Hra 310 chapter 12

Chapter Twelve
Incentive
Compensation

Copyright © Houghton Mifflin Company. All rights reserved. 12–2
Chapter Outline
• Strategic Importance of Variable Pay
• Linking Pay to Performance
• Individual Incentives
• Group Incentives
• Barriers to Pay-for-Performance Success
• Summary: Making Variable Pay Successful
• Executive Compensation

Strategic Importance of Variable Pay
• Aim is for Employees Who Can:
– Understand the Goals of the Organization
– Know their Role in Accomplishing these
Goals
– Become Appropriately Involved in
Decisions of the Organization
– Accept that Their Rewards Are Related to
Their Contribution to the Goal Attainment
of the Organization

Alignment
• A major strategic goal is to align
organizational and individual goals
through pay
• Best understood through examples of
misalignment

Examples of Misalignment
• What is being signaled to co-workers when well-
intentioned but ineffective employees are given
above-average merit increases?
• What is being signaled when executives are given
large bonuses after the organization has had a
below-average year, and only small increases are
given to other workers?
• What is being signaled if high commissions and
other incentives are paid to field sales reps, but
there is no monitoring of sales practices?
• What is being signaled if bonuses are paid even
when the organization did not earn the profits
necessary?

Table 12.1 Ratings of the Effectiveness of
Various Incentive Pay Reward Programs
Source: HR Focus, Vol. 78 (4), April 2001, pp.3-4.

Linking Pay to Performance
• Reasons to Link Pay to Performance
– Motivation
• Expectancy
• Instrumentality
• Valence

Figure 12.1 Major Elements of
Expectancy Theory

Table 12.2: Ratings of Pay Incentive
Plans
Source: E.E. Lawler, Pay and Organization Development, 1981 Addison Wesley Longman, Inc. Reprinted by permission of Addison Wesley Longman.

Linking Pay to Performance
• Reasons to Link Pay to Performance
– Motivation
– Retention
– Productivity
– Cost Savings
– Organizational Objectives
• Reasons Not to Link Pay to Performance
• Factors Affecting the Design of Incentive
Systems

Individual Incentives
• Piece-Rate Incentive
– The Taylor Plan
– Standard Hour Plan
• Commissions
• Bonuses
• Skill-Based Pay
• Merit Pay

Skill-Based Pay
• A reward system that pays employees
on the basis of the work-related skills
they possess rather than associated
rewards with performance levels or
seniority
– Stair-step model
– Job-point accrual model
– Cross-department model

Table 12.4 Merit Increase Guidelines

Merit Pay
+
A major motivational device
–
Permanent commitment to an increased
salary

Group Incentives
• Profit Sharing
• Gain-Sharing Plans
– Scanlon Plan
– Rucker Plan
– Improshare
– Winsharing
– Summary

Table 12.5 Principal Features of Gain-
Sharing and Profit-Sharing Programs
Source: Robert Doyle, Gainsharing and Productivity: A Guide to Planning, Implementation, and Development. Copyright © 1983 by AMACOM, a division of
American Management Association. Sections adapted from Jay R. Schuster and Patricia K. Zingheim, The New Pay: Linking Employees and
Organizational Performance (Lexington, Mass.: Lexington Books, 1992).

Group Incentives
• Profit Sharing
• Gain-Sharing Plans
– Scanlon Plan
– Rucker Plan
– Improshare
– Winsharing
– Summary
• Employee Stock Ownership Plans (ESOPs)

Table 12.6 America’s Largest Companies
Over 50% Employee Owned
Source: “The Employee Ownership 100,” National Center for Employee Ownership, July 2004. (Available at : http://www.nceo.org/library/eo100.html)

Barriers to Pay-for-Performance
Success
• Nature of the Task
• Performance Measurement
• Amount of Payout
• Frailty of the Linkage

Summary: Making Variable Pay
Successful
• Characteristics of Successful Incentive
Systems:
– Employee-Organization Partnerships
– Employee Empowerment
– Relevant, Simple Measures
– Effective Communication
– Balance Between Short- and Long-Term
Performance Factors
– Line-of-Sight Considerations

Executive Compensation
• Goals of Executive Compensation
• Executive Bonus Plans
• Long-Term Incentives
• Perquisites
• Determining Executive Compensation
• Reforming Executive Compensation

Reasons for Interest in Executive
Compensation
• In 1993, the average CEO earned
$3,841,273. In 1997, just four years later,
CEO pay more than doubled to an average
$7.8 million.
• In 2000, U.S. CEOs earned on average a
princely $13.1 million.
• The result of the weakening returns led to the
first decreases in more than a decade in the
early 2000s with the 2003 average of CEO
salary, bonus, and long-term compensation at
$8.1 million.

Compensation (cont’d)
• Reuben Mark, CEO, Colgate-Palmolive,
was the top-paid CEO with a total pay
of $141.1 million. This at a time when
Colgate-Palmolive saw a –19 percent
return in the three year period ending in
2003
• In 1980, CEO pay was 42 times the pay
of a factory worker; in 1997, the CEO
earned 326 times as much.

• In 1980 CEO pay was 42 times the pay of the
ordinary factory worker; by 1991 this ratio had
increased to 104; by 1993 to 149; by 1997 to
326; and was 531 times the average worker
in 2001. As a result of the collapsing stock
market, this ratio fell to 282 in 2002
• In the period 1990 to 2003, CEO pay rose
313 percent. During that time the S&P 500
stock index rose 242 percent, corporate
profits increased 128 percent, the average
worker’s pay climbed 49 percent, and inflation
rose 41 percent

• If the minimum wage had risen as much
as CEO pay over the thirteen years, it
would be more than $15.00 per hour
instead of the current rate of $5.15.

Review
• Strategic Importance of Variable Pay
• Linking Pay to Performance
• Individual Incentives
• Group Incentives
• Barriers to Pay-for-Performance Success
• Summary: Making Variable Pay Successful
• Executive Compensation

Hra 310 chapter 12

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Hra 310 chapter 12