D. Advantages of ESOPs
Organizations offer ESOPs for several reasons: to encourage employee pride in
organizational ownership, to take advantage of favorable federal tax provisions, and
to increase employee productivity.
1. Problems with ESOPs
VII. INCENTIVES FOR PROFESSIONAL EMPLOYEES
• Professional employees such as engineers, scientists, and lawyers can be paid on a
merit basis or given a bonus.
Chapter 10: Pay-for-Performance: Incentive Rewards 137
• A problem for professional employees is that their pay may peak unless they obtain an
administrative position. To overcome this dilemma, organizations may establish a
double-track pay program. With an administrative pay track and a parallel professional
VIII. INCENTIVES FOR EXECUTIVES
A. The Executive Pay Package
• Organizations may employ different compensation strategies to fit specific execu-
tive needs. Chief executive officers may have their compensation heavily weighted
1. Executive Base Salaries
• Market salary levels exert a substantial impact on executive base salaries.
Market salaries are determined through salary surveys conducted with
2. Executive Short-Term Incentives
• Bonuses for executives can be based on the following: (1) percentage of total
profits, (2) percentage of profits in excess of a specific return to stockholders’
investment, (3) achievement of some long-term growth plan, and (4) other
138 Part 4: Implementing Compensation and Security
3. Executive Long-Term Incentives
• One of the biggest criticisms of executive incentive plans is that they cause
executives to concentrate on yearly profits to the detriment of long-term sur-
vival and growth objectives.
4. Executive Benefits
• Executives can receive benefits similar in type to other employees. For
example, health insurance, life insurance, retirement plans, and vacations.
5. Executive Perks
• In addition to their incentive pay, executives frequently receive perquisites, or
“perks,” to emphasize their importance and status to the organization. Common
perks include country club membership, special travel and eating privileges,
financial counseling, chauffeur, and customized insurance plans.
B. Executive Compensation: Ethics and Accountability
• Executive salary surveys in magazines such as Fortune and Business Week have
Chapter 10: Pay-for-Performance: Incentive Rewards 139
C. Executive Compensation Reform
• The large amount of executive pay, along with selected abuses in this area,
have caused reform measures in executive compensation. Three of the more
ANSWERS TO END–OF-CHAPTER DISCUSSION QUESTIONS
1. Compensation specialists note a number of characteristics of successful incentive plans.
Among these are that incentive plans should be customized to the organization and
complement the organization’s culture and strategic objectives. Incentive plans should
2. Straight piecework plans are the simplest of all piecework schemes since they pay off in
direct relationship to units produced. A “piece rate” is established for each unit of output,
and total employee earnings are based on total units produced. Under a differential
piecework program, employees can earn higher rates for each unit produced only when
3. Merit raises may not serve their intended purpose when they are seen as entitlements by
employees and they bear little relationship to individual effort. Politics—awarding merit
140 Part 4: Implementing Compensation and Security
4. A straight salary plan is used for training purposes or when salespersons are to be paid
for performing various duties that are not reflected in sales volume. A straight commission
plan emphasizes total sales volume. A combination salary and commission plan can be
structured to highlight sales, service to customer needs, and organizational sales objectives.
5. The success of the Scanlon Plan and Improshare is due in large measure to the opportunity
they provide for employees to share in decisions affecting the operation of a company, as
6. The philosophy behind profit sharing is to have employees share in the success (profits) of
the organization. The intent is to give employees the opportunity to raise their income by
7. The major stimulus for the growth of ESOPs has been the federal legislation encouraging
employers to establish the plan. This legislation, in effect, has provided a federal subsidy to
employers. Employers also recognize that, if properly administered, the plans can have
motivational value. The problem with ESOPs is that the stock may not have much value when
employees attempt to sell it, because there may be no market for it. Some owners have used
the plans to overstate the value of the stock they are distributing to employees, thereby realizing
an undeserved personal gain.
Awarding Salary Increases
• The exercise will provide students with the difficult problem of evaluating the
performance of employees and granting salary increases based on those
evaluations.
HRM EXPERIENCE
Chapter 10: Pay-for-Performance: Incentive Rewards 141
performing employees will be upset when they are not rewarded based on
their merit and other employees receive increases because of personal needs
or unfavorable circumstances.
ANSWERS TO USING THE INTERNET ACTIVITIES
Internet Exercise #1, page 455
Question:
Search the Internet for “Lincoln Electric’s Incentive Management System” and collect
information on the company’s pay for performance system. How does the company compensate
employees in comparison to compensation techniques for similar companies within the industry?
Would such a system motivate you? Explain.
Answer:
Student answers will vary depending on the resources selected. Lincoln Electric is famous for its
productive and highly-skilled work force, as well as its unique compensation system, Incentive
142 Part 4: Implementing Compensation and Security
Internet Exercise #2, page 458
Question:
Visit the website of Woodward Communications Inc. (WCI) and review the company’s
employee stock ownership plan (ESOP). What advantages of shifting from a 401(k) to an ESOP
are described? What might be some of the disadvantages?
Answer:
In 1992, Woodward Communications Incorporated (WCI) became an ESOP company, and in
Chapter 10: Pay-for-Performance: Incentive Rewards 143
VIDEO CASE DISCUSSION GUIDE
This video case provides an interesting opportunity to guide students through a discussion of
what might motivate higher-level executives other than money, such as purpose, a desire to
serve, an opportunity to be creative and innovative, or a sense of contribution to the greater
good. However, it should be noted that Bright Horizons does need to offer competitive
compensation, benefits, and reasonable perks in order to attract good quality executives.
NOTES FOR END–OF-CHAPTER CASE STUDIES
Case Study 1: United States Auto Industry Back on Top … of CEO Pay
1. Discussion of this question should elicit a variety of opinions. It could be argued that if a
CEO is truly a strategist whose policies can enable a firm to earn more that it would have
earned otherwise, the high pay may be more than offset by the firm’s even higher earnings.
2. It is unlikely that many students would agree with the pay policies of Peter Drucker. Current
competition for top executive talent, plus the demands of the job, would make the practice of
3. The answer to this question may depend on how interested individuals are in reading
company financial statements particularly related to executive pay. If a shareholder is largely
satisfied with his/her financial gain than he/she may have little concern when executive pay
144 Part 4: Implementing Compensation and Security
is large. Shareholder concern, or even revolt, over high executive pay is more likely when
Case Study 2: Team-Based Incentives: Not Your Usual Office
1. Complaints noted by the representatives are typical problems found in research studies on
ineffective teams. Not all employees like working in teams and may prefer working alone or
in an environment where they either rise or fall on their own merit. Free-riders (those who
2. Students may offer various changes to improve the incentive reward program. Several of the
more obvious changes might be as follows:
a. To ensure that all teams have an equal chance to earn the maximum. If some regions are
3. When establishing teams, experience has demonstrated that it is always prudent to
involve employees both in the design and implementation of the program. Employee