PAY FOR

PERFORMANCE
AND FINANCIAL
INCENTIVES
Ervina Maulida, MBA
Money’s Role In
Motivation
Productivity “is the ratio of outputs
(goods and services) divided by the
inputs (resources such as labor and
capital)

Frederick Taylor popularized using

financial incentives—financial rewards
paid to workers whose production
exceeds some predetermined
standard—in the late 1800s.
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Incentive Pay Terminology

Managers often use two terms synonymously Variable pay is more specific: It is usually an incentive
with incentive plans. Traditionally, all plan that ties a group’s or team’s pay to some measure
incentive plans are pay-for-performance of the firm’s (or the unit’s) overall profitability; profit-
plans. sharing plans (discussed later) are one example.
Individual Employee Incentive
and Recognition Programs
Several incentive plans are particularly suited for use with
individual employees.
Piecework
• A system of pay based on the
number of items processed by
each individual worker in a unit
of time, such as items per hour
or items
per day.
• Thus, if Tom Smith gets $0.40
apiece for stamping, then he
would get, say, $80 for stamping
out 200.
Straight piecework
• An incentive plan in which a
person is paid a sum for each
item he or she makes or sells,
with a strict proportionality
between results and rewards.
• Tom Smith would be paid $7.25
per hour (the 2015 minimum
wage) whether or not he
stamped out 18 doorjambs per
hour (at $0.40 each). But he
would also get $0.40 for each
unit over 18.
The standard hour plan
• A plan by which a worker is paid • So if Tom’s standard is 160
a basic hourly rate but is paid an doorjambs per day ($64 per
extra percentage of his or her day), and he brings in 200 jambs,
rate for production exceeding he’d get an extra 25% (40/160),
the standard per hour or per or $80.
day.
• Similar to piecework payment
but based on a percent
premium.
Merit Pay as an
Incentive
• Merit pay or a merit raise is a
salary increase the firm awards to
an individual employee based on
individual performance.
Merit pay options : Two adaptations of
merit pay plans are popular.
1. Merit raises in a lump sum once a year
and does not make the raise part of the
employee’s salary
2. Ties merit awards to both individual and
organizational performance.
Ex: an outstanding performer would
receive 70% of his or her maximum
lump-sum award even when the
organization’s performance was
marginal.
However, employees with marginal or
unacceptable performance would get no
lump-sum awards even when the firm’s
performance was outstanding.
Incentives for Professional Employees
• Making incentive pay decisions • As at most Silicon Valley firms,
for professional employees is Google’s professionals also bask
challenging. in the light of potentially
• For one thing, firms usually pay millionaire-making stock option
professionals well anyway. grants.
• For another, they’re already • Dual-career ladders are another
driven by the desire to produce way to manage professionals’
high-caliber work. pay
Incentives for Managers and Executives

Most managers get short- Short-term incentive plans, Long-term incentives,

term and long-term 96% in one study— about 48% offer them as
incentives in addition to provided those incentives stock options.
salary. in cash
Short-Term Incentives and the Annual Bonus
• Most firms have annual bonus plans for motivating managers’ short-
term performance.
• Such short-term incentives can easily produce plus-or-minus
adjustments of 25% or more to total pay.
• Three factors influence one’s bonus: eligibility (job level/job title, or
salary), fund size, and individual performance.
• A typical bonus percentage might be executives, 45% of base salary;
managers, 25%; and supervisory personnel, 12%.
Long-term Incentives

• PepsiCo’s CEO was paid $13.2 million recently, including a base salary of $1.6 mil- lion,
stock awards of $7.5 million, and a performance-based bonus of $4 million, plus perks
such as air travel.
• Long-term incentives such as stock options, if well-designed, should only pay off if the
firm achieves its strategic goals (such as “double our rate of return”), because the
owners and investors should also benefit from the executives’ efforts.
• Popular long-term incentives include cash, stock, stock options, stock appreciation
rights, and phantom stock.
Stock Options
• Stock options : is the right to purchase a specific number of shares of
company stock at a specific price during a specific period.
• With performance-contingent restricted stock, the executive receives
his or her shares only if he or she meets the present performance
targets.
• With (time-based) restricted stock plans, the firm usually awards
rights to the shares without cost to the executive but the employee is
restricted from acquiring (and selling) the shares for, say, 5 years.
• Stock appreciation rights (SARs) let the recipient exercise the stock
option (by buying the stock) or to take any appreciation in the stock
price in cash, stock, or some combination of these.
• Under phantom stock plans, executives receive not shares but “units”
that are similar to shares of company stock. Then at some future time,
they receive value (usually in cash) equal to the appreciation of the
“phantom” stock they own.
Some Other
Executive Incentives
• Golden parachutes are extraordinary (large) payments
companies make to executives in connection with a change
in company ownership or control.
• A golden parachute, in mergers and acquisitions (M&A),
refers to a large financial compensation or substantial
benefits guaranteed to company executives upon
termination following a merger or takeover. Benefits
include severance pay, cash bonuses, and stock options.
• Jeff Smisek, the former CEO of United Airlines, received a
separation payment of $4.875 million in cash along with
additional equity awards and other benefits for a total of
close to $37 million after being ousted from his company.
How to Design
Team
Incentives
Firms need incentive plans
that encourage teamwork and
focus teams on performance.
Team (or group) incentive
plans
• Team (or group) incentive plans pay incentives to the team
based on the team’s performance.
• Inequity was the big problem. Sometimes all team
members’ financial compensation was the same, although
one or two people “did the lion’s share of the work.”
• In other cases, the employer chose one or two team
members for promotion, leaving others to feel they’d
worked hard to support someone else’s career.
• The bottom line is that unless you take steps to minimize
inequities, it may be best to pay employees based on their
individual contributions, rather than on collective team
performance.
 Organization-wide
incentive plans
Organization-wide incentive plans are plans in which all or most
employees can participate, and which generally tie the reward to
some measure of company-wide performance.
Also called variable pay plans.
Profit-Sharing Plans
• Profit-sharing plans are plans in which all or most
employees receive a share of the firm’s annual profits.
• Current profit-sharing or cash plans, employees share
in a portion of the employer’s profits quarterly or
annually. Here the firm simply distributes a percentage
of profits (usually 15% to 20%) as profit shares to
employees at regular intervals.
• With deferred profit-sharing plans, the employer puts
cash awards into trust accounts for the employees’
retirement
Scanlon Plans
• An incentive plan developed in 1937 by Joseph Scanlon and designed to
encourage cooperation, involvement, and sharing of benefits.
• Scanlon plans have 5 basic features:
1. philosophy of cooperation (a sense of ownership in the company),
2. identity (the company must articulate its mission or purpose, and
employees must understand how the business operates in terms of
customers, prices, and costs),
3. competence (demands a high level of competence from employees at all
levels),
4. involvement system (Employees present improvement suggestions to
the appropriate departmental-level committees), and
5. sharing of benefits formula (If a suggestion is implemented and
successful, all employees usually share in 75% of the savings).
Gainsharing Plans

• Gainsharing is an incentive plan that

engages many or all employees in a
common effort to achieve a
company’s productivity objectives,
with any resulting cost-savings gains
shared among employees and the
company.
• The basic difference among Scanlon
plan and gainsharing plan is how
employers determine employee
bonuses.
Earnings-at-risk Pay Plan

• Plan that puts some portion of employees’

normal pay at risk if they don’t meet their
goals, in return for possibly obtaining a
much larger bonus if they exceed their goals.
• For example, the employees’ pay “at risk” by
replacing (1) 10% of each worker’s wages
with (2) a 10% bonus if the company meets
its goals plus an additional 3% bonus if it
exceeds these goals.
Employee stock
ownership plans (ESOPs)
• Employee stock ownership plans (ESOPs) are
company-wide plans in which the employer
contributes shares of its own stock (or cash to be
used to purchase such stock) to a trust established
to purchase shares of the firm’s stock for
employees.
• The firm generally makes these contributions
annually in proportion to total employee
compensation, with a limit of 15% of
compensation.
Employee Engagement Guide for Managers: Incentives and Engagement

1 2 3
Make improving Appraise and incentivize If possible, let
employee engagement your supervisors partly employees participate
a formal target of your based on whether they in devising the
compensation plan; take steps to improve compensation plan.
their subordinates’
engagement;
Thank you
See you next week

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