Module lll

Performance Management

Performance management is a corporate management tool that helps managers monitor and
evaluate employees' work. Performance management's goal is to create an environment where
people can perform to the best of their abilities and produce the highest-quality work most
efficiently and effectively.

• Performance management tools help people to perform to the best of their abilities and
produce the highest-quality work most efficiently and effectively.
• The precept of performance management is to view individuals in the context of the
broader workplace system.
• Performance management focuses on accountability and transparency and fosters a clear
understanding of expectations.

Performance-Management Programs

• Aligning employees' activities with the company's mission and goals. Employees
should understand how their goals contribute to the company's overall achievements.
• Developing specific job-performance outcomes. What goods or services does my job
produce? What effect should my work have on the company? How should I interact with
clients, colleagues, and supervisors? What procedures does my job entail?
• Creating measurable performance-based expectations. Employees should give input
into how success is measured. Expectations include results—the goods and services an
employee produces; actions—the processes an employee uses to make a product or
perform a service; and behaviors—the demeanor and values an employee demonstrates
at work.
• Defining job-development plans. Supervisors and employees together should define a
job's duties. Employees should have a say in what types of new things they learn and
how they can use their knowledge to the company's benefit.
• Meeting regularly. Instead of waiting for an annual appraisal, managers and employees
should engage actively year-round to evaluate progress.

The Performance Management Cycle

The performance management process or cycle is a series of five key steps. These steps are
imperative, regardless of how often you review employee performance.

1. Planning

This stage entails setting employees’ goals and communicating these goals with them.
While these goals should be disclosed in the job description to attract quality candidates,
they should be communicated once again when the candidate becomes a new hire.
Depending on the performance management process in your organization, you may want to
assign a percentage to each of these goals to be able to evaluate their achievement.
 2. Monitoring

In this phase, managers are required to monitor the employees performance on the goal.
This is where continuous performance management comes into the picture. With the right
performance management software, you can track your teams performance in real-time and
modify and correct course whenever required.

3. Developing

This phase includes using the data obtained during the monitoring phase to improve the
performance of employees. It may require suggesting refresher courses, providing an
assignment that helps them improve their knowledge and performance on the job, or altering
the course of employee development to enhance performance or sustain excellence.

4. Rating

Each employees performance must be rated periodically and then at the time of the
performance appraisal. Ratings are essential to identify the state of employee performance
and implement changes accordingly. Both peers and managers can provide these ratings for
360-degree feedback.

5. Rewarding

Recognizing and rewarding good performance is essential to the performance management

process, as well as an important part of employee engagementOpens a new window. You
can do this with a simple thank you, social recognition, or a full-scale employee rewards
program that regularly recognizes and rewards excellent performance in the organization.

Performance appraisal

A performance appraisal is a systematic and periodic process of measuring an individual’s work

performance against the established requirements of the job. It’s a subjective evaluation of the
employee’s strengths and weaknesses, relative worth to the organization, and future
development potential.

Performance appraisals are also called performance evaluations, performance reviews,

development discussions, or employee appraisals.

The term “performance appraisal” refers to the regular review of an employee’s job
performance and overall contribution to a company. Also known as an annual review,
performance review or evaluation, or employee appraisal, a performance appraisal evaluates an
employee’s skills, achievements, and growth, or lack thereof.
Companies use performance appraisals to give employees big-picture feedback on their work
and to justify pay increases and bonuses, as well as termination decisions. They can be
conducted at any given time but tend to be annual, semiannual, or quarterly.

Types of Performance Appraisals

Most performance appraisals are top-down, meaning that supervisors evaluate their staff with
no input from the subject. But there are other types:

• Self-assessment: Individuals rate their job performance and behavior.

• Peer assessment: An individual’s work group or co-workers rate their performance.
• 360-degree feedback assessment: Includes input from an individual, supervisor, and
peers.
• Negotiated appraisal: This newer trend utilizes a mediator and attempts to moderate the
adversarial nature of performance evaluations by allowing the subject to present first. It
also focuses on what the individual is doing right before any criticism is given. This
structure tends to be useful during conflicts between subordinates and supervisors.

Meaning of reward schemes

A broad definition of reward schemes is provided by Bratton:

‘Reward system refers to all the monetary, non-monetary and psychological payments that an
organisation provides for its employees in exchange for the work they perform.’

Rewards schemes may include extrinsic and intrinsic rewards. Extrinsic rewards are items such
as financial payments and working conditions that the employee receives as part of the job.
Intrinsic rewards relate to satisfaction that is derived from actually performing the job such as
personal fulfilment, and a sense of contributing something to society. Many people who work for
charities, for example, work for much lower salaries than they might achieve if they worked for
commercial organisations. In doing so, they are exchanging extrinsic rewards for the intrinsic
reward of doing something that they believe is good for society.

Types of reward scheme

Base pay Base pay, or basic pay, is the minimum amount that an employee receives for working
for an organisation. For example, the employee may be paid $10 per hour for a minimum of 40
hours per week. The employee will therefore earn at least $400 per week. This will be paid
regardless of how many of those 40 hours the employee is actually working. A fixed annual
salary is another example of basic pay.
Basic pay may be supplemented by other types of remuneration. A blue collar worker may be
paid overtime for example if he works more than 40 hours per week, and a manager may receive
some form of performance pay in addition to the base pay. Basic pay is likely to address the
lower levels of Maslow’s hierarchy of needs mentioned above.

Performance-related pay Performance-related pay is a generic term for reward systems where
payments are made based on the performance, either of the individual (individual performance-
related pay) or a team of employees (group performance-related schemes).

In recent decades there has been a move toward performance-related pay schemes in many
organisations. This has lead to a situation where a higher portion of the employees pay is
dependent on performance. This rationale for performance-related pay is that it motivates
employees to work harder, and rewards those who make a greater contribution to the
organisation’s goals. This should lead to efficiency savings. There are many types of
performance-related pay, and the most popular ones are described below:

1. Piecework schemes

Under Piecework schemes, a price is paid for each unit of output. Piecework schemes are the
oldest form of performance pay, and were used for example in the textile industries in Great
Britain during the industrial revolution. Piecework schemes are appropriate where output can be
measured easily in units. They are typically used for paying freelance, creative people. Freelance
writers for example are often paid based on the number of words.

The benefit of piecework schemes is their inherent fairness. The higher the output, the more the
employee (or subcontractor) receives. From the employer’s perspective, the employer does not
have to pay for idle time or inefficiencies.

From the employee’s perspective, such schemes mean that the employee bears commercial risk if
demand for their product falls.

A further disadvantage of piecework schemes is that the payment is not based on the quality of
output. However, some sort of quality control is likely, and if the quality is not of a required
standard, the employee or subcontractor will not be paid.

2. Individual performance-related pay schemes

Individual performance-related pay schemes are where the employee receives either a bonus, or
an increase in base pay on meeting previously agreed objectives or based on assessment by their
manager, or both. They are typically used for middle managers in private sector organisations
and for professional staff.
The advocates of individual performance-related pay schemes claim that their they are an
obvious way to align to objectives of middle managers with the goals of the organisation. If
performance targets set are based on the goals of the organisation, then it appears obvious that
making part of the rewards of employees’ contingent on achieving those targets will mean that
employees are motivated to achieve the goals of the organisation.

Individual performance-related schemes also have the advantage over group schemes that the
employee has control over her rewards, as they do not depend on the effort (or lack of) of other
members of the team.

Critics of such schemes point out that the link between rewards and motivation is far from clear,
as discussed above. It is also argued that performance-related schemes lead a situation of tunnel
vision whereby if something is not measured, and then rewarded, it won’t get done.

Individual reward schemes may lead to a lack of teamwork and may lead to variances in pay
among individuals, which can lead to ill feeling.

An example of an individual performance-related pay scheme is one that is operated by a UK

bank. Under the scheme, a bonus pool is allocated to each region based on the performance of
that region. From this pool, individual awards are made based on assessment of performance,
taking into account the rating on a five-point scale. Those with scores of 1 to 3 qualify for a
discretionary bonus. The assessment depends on how much new business the individuals have
brought in, or how much efficiency savings they have generated. The rewards are usually paid in
cash, although for senior employees receive a portion as deferred stock.

3. Group-related performance-related pay schemes

Group-related performance-related schemes are similar to individual, in that rewards are paid
based on the achievement of targets. However the targets are set for a group of employees, such
as a particular department, or branch of a company, rather than for an individual. Since the
rewards apply to a group, they are likely to be based on a pre-determined quantitative formula,
rather than on assessment of staff.

A bonus pool is calculated based on the performance of the team, and this is shared among the
members of the team. Bonuses may be paid up at the end of the year, or may be deferred, and
paid at a later date, as this may encourage staff and managers to take a longer term view, rather
than simply focusing on the current year’s bonus.

The advantage claimed for group schemes is that they encourage teamwork. The disadvantage is
that the lazier members of the team benefit from the hard work of the more dedicated.
Hope and Fraser give the example of a scheme operated by Svenska Handelsbanken, where each
year, a portion of the banks profits are paid to a profit sharing pool for employees, provided that
certain conditions are made. The main conditions are that the Handelsbanken Group must have a
higher return on shareholder’s equity than the average of its peer group. The upper limit of the
amount paid into the scheme is 25% of the total dividends paid to shareholders. Employees do
not actually receive anything from the pool until they reach the age of 60, at which point they
receive a pay out based on the number of years that they have worked for the bank. The CEO of
Handlesbanken claimed that employees are not motivated by financial targets, but by the
challenge of beating the competition. The reward scheme is designed to be a dividend on their
intellectual capital.

4. Knowledge contingent pay

Knowledge contingent pay is where an employee will receive a pay rise or a bonus, or both, for
work-related learning. An ACCA candidate, for example, may receive a higher salary once he
has passed all the knowledge level papers, and an even higher salary after passing all of his
exams.

5. Commissions

Commissions are a form of remuneration normally used for sales staff. The staff may receive a
low basic pay, but will then receive commission, based on a percentage of the amount of their
sales.

The advantages of commission are that they should motivate sales staff to achieve higher sales,
as their rewards depend on it, and they mean that the large part of the salesman’s salary becomes
variable. If sales are low, the organisation will have to pay less.

The disadvantage of commission is that it may lead to dysfunctional behaviour. Sales staff may
indulge in window dressing, for example to meet this years sales target, by selling on a ‘sale and
return basis’ in the final month of the year, with the inherent understanding that the goods will be
returned in the following month of next year. They may also lead to short termism, where sales
staff ‘never put the customer above the sales target’ to quote Hope and Fraser.

6. Profit-related pay

Profit-related pay is a type of group performance-related pay scheme where a part of the
employee’s remuneration is linked to the profits of the organisation. If the company’s profits hit
a pre-determined threshold, a bonus will be paid to all members of the scheme. Typically the
bonus will be a percentage of the basic pay. The bonus may be paid during the year in question;
for example, quarterly, or it may be deferred until some later date, such as the retirement of the
staff.
Advocates of profit-related pay argue that it motivates employees to become more interested in
the overall profitability and therefore become more motivated to ‘do their bit’ to improve it. It
may also encourage loyalty in cases where staff may lose their bonus if leaving the organisation
means that they lose the right to it.

The obvious disadvantage with profit-related pay is that it does not match the primary objective
of commercial organisations, which is to maximise the wealth of the shareholders. Managers
may be motivated to increase profits by taking short-term actions that will harm the business in
the long run, for example, or destroy wealth by investing in projects that increase the profits of
the organisation, but produce a return that is below the cost of capital of the organisation.

Profit-related pay might not be a motivator for junior employees, who may fail to see the link
between their effort and the overall profits of the organisation.

7. Stock option plans

Stock option plans have become very popular since the 1990s, when greater emphasis started to
be given to shareholder value. Under stock option plans, staff receive the right to buy shares in
their company at a certain date in the future, at a price agreed today.

For example, Alpha Co is listed on the stock exchange of Homeland. Today, shares in Alpha Co
are trading at $100 each. The company has just awarded the CEO of Alpha Co the option to buy
1 million shares for $100 each in exactly ten years time. These options have no intrinsic value at
the granting date.

If the share price rises to say $200 in 10 years time, the CEO could exercise his options, buying 1
million shares at a price of $100 each. Since the shares would be worth $200 each by then the
CEO would make a gain of $100 per share, or $100m in total.

Stock option plans are most appropriate for the senior management of organisations as they are
the people who have the most influence over its share price. The rational for using stock option
plans is that they align the objectives of the directors with the objectives of shareholders. If the
share price rises, the senior management benefit because their options increase in value. Thus
senior managers will start to think like investors.

The big weakness of stock option plans is that share prices may depend on external factors as
much as on the performance of the directors. During the bull markets of the 1990s and 2000s,
many companies share prices rose simply because the market rose.

Another weakness is risk misalignment. Share options reward managers if the share price goes
up. If the share price falls, however, there is no difference in reward between the share price
remaining the same ($100) and falling to ($1) – so managers may be motivated to take extreme
risks where the exercise price may not be met.

What shareholders really want is the performance of their company to be better than the market.
One solution to this is to use an indexed exercise price, where the price at which the director can
buy the shares is equal to the current market price, plus the increase in the stock market index
between the date that the options are issued, and the exercise date. This means that the share
option reflects the controllability principle more closely, as directors would not be rewarded for
rises in the stock market in general.

Pension schemes

Defined benefit pension schemes used to be a popular form of reward. Under such schemes, the
employee pays a pension to former employees based on their final salary, and the number of
years that the employee worked for the organisation. A typical example is that the former
employee receives 1/60ths of their final salary for every year of service. An employee who
works for 40 years for the same organisation would therefore receive a pension equal to 40/60ths
of their final salary from the date of retirement to the date of death.

Defined benefit schemes leave organisations with an uncertain, often large liability, and for this
reason, many organisations have now discontinued such schemes.

Defined contribution schemes are another form of pension scheme where the employer pays a
certain percentage of the employee’s salary into an account for the employee in a pension ‘pot.’
The employee may also have the option of making additional voluntary contributions into this
pension pot. The pension pot is then invested, and the employee receives whatever is in their
account on retirement. In some countries, employees may be required to use what is in the pot to
buy an annuity, which pays them a fixed income for the rest of their lives.

Many countries offer tax incentives for such pension schemes, such as allowing employees to
reduce their taxable income by the value of contributions made to the schemes.

Benefits in kind

Benefits in kind (or indirect pay) are paid to employees in addition to their base salary and
performance-related pay. Benefits in kind include items such as health insurance and meal
vouchers. They are usually provided to more junior staff in order to provide additional incentives
at a lower cost. They are often used as a form of recognition, so the employee of the month for
example will be given a benefit rather than a cash payment.
The advantage of benefits in kind is that greater flexibility can be given in designing a reward
scheme for an individual.

‘Cafeteria’ schemes have also become popular, whereby employees are told that they may select
benefits from a menu up to a certain value. The advantage of this is that employees will select
the benefits that they value most. Benefits from which the employees can choose typically
include such items as health insurance, holiday vouchers, company cars or sports vouchers.

Cafeteria schemes may be difficult to administer. Staff may also find them complex to
understand, as they will have to select a number of benefits that have a value that is within the
agreed limit.

The role of appraisal in reward systems

Many of the performance-related reward schemes depend on the performance of the employees.
As such, the employees’ performance has to be assessed. This usually takes place during the
appraisal process. Staff will be assessed on a regular basis, for example twice a year. During the
appraisal, targets will be set for the next period, and rewards agreed if the targets are met.

Conclusion

A good reward system aims to motivate employees to work harder, and align their goals with
those of the organisation they work for. The current trend towards performance-related reward
systems is designed to lead to greater rewards and motivation for those who contribute the most.
However, designing such reward systems is complex, as they aim to influence human behaviour.
As the human resources director of Flowpack Engineering said (quoted in Bratton) ‘There is no
such thing as a good pay system; there is only a series of bad ones. The trick is to choose the
least bad one.’

Approaches to Reward Performance

There are three major approaches as given here:

1. Bargaining Approach:
For a long, within the HR scenario, whatever the employees required to get some consideration
or wages that were the mutual rate towards the compensation structure. The capitalist and
workers have been mutually determine the considerable amount between them. So it was the
long back approach which determine the compensation based on bargaining capacity of workers
with their employees.
2. Traditional Approach:
This approach compensates employees through job based pay system. It is based on the
analytical study as well as job evaluation of a particularly job and its design. It is determine the
relative worth and technological factors concerning of jobs or a specified job.
3. Contemporary Compensation Approach:
This approach has more emphasise on skill, efficiencies and competencies which are worthwhile
aspect to determine the compensation and rewards. Today, within HR scenario, there is need to
promote and accommodate most skilled and knowledgeable employees. The employees can
influence their compensation through their efficient performance.

Definition of Incentive
Incentive in simple terms is something that encourages a person or organization to do or achieve
something. It is something that incites or has a tendency to incite a determination. This is usually
given in cash or in kind.

In business, the objective of incentive is to increase employee productivity, improve industrial

and interpersonal relations, and as result increase the overall profit of the organization.

Types of Incentives
Incentives can be generally classified as financial (monetary) incentives and non-financial (non-
monetary) incentives.

1. Financial (Monetary) Incentives

Financial incentive pertains to those incentives which are in the form of money or can be
measured in monetary terms. This is sometimes referred to as monetary benefit offered to
consumers, employees, and organizations to encourage behavior or actions which otherwise
would not take place.
These incentives can be given on an individual or group basis and satisfy the monetary and
future security needs of individuals. It lifts the eagerness and self-confidence of the employees
thus, resulting in better productivity and performance.

The most commonly used financial incentives are:

Pay and allowance salary is the basic incentive given to every employee to work efficiently and
effectively in an organization. This includes the basic pay, dearness allowance, clothing
allowances, house rent allowances, and other similar allowances. It is paid most commonly
monthly.
Typically, employees are given annual increments in their basic pay and allowances depending
on the employee’s performance during the year.
• Bonus
It is a sum of money added to the basic salary or wages on a seasonal basis, as a reward for a
good performance. Many companies offer bonuses during the festivals of Diwali, Christmas,
New Year, etc.

• Productivity linked Wage Incentives

This refers to performance-linked compensation given to increase productivity. Wage incentives
are offered to employees to make them perform beyond the accepted standards.

For example, a manufacturing worker is paid 50 dollars per item if he produces 50 items a day
but if he produces more than 50 items a day, he is paid 5 dollars extra per item. Thus, on the 51st
item, he will receive 55 dollars.

• Profit-Sharing
It is an incentivized compensation program in which an employee receives a direct share of the
company’s profits. The amount granted is normally based on the company’s positive earnings
over a set period. This motivates them to perform efficiently and give their best to increase the
company’s profits.

• Retirement benefits
Retirement benefits like gratuity, pension, provident fund, leave encashment, etc. provide
financial security to the employees upon retiring from the company Hence, they work properly
during their term of service.

Thinking about your own retirement planning? Read the free guide on how to be a smart
investor.
• Commission
Some companies offer a commission on top of the employee’s salary for successfully hitting
targets over a set period. This incentive motivates the employees to increase the client base of the
organization.

• Perquisites
Several organizations offer perquisites and fringe benefits such as free accommodation, medical,
educational, and recreational facilities, car allowances, etc. in addition to the salary and
allowances to their employees. Sometimes, this incidental payment, benefit, or privilege is
enjoyed as a result of one’s position.

• Co-partnership/Stock Option
Under this incentive system, employees are offered shares at a price that is lower than the market
price. This practice helps in creating a feeling of ownership among employees and motivates
them to give their all-out contribution towards organizational growth and success.
 2. Non-Financial (Non-Monetary) Incentives

These are types of rewards that do not form part of an employee’s pay or cannot be measured in
terms of money.

While the monetary and future security needs are important, the fulfillment of an individual’s
social, psychological, and emotional needs also plays an important role.

• Status
It is one’s social or professional position. In an organization, this refers to the position in the
hierarchy of the organizational chart. Management-level employees have more authority,
responsibility, recognition, salary, etc., than those of the rank-and-file employees.

The level of authority and responsibility determine the status of an employee in an organization.
Status increases the self-esteem, confidence, and psychological needs of an individual resulting
in a motivated attitude at work.

• Organizational Climate
Organizational climate refers to the environmental characteristics of an organization as perceived
by its employees. It conveys the impression that people have towards the internal environment of
the company within which they work and have a key influence on their performance.

This differs from one organization to another. Several factors may influence the organizational
climate of a company, such as organizational structure, individual responsibility, risk and risk-
taking, warmth, and support within the company, its tolerance and conflict, and more. A positive
organizational climate tends to increase the efficiency of employees at work.

• Career Advancement Opportunity

Organizations have to establish the appropriate skill and career development programs, and even
a sound promotion policy for their employees, that serves as a booster for them to perform well
and get promoted. Upward progress in one’s career, such as promotion, shows recognition and
appreciation of an employee’s work, motivating him to do better.
• Job Enrichment
It refers to the designing of jobs in such a way that it involves challenging and variety of tasks,
requiring a higher level of knowledge and skill, more autonomy and responsibility, and more
growth opportunities and thus, could also increase employees’ pay. Sometimes, when the job
itself is interesting, it already serves as a good source of motivation.

• Job Security
Job security offers future stability and a sense of security among the employees in an
organization. Not having to worry about the future gives a sense of enthusiasm at work. While
there is an undesirable aspect of this incentive, like employees taking their jobs for granted, the
increasing rate of unemployment in our country makes this a great work incentive.
• Employee Recognition Programs
The organization adopts this to raise employee morale, attract and retain key employees, elevate
productivity within an organization, and increase competitiveness. This pertains to employers’
initiatives to reward their employees for achievements, new behaviors, anniversaries, and
milestones unlocked during their stay in the company.

For example, rewarding the best performer of the month, and announcing and displaying their
names on the notice boards, are programs for employee recognition.

• Employee Participation and Empowerment

This refers to the employee’s involvement in decision making on the matters related to them
(participation) inducing a sense of belongingness and giving them more autonomy and powers to
subordinates (empowerment) to make them feel the importance of their presence and service to
the organization.

Essentials - Incentives

1. Increases productivity

Everyone knows that productivity is essential to ensuring your company’s success. Productivity
drives business, so what drives your employees? Incentives are a great way to ensure that your
employees stay motivated to do their job to the best of their ability. By offering something they
can achieve if they hit a certain target or achieve something, they have something to work
towards.

2. Decreased Employee Turnover

Giving incentives to your employees not only motivates them to do their work, but it can also
motivate them to stay longer at the business. Having these perks might be the reason they choose
to stay at your company, instead of looking elsewhere.

3. Happy Employees

Not only are incentives great for your company they are also great for your employee’s
happiness and wellbeing. Allowing them to blow off steam or win prizes is a great way to ensure
they are happy working for the company.

4. Help attract new talent

According to Glassdoor, incentives do attract talent, with 57% of candidates reporting it as one
of their top considerations before accepting a job. To attract top candidates, you need to stand out
from the competition and offering unique incentive schemes could do just that. It could be the
reason a candidate chooses your company over another one.
 5. Team Culture

It has been found that productivity improves by 20-25% in organizations with connected
employees. If you are offering incentive trips or things that multiple people will be able to win or
attend, then it can help with team bonding and strengthen the relationships between your
employees.

Problems Arising out of Incentives

The following problems are bound to arise while implementing an incentive plan:

• Quality of work may suffer: The workers, those in the production department in particular,
may give undue importance to the quantity of output produced neglecting the quality of output.
Such a problem can be overcome only if the organization has a perfect system of quality control.
• Inter-personnel relationships may suffer: Only those employees who are really efficient will
be benefited out of incentives. This may promote ill-feelings among the employees of an
organization.
• Wear and tear of machines may be more: As the employees are keen on increasing the output
all the time, they may handle the machines carelessly. This increases the wear and tear of
machines.
• Health of the workers may get affected: Some workers tend to overwork in order to earn more
and this may affect their health.
• Increase in accidents: There is always a preference to step up output disregarding even safety
regulations and this may increase the rate of accidents in the workplace.
• Increase in paper work: Proper administration of any incentive scheme involves lot of paper
work. It necessitates the maintenance of proper records and books

limitations - Incentives

Stock Based Compensation

Stock compensation is a way corporations use stock options to reward employees. Employees
with stock options need to know whether their stock is vested and will retain its full value even
if they are no longer employed with that company. Because tax consequences depend on the fair
market value (FMV) of the stock, if the stock is subject to tax withholding, the tax must be paid
in cash, even if the employee was paid by equity compensation.

Stock-based compensation, sometimes known as equity or share-based compensation, is a

practice in which companies supplement employees’ cash compensation (salary and bonuses)
with shares of ownership in the business. It’s most commonly awarded to employees in the form
of stock options or restricted stock.

One reason that companies offer stock-based compensation is to correct what’s called the
“principal/agent problem.” Simply stated, a company’s employees (the “agents”) may not have
the same incentives as the owners (the “principals”). If someone is both the owner and the
manager of a business, they tend to be careful with expenses—they economize by flying coach
instead of first class, for example, or they maintain a simple office instead of an expensively
furnished one.

When the manager of a company is not also the owner, they have an incentive to make decisions
that benefit themselves at the expense of the owners—they fly first class or maintain expensive
offices. Giving employees stock-based compensation is an attempt to make them part-owners of
the company and align their interests with the other owners.

Another reason, especially for small tech-based startups, is to avoid paying out cash. For many
small companies, cash may be exceptionally tight, and paying employees in the form of stock
offers payment tomorrow for work today. This can cut expenses for the company in the short-
term and be exceptionally profitable for the employee in the long-term—think about stories of
the Google janitor now worth millions, for example. If the company does poorly, this isn’t the
case.

Stock Based Compensation - Types

Some companies base their stock compensation on specific performance metrics while others
may offer certain tax advantages. Each type of stock compensation has its own advantages and
considerations. Here are the different types of stock compensation a company may offer
employees:

Stock options

With stock options, companies allow employees to purchase shares of the companies' stocks at a
predetermined price, also known as the strike or exercise price, for a set number of years. Stock
options often require employees to remain with the company during vesting before they can
exercise the options. When the option vests, the employee receives the full right to sell the option
if they choose.

Stock options don't offer employees the same rights as shareholders but may offer certain
advantages. For example, if the company is financially performing well, the exercise price might
be lower than its fair market value, meaning the employee can buy the stock at a lower price and
sell at a higher price, providing significant financial benefit depending on how quickly the stock
price rises. Stock options may also offer tax benefits and ease the process of starting a savings
plan.

Non-qualified stock options (NSOs)

A non-qualified stock option (NSO) is a stock option that requires the payment of income tax on
the exercise price, or the price paid to the company per share, subtracted by the price of the
exercised option. They also offer the tax advantage of not having to report when the option
becomes exercisable. These stock options have a price similar to the market value of the shares
when the company makes them available. While employees still have to pay income tax, they
may be able to acquire the stock at a significant discount.

Some companies may have clawback provisions, which are provisions that allow the company to
reclaim the NSO for a certain reason, such as in the case of a buyout or bankruptcy. In some
cases, a company may also use a clawback when an employee leaves the company before a
predetermined date. This can prevent an employee from leaving a company prematurely.

Incentive stock options (ISOs)

An incentive stock option (ISO) is a special stock option that's only available to employees and
provides them with certain tax advantages, such as preventing the employee from having to pay
taxes on the shares when purchasing them. It may also qualify employees for a lower tax rate,
reducing their overall burden because the government typically taxes them at a capital gains rate,
rather than the rate for ordinary income. Companies normally award this type of stock
compensation to high-performing employees the company wants to retain long term.

Publicly traded companies most often offer ISOs, as well as privately owned companies that are
planning on becoming public in the future. This can be a way to attract talented professionals,
which is similar to other benefits, and can be a powerful incentive for high-performing
employees. Like an NSO, ISOs may be subject to clawback provisions and require employees to
hold the stock for longer than a year in order to qualify for a decreased tax rate.

Performance shares

Performance shares are special shares that a company may award to corporate managers and
executives if they meet certain performance criteria. Companies often offer performance shares
in the form of stock options and bonuses in order to prioritize business activities that positively
impact shareholder value and overall productivity. Managers often receive this type of
compensation for meeting specific targets, such as earnings per share (EPS) or return on equity
(ROI) targets.

Performance shares are often highly dependent on a company's performance. In some cases, a
company may only issue performance shares if its stock meets or exceeds a certain value.
Companies may also structure performance shares based on different accounting measures that
measure how well the company is financially performing, such as cash flow or return on capital.

Restricted stock

Restricted stock includes shares of a company's stock that require the completion of a vesting
period. The company may require vesting in any way they find suitable. While the company
restricts the employee from selling the stock, they may enjoy the benefits of the stock ownership,
such as dividends. Like other stock compensation, the employee forfeits their right to the stock if
they leave the company prematurely. Employees pay taxes on the number of shares received on
the vesting date, based on the stock's closing market value.
 Restricted stock units (RSUs)

A restricted stock unit (RSU) is a company's promise to pay a certain number of shares based on
a vesting schedule. RSUs make it easier for a company to avoid diluting its share base and lower
administrative costs because the company hasn't yet issued the shares to employees. After
vesting, an employee gains the rights of stock ownership, such as voting rights. For tax purposes,
the entire value of an employee's stock counts as ordinary income on the vesting date, or when
the stocks become transferable.

Guidelines of SEBI on Stock Based Compensation

On August 13, 2021, the Securities and Exchange Board of India (SEBI) (Share Based Employee
Benefits and Sweat Equity) Regulations, 2021 were published. The New SEBI ESOP
Regulations apply to all share-based employee benefit schemes that deal in securities, including
employee stock options, employee share purchase, stock appreciation rights, general employee
benefits, and retirement benefits. The new SEBI ESOP Regulations likewise governed sweat
equity shares.

The New SEBI ESOP Regulations was formed in response to an expert group's advice to SEBI
on the SEBI (Share Based Employee Benefits) Regulations, 2014, and the SEBI (Issue of Sweat
Equity) Regulations, 2002, dated June 18, 2021, on the SEBI (Share Based Employee Benefits)
Regulations, 2014. The purpose was to make the regulations' provisions simpler and more
robust, to line them with the best global practises, and to make doing business easier.

SEBI prepared Frequently Asked Questions on November 16, 2021, to explain essential
principles under the New SEBI ESOP Regulations. We examined one major issue in this post
based on the SEBI FAQs, namely the broadened definition of "employee" under the New SEBI
ESOP Regulations and its practical implications.

The Securities and Exchange Board of India (SEBI) notified the SEBI (Share Based Employee
Benefits and Sweat Equity) Regulations, 2021 (SEBI ESOP Regulations 2021) on 13 August
2021. The SEBI-Employee Stock Option Plan (ESOP) regulations 2021 govern all sweat equity
shares and share-based employee benefit schemes dealing in securities, including employee stock
options, employee share purchase, stock appreciation rights, general employee benefits and
retirement benefits (share-based benefit schemes). Purpose of the new regulation is to streamline
and rationalise the provisions by:

• Making them more robust

• Synchronising them with global best practices
• Improving ease of doing business
 Key changes in the regulations

SEBI ESOP regulations 2021 include specific references to employees of a group company and
its associate company. The term group has been included for the first time under the new
regulations to mean two or more companies which, directly or indirectly, are in a position to:

• Exercise 26% or more of the voting rights in the other company

• Appoint more than 50% of members of the board of directors in the other company
• Control the management or affairs of the other company.

Other key changes in SEBI ESOP regulations 2021 includes, in principle approval from the stock
exchanges prior to the grant of options, vesting in case of superannuation/layoff, applicability of
minimum vesting period in case of death, switch routes for implementation of scheme and many
more.

Conclusion

SEBI ESOP regulations 2021 is a welcome step at a time when the markets are overwhelmed
with positive intent owing to many new generation companies having listed their shares. The
regulations provide additional flexibility, transparency and good governance in relation to
dealing with equity shares in connection with share-based employee benefit schemes. To make
the erstwhile regulations more robust and in sync with ease of doing business and best global
practices, the new promulgated regulations are bringing dynamic changes to the industry and are
expected to bring more needed change in the future in the corporate world.

Fringe Benefits

Fringe benefits are additions to compensation that companies give their employees. Some fringe
benefits are given universally to all employees of a company while others may be offered only to
those at executive levels. Some benefits are awarded to compensate employees for costs related
to their work while others are geared to general job satisfaction.

In any case, employers use fringe benefits to help them recruit, motivate, and keep high-quality
people.

• Fringe benefits help companies recruit, motivate, and keep high-quality employees.
• Companies competing for the most in-demand skills tend to offer the most lavish
benefits.
• Some of the most common fringe benefits like health and life insurance are not taxable
but others are taxed at fair market value.
• Adoption assistance is exempt from income tax.

Common fringe benefits are basic items often included in hiring packages. These include
health insurance, life insurance, tuition assistance, childcare reimbursement, cafeteria
 subsidies, below-market loans, employee discounts, employee stock options, and personal
use of a company-owned vehicle.

Uncommon fringe benefits may fit the company profile. PetSmart And Dogtopia both
operate pet-friendly workplaces. Ben & Jerry's rewards its workers with free ice cream.1

Patagonia's headquarters features extensive volleyball courts and yoga classes.

The companies that compete for the best talent in highly competitive fields may offer the
most extraordinary fringe benefits. Alphabet, the parent company of Google, is known for its
benefits that include free commuter bus service and a free gourmet cafeteria. Microsoft gives
20 weeks of paid time off to new birth mothers and 12 weeks for other new parents.

Types of Benefits

Fringe benefits can be categorized into two categories. Some benefits are required by law and
others are provided at the employer’s discretion.

1. Fringe benefits required by law

The mandatory fringe benefits are intended to provide employees with medical care, mitigate
them from economic hardships in the event they lose employment, and provide them with
retirement income to sustain them during retirement. The following are some of the mandatory
fringe benefits that employers are required to provide:

Health insurance

This fringe benefit is contained in the Patient Protection and Affordable Care Act. It requires
businesses that employ more than 50 people to provide healthcare plans, and employees are
required to have health insurance coverage. The health care plans cover visits to primary care
physicians, specialist doctors, and emergency care.

Unemployment insurance

The Federal Unemployment Tax Act (FUTA) requires employers to pay a federal and state
unemployment tax to the Department of Labor, which provides wages, training, and career
guidance to employees who become unemployed due to no fault of their own. Such benefits are
meant to provide brief monetary assistance to unemployed citizens who meet the requirements of
the act.

Medical leave

Businesses that employ over 50 employees are required by law to provide family and medical
leave to an employee who has worked for over one year in the company. The medical leave is
unpaid, protected, and can last up to 12 weeks.
Worker’s compensation

The worker’s compensation benefit is administered by the Department of Labor to federal

workers who are injured at their workstation or acquire an occupational disease. Employees are
provided with medical treatment, wage replacement benefits, rehabilitation, and other benefits.
The compensation requirements vary by state, and injured employees should contact their state
worker’s compensation board.

2. Fringe benefits not required by law

The following benefits are provided at the employer’s discretion. On the side of the employer,
most of these benefits are taxable, but with certain exceptions. Examples of these fringe benefits
include:

• Stock options
• Disability insurance
• Paid holidays
• Education reduction
• Retirement planning services
• Life insurance
• Paid time off
• Commuter benefits
• Achievement awards
• Fitness training
• Employee discounts
• Meal plans