Northern Arizona University
College of Business Administration

MGT 310--Human Resource Management

Ch 10: Pay-for-Performance

• Pay as a motivator--pay may fail to motivate employees, but is still the most commonly used incentive (95%)

• Reasons for incentive plans

  • Variable pay--based on level of performance (fairness or equity)

  • Shared focus--on organizational objectives; "ownership" of objectives

• Advantages (see Fig. 10.2, p. 437)--productivity gains 20%

  • Focus efforts

  • Variable costs

    • Paid only if objectives are met

  • Fosters teamwork--when based on team results

  • Distributes success--among those responsible for producing the success

  • Reward or attract top performers

• Problems

  • May fail to satisfy employee needs--Expectancy Theory

  • Poor design and implementation--what measure, equity, subjectivity...

  • Employees may have little ability to affect standards--top down

  • Performance may be out of employee's control

  • May take away intrinsic rewards!

• Characteristics of a successful plan

  • Employees must desire the plan

  • Employees must have a say in the design

  • Must be a clear connection between payments and performance

    • Goals are challenging but attainable

    • Formulas must be simple and understandable

      • Beware!--What gets measured gets done. What does not get measured...

  • Mutual trust

  • Open communication

  • Payments must be viewed as a reward earned through effort

  • Best when issued as a separate paycheck

• Measures--Keys: HRM 2, p. 440

  • Measure what is important--quality, customer satisfaction, cost control...

  • Avoid being overly quantitative

  • Guard against "ratcheting up" performance goals--employee frustration or backlash

• Administration

  • Grant incentives based on differences

  • Salary budgets must be adequate--Expectancy Theory: Will I get it?

  • Overhead costs--setting standards, record keeping, communication, resolving complaints...

• Individual plans

  • Piecework

    • Straight piecework--rate per unit

    • Differential piece rate--higher rate for all work when exceed goal

    • Problems

      • Difficult to measure in some jobs

      • Little control over output

      • Can work against culture promoting cooperation

      • "Rate busting" may provoke disapproval of others

      • Inappropriate when

        • Focus is on quality

        • Technology changes often

        • Cross-training is desired

  • Standard hour plan--predetermined "standard time" for each "job"

    • Suitable for non-repetitive jobs requiring a variety of skills

    • Incentive based on percent of time improvement

    • Problems--equipment maintenance, quality

  • Bonuses--extra pay for extra effort or meeting goals

    • Common among managers and executives (even when don't meet goals!)

    • Increasingly given throughout the organization for overall performance

    • May relate to revenue, cost reduction, quality improvement, performance

    • Spot bonus--given on the spot for extra effort (not established standard)

  • Merit pay--increase in base pay for achieving performance standard

    • Must be objective

    • Trust is critical (judgment)

    • Must be distinguished from regular pay, esp. cost-of-living increases

    • Problems

      • Measurement

      • Tend to be perpetuated as steps (automatic)

      • Often based on seniority or favoritism

      • May be offset by inflation

      • Increase may not be sufficient to be satisfactory (or only some % are eligible--equity)

      • Expectation--may not deliver if profit or economy changes

    • Lump-sum merit pay--not added to base pay; better pay/performance link

  • Incentive awards (noncash tangible) and recognition (intangible)

    • Most effective when linked to recognition!

• Sales incentives

  • Unique needs

    • Wide differences in jobs

    • New accounts vs. sustain current accounts

    • Promote new products or services

    • Customer service and assistance

    • Factors outside of employee's control

    • Size of territory

    • Income stability

  • Types of plans

    • Straight salary--may not motivate, but increasingly common

    • Straight commission--excessive motivation, focus only on sales

    • Combination plan--most common

      • Greater flexibility

      • Consider other objectives than just sales

  • VIDEO--Verizon

• Professional employees

  • Engineers, scientists, attorneys, etc.--advancement issue

    • Extended salary range

    • Dual career path

    • Profit sharing, stock ownership, bonuses

  • Executive compensation

    • Salaries--job market ("competitive benchmarking"--size, sales, industry)

    • Short-term incentives

      • Percent of profit or return on investment (quarterly)

      • Cash, stock, or retirement options

        • Stock dilution makes stock of others worth less ... decreasing shareholder value!

      • Balanced scorecard

    • Long-term incentives

      • Personal performance goals

      • Organization performance goals

      • Stock options (often given even when stock price or performance declines)

    • Perks (see HRM 4, p. 452)--often "status" oriented

    • Ethics and accountability

      • Widening gap between employees and CEOs

        • 301:1 US, 15:1 Japan, 20:1 Europe

        • Credibility of leadership

        • "Justification" (or rationalization?)

          • Reward performance (even if don't perform)

          • Job pressure (downsizing, longer work weeks...)

          • Talent demand (general labor shortage)

          • Create shareholder value (or not!)

        • Reward vs. greed

      • Reform

        • IRS--tax-code violations

        • SEC--NYSE & NASDAQ require shareholder approval for stock options or other equity compensation

        • FASB--stock options as expense

        • Other--use of more sophisticated formulas, pay package structure changes, harder to cash out options

• Group plans

  • Team compensation

    • Team performance

    • Issues

      • Social loafing

      • Individual differences

      • Fixed amount vs. percent of base pay

  • Gainsharing

    • Improved productivity, profitability, cost savings

    • Scanlon Plan--employee and management committees focused on cost reductions; share a percent of savings

    • Rucker Plan--bonus for improved productivity of production workers (value-added)

    • Improshare--bonus for improved output; share a percent of gains

    • Earnings-at-risk--portion of pay at risk, but includes reward for performance

    • Lessons learned--see HRM 5, p. 456 (similar to all other incentive pay plans)

• Enterprise plans

  • Profit-sharing--reward based on company performance (usually bonus based on profitability)

    • Engage employees in "ownership" of goals

    • May be substantial relative to base pay

    • Variations

      • Fixed amount or percent of base pay

      • Percent of profit (5-50%, most 20-25%)

      • May include seniority or merit component

      • Cash or deferred or combination

    • Weaknesses

      • Factors outside of employee control

      • Losses may occur when performance/effort is best!

      • Timing (once a year or at retirement) may reduce effectiveness as motivator

  • Stock options--right to purchase stock at guaranteed price during designated period

    • Ownership incentive

    • Links to increase in shareholder value

    • Issues

      • Executive abuses

      • Faulty accounting

      • Risk (all eggs in one basket)

  • Employee stock ownership plans (ESOPs)

    • Separate trust given shares of stock for employees or cash to buy outstanding shares for employees

    • Employees can sell when leave or retire

    • Tax deductible for organization

    • Sense of ownership for employees

    • Problems

      • Value of stock fluctuates (market, management mistakes)

      • Contributions are not guaranteed (retirement drawback)

      • Best when involve employees in organizational decision-making (ownership)