Garry Dessler Human Resource Management: Pay For Performance and Financial Incentives

CHAPTER 12
GARRY DESSLER
HUMAN RESOURCE MANAGEMENT
PAY FOR PERFORMANCE AND

FINANCIAL INCENTIVES
LEARNING OBJECTIVES:
1. Discuss the main incentives for individual employees.

2. Discuss the pros and cons of incentives for
salespeople.
3. Name and define the most popular organizationwide

variable pay plans.
4. Describe the main incentives for managers and
executives.
5. Outline the steps in developing effective incentive plans.

MOTIVATION, PERFORMANCE, AND PAY:
 Incentives
 Financial rewards paid to workers whose production
exceeds a predetermined standard.
 Frederick Taylor
 Popularized scientific management and the use of
financial incentives in the late 1800s.
 Systematic soldiering: the tendency of employees to work at the
slowest pace possible and to produce at the minimum
acceptable level.
INDIVIDUAL DIFFERENCES
 Law of individual differences

 The fact that people differ in personality, abilities, values, and
needs.
 Different people react to different incentives in different
ways.
 Managers should be aware of employee needs and fine-tune
the incentives offered to meets their needs.
 Money is not the only motivator.
NEEDS AND MOTIVATION
 Abraham Maslow’s Hierarchy of Needs
 Five increasingly higher-level needs:
 physiological (food, water, sex)
 security (a safe environment)
 social (relationships with others)
 self-esteem (a sense of personal worth)
 self-actualization (becoming the desired self)
 Lower level needs must be satisfied before higher level

needs can be addressed or become of interest to the
individual.
NEEDS AND MOTIVATION
 Herzberg’s Hygiene–Motivator theory
 Hygienes (extrinsic job factors)
Inadequate working conditions, salary, and incentive pay can cause
dissatisfaction and prevent satisfaction.
 Motivators (intrinsic job factors)
Job enrichment (challenging job, feedback and recognition)
addresses higher-level (achievement, self- actualization) needs.
 The best way to motivate someone is to organize the job
so that doing it helps satisfy the person’s higher-level
needs.
NEEDS AND MOTIVATION (CONT’D)
 Edward Deci
 Intrinsically motivated behaviors are motivated by the
underlying need for competence and self- determination.
 Offering an extrinsic reward for an intrinsically-
motivated act can conflict with the acting individual’s
internal sense of responsibility.
 Some behaviors are best motivated by job challenge
and recognition, others by financial rewards.
VROOM’S EXPECTANCY THEORY
 A person’s motivation to exert some level of effort is a function
of three things:
• Expectancy: that effort will lead to performance.
• Instrumentality: the connection between performance and the
appropriate reward.
• Valence: the value the person places on the reward.
 Motivation = E x I x V
• If any factor (E, I, or V) is zero, then there is no motivation to
work toward the reward.
• Employee confidence building and training, accurate appraisals, and
knowledge of workers’ desired rewards can increase employee
motivation.
TYPES OF INCENTIVE PLANS
 Pay-for-performance plans
 Variable pay (organizational focus)
A team or group incentive plan that ties pay to some measure of

the firm’s overall profitability.
 Variable pay (individual focus)
Any plan that ties pay to individual productivity or profitability,

usually as one-time lump payments.
TYPES OF INCENTIVE PLANS (CONT’D)
 Pay-for-performance plans
 Individual incentive/recognition programs
 Sales compensation programs
 Team/group-based variable pay programs
 Organizationwide incentive programs
 Executive incentive compensation programs

TYPES OF INCENTIVE PLANS (CONT’D)
 Piecework Plans:
The worker is paid a sum (called a piece rate) for each unit
he or she produces.
• Straight piecework: A fixed sum is paid for each unit the worker
produces under an established piece rate standard. An incentive may be
paid for exceeding the piece rate standard.
• Standard hour plan: The worker gets a premium equal to the

percent by which his or her work performance exceeds the
established standard.
PIECEWORK PLANS:
 Pro and cons of piecework plans:

 Easily understandable, equitable, and powerful incentives
 Employee resistance to changes in standards or work
processes affecting output
 Quality problems caused by an overriding output focus
 Possibility of violating minimum wage standards
 Employee dissatisfaction when incentives either cannot
be earned due to external factors or are withdrawn due to
a lack of need for output.
INDIVIDUAL INCENTIVE PLANS (CONT’D)
 Merit pay
A permanent cumulative salary increase the firm awards to
an individual employee based on his or her individual
performance.
 Merit pay options
 Annual lump-sum merit raises that do not make the
raise part of an employee’s base salary.
 Merit awards tied to both individual and organizational
performance.
 Incentives for professional employees
 Professional employees are those whose work involves the
application of learned knowledge to the solution of the employer’s
problems.
 Lawyers, doctors, economists, and engineers.
 Possible incentives
 Bonuses, stock options and grants, profit sharing
 Better vacations, more flexible work hours
 improved pension plans
 Equipment for home offices
RECOGNITION-BASED AWARDS
 Recognition has a positive impact on performance, either

alone or in conjunction with financial rewards.
Combining financial rewards with nonfinancial ones produced
performance improvement in service firms almost twice the
effect of using each reward alone.
 Day-to-day recognition from supervisors, peers, and
team members is important.
 Online award programs
 Programs offered by online incentives firms that improve and
expedite the awards process.
• Broader range of awards
• More immediate rewards
 Information technology and incentives

 Enterprise incentive management (EIM)
• Software that automates the planning, calculation, modeling and
management of incentive compensation plans, enabling
companies to align their employees with corporate strategy and
goals.
 Salary plan
 Straight salaries
• Best for: prospecting (finding new clients), account servicing, training
customer’s salesforce, or participating in national and local trade shows.
 Commission plan
 Pay is only a percentage of sales
• Keeps sales costs proportionate to sales revenues.
• May cause a neglect of nonselling duties.
• Can create wide variation in salesperson’s income.
• Likelihood of sales success may linked to external factors rather than to
salesperson’s performance.
• Can increase turnover of salespeople.
 Combination plan
• Pay is a combination of salary and commissions, usually
with a sizable salary component.
• Plan gives salespeople a floor (safety net) to their
earnings.
• Salary component covers company-specified
service activities.
• Plans tend to become complicated, and
misunderstandings can result.
 Commission-plus-drawing-account plan
 Commissions are paid but a draw on future earnings helps
the salesperson to get through low sales periods.
 Commission-plus-bonus plan
 Pay is mostly based on commissions.
 Small bonuses are paid for directed activities like selling
slow-moving items.
 Team or group incentive plan
 A plan in which a production standard is set for a specific work
group, and its members are paid incentives if the group exceeds the
production standard.
 Set individual work standards

 Set work standards for each team member and then calculate each member’s
output.
 Members are paid based on one of three formulas:
• All members receive the same pay earned by the highest
producer.
• All members receive the same pay earned by the lowest producer.
• All members receive same pay equal to the average pay
earned by the group.
 Use an engineered production standard based on the

output of the group as a whole.
 All members receive the same pay, based on the piece rate for
the group’s job.
• This group incentive can use the piece rate or standard hour plan, but
the latter is more prevalent.
 Tie rewards to goals based on an overall standard of
group performance
 If the firm reaches its goal, the employees share in a percentage
of the improvement (in labor costs saved).
 Profit-sharing plans
 Cash plans
• Employees receive cash shares of the firm’s profits at
regular intervals.
 The Lincoln incentive system
• Profits are distributed to employees based on
their individual merit rating.
 Deferred profit-sharing plans
• A predetermined portion of profits is placed in each
employee’s account under a trustee’s supervision.
 Employee stock ownership plan (ESOP)
 A corporation annually contributes its own stock— or cash (with a limit of

15% of compensation) to be used to purchase the stock—to a trust
established for the employees.
 The trust holds the stock in individual employee accounts and

distributes it to employees upon separation from the firm if the
employee has worked long enough to earn ownership of the stock.
ADVANTAGES OF ESOPS
 Employees
 ESOPs help employees develop a sense of ownership in and
commitment to the firm, and help to build teamwork.
 No taxes on ESOPs are due until employees receive a distribution from
the trust, usually at retirement when their tax rate is lower.
 Shareholders of closely held corporations

 Helps to diversify their assets by placing their shares of company stock
into an ESOP trust and allowing them to purchase other marketable
securities for themselves in their place.
SCANLON PLAN
 Scanlon plan (Joseph Scanlon, 1937)
 Philosophy of cooperation:
No "us” and “them” attitude that inhibit employees from developing a
sense of ownership in the company.
 Identity:
Employees understand the business’s mission and how it operates in terms
of customers, prices, and costs.
 Competence:
The plan depends a high level of competence from employees at all
levels.
 Sharing of benefits formula: Employees share in 75% of the
savings (reduction in payroll expenses divided by total sales).
GAINSHARING PLANS
 Gainsharing
 An incentive plan that engages many or all
employees in a common effort to achieve a
company’s productivity objectives.
 Cost-savings gains are shared among
employees and the company.
 Rucker plan
 Improshare
IMPLEMENTING A GAINSHARING PLAN
1. Establish general plan objectives.
2. Choose specific performance measures.
3. Decide on a funding formula.
4. Decide on a method for dividing and distributing the
employees’ share of the gains.
5. Choose the form of payment.
6. Decide how often to pay bonuses.
7. Develop the involvement system.
8. Implement the plan.
AT-RISK VARIABLE PAY PLANS
 At-risk variable pay plans that put some portion of the
employee’s weekly pay at risk.
 If employees meet or exceed their goals, they earn incentives.
 If they fail to meet their goals, they forgo some of the pay they
would normally have earned.
 Annual bonus
 Plans that are designed to motivate short-term performance of
managers and are tied to company profitability.
• Eligibility basis: job level, base salary, and impact on profitability
• Fund size basis : nondeductible formula (net income) or deductible
formula (profitability)
• Individual awards: personal performance/contribution
MULTIPLIER APPROACH TO
DETERMINING ANNUAL
BONUS
Note: To determine the dollar amount of a manager’s award, multiply the

maximum possible (target) bonus by the appropriate factor in the
matrix.
LONG-TERM INCENTIVES FOR MANAGERS AND
EXECUTIVES
 Stock option
 The right to purchase a specific number of shares of
company stock at a specific price during a specific period
of time.
• Nonqualified stock option
• Indexed option
• Premium priced option
 Options have no value (go ―underwater) if the price of
the stock drops below the option’s strike price (the
option’s stock purchase price).
LONG-TERM INCENTIVES FOR MANAGERS
AND EXECUTIVES (CONT’D)
 Other plans
• Key employee program
• Stock appreciation rights
• Performance achievement plan
• Restricted stock plans
• Phantom stock plans
 Performance plans
Plans whose payment or value is contingent on financial
performance measured against objectives set at the start of a
multi-year period.
OTHER EXECUTIVE INCENTIVES
 Golden parachutes
 Payments companies make to departing executives
in connection with a change in ownership or control
of a company.
 Guaranteed loans to directors
 Loans provided to buy company stock.
 A highly risky and now frowned upon practice.

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CHAPTER 12

PAY FOR PERFORMANCE AND

1. Discuss the main incentives for individual employees.

3. Name and define the most popular organization- wide

5. Outline the steps in developing effective incentive plans.

 Law of individual differences

 security (a safe environment)

 social (relationships with others)

 self-esteem (a sense of personal worth)

 self-actualization (becoming the desired self)

 Lower level needs must be satisfied before higher level

A team or group incentive plan that ties pay to some measure of

 Variable pay (individual focus)

Any plan that ties pay to individual productivity or profitability,

 Sales compensation programs

 Team/group-based variable pay programs

 Organizationwide incentive programs

 Executive incentive compensation programs

• Standard hour plan: The worker gets a premium equal to the

 Pro and cons of piecework plans:

 Recognition has a positive impact on performance, either

 Information technology and incentives

 Set individual work standards

 Use an engineered production standard based on the

 Employee stock ownership plan (ESOP)

 A corporation annually contributes its own stock— or cash (with a limit of

 The trust holds the stock in individual employee accounts and

 Shareholders of closely held corporations

Note: To determine the dollar amount of a manager’s award, multiply the

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