Pay for Performance and

Financial Incentives

Part Four | Compensation

LEARNING OUTCOMES
1. Explain how you would apply five motivation theories in
formulating an incentive plan.
2. Discuss the main incentives for individual employees.
3. Discuss the pros and cons of commissions versus
straight pay incentives for salespeople.
4. Describe the main incentives for managers and
executives.
5. Name and define the most popular organizationwide
variable pay plans.
6. Outline the steps in designing effective incentive plans.

12–2
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
 Fair day’s work
• Linking Pay and Performance
 Understanding the motivational
bases of incentive plans

12–3
The Hierarchy of Needs
• Maslow’s Hierarchy of Needs:
 Physiological (food, water, warmth)
 Security (a secure income, knowing one has a job)
 Social (friendships and camaraderie)
 Self-esteem (respect)
 Self-actualization (becoming a whole person)

• Maslow’s prepotency process principle:

 People are motivated first to satisfy each lower-order need
and then, in sequence, each of the higher-level needs.

12–4
Herzberg’s Hygiene–Motivator Theory
• Hygienes (extrinsic job factors)
 Satisfy lower-level needs
 Inadequate working conditions, salary, and incentive pay can cause dissatisfaction and
prevent satisfaction.
• Motivators (intrinsic job factors)
 Satisfy higher-level needs
 Job enrichment (challenging job, feedback, and recognition) addresses higher-level
(achievement, self-actualization) needs.
• Premise:
 The best way to motivate someone is to organize the job so that doing it provides
feedback and challenge that helps satisfy the person’s higher-level needs.

12–5
Demotivators and Edward Deci
• Intrinsically motivated behaviors are motivated by the
individual’s 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.

12–6
Victor Vroom’s Expectancy Theory
• Motivation is a function of:
 Expectancy: the belief 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.

12–7
Behavior Modification /
Reinforcement Theory
• B. F. Skinner’s Principles
 To understand behavior one must understand
the consequences of that behavior.
 Behavior that leads to a positive consequence (reward)
tends to be repeated, while behavior that leads to a
negative consequence (punishment) tends not to be
repeated.
 Behavior can be changed by providing properly scheduled
rewards (or punishments).

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Incentive Pay Terminology
• Pay-for-Performance Plan
 Ties employee’s pay to the employee’s performance

• Variable Pay Plan

 Is an incentive plan that ties a group or team’s pay to some measure of the firm’s (or the
facility’s) overall profitability
 Example: profit-sharing plans
 May include incentive plans for individual employees

12–9
Types of Employee Incentive
Plans
Individual Employee Incentive
and Recognition Programs

Sales Compensation
Programs

Pay-for-Performance Team/Group-based
Plans Variable Pay Programs

Organizationwide
Incentive Programs

Executive Incentive
Compensation Programs

12–10
Individual Incentive Plans
• Piecework Plans
 The worker is paid a sum (“piece rate”)
for each unit he or she produces.
 Straight piecework
 Standard hour plan

12–11
Pros and Cons of Piecework
• 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
or are withdrawn

12–12
Individual Incentive Plans (cont’d)
• Merit Pay
 Is a permanent cumulative salary increase the firm awards
to an individual employee based on his or her individual
performance
 Can detract from performance if awarded across the board
 Becomes permanent ongoing reward for past performance

• Merit Pay Options

 Give annual lump-sum merit raises that do not make the
raise part of an employee’s base salary.
 Tie merit awards to both individual and organizational
performance.

12–13
TABLE 12–1 Merit Award Determination Matrix (an Example)

Company Performance (Weight = 0.50)

Employee Performance
Rating (Weight = .50) Outstanding Excellent Good Marginal Unacceptable

Outstanding 1.00 0.90 0.80 0.70 0.00

Excellent 0.90 0.80 0.70 0.60 0.00

Good 0.80 0.70 0.60 0.50 0.00

Marginal — — — — —

Unacceptable — — — — —

To determine the dollar value of each employee’s incentive award: (1) multiply the
employee’s annual, straight-time wage or salary as of June 30 times his or her maximum
incentive award and (2) multiply the resultant product by the appropriate percentage figure
from this table.
Example: if an employee had an annual salary of $20,000 on June 30 and a maximum
incentive award of 7% and if her performance and the organization’s performance were
both “excellent,” the employee’s award would be $1,120 ($20,000 × 0.07 × 0.80 = $1,120).

12–14
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

12–15
Nonfinancial and Recognition Awards
• Effects of Recognition-Based Awards
 Recognition has a positive impact on performance,
either alone or in conjunction with financial rewards.
 Day-to-day recognition from supervisors, peers, and
team members is important.
• Ways to Use Recognition
 Social recognition
 Performance-based recognition
 Performance feedback

12–16
FIGURE 12–1 Social Recognition and Related Positive
Reinforcement Managers Can Use

• Challenging work assignments • Being provided with ample

• Freedom to choose own work encouragement
activity • Being allowed to set own goals
• Having fun built into work • Compliments
• More of preferred task • Expression of appreciation in
• Role as boss’s stand-in when he front of others
or she is away • Note of thanks
• Role in presentations to top • Employee-of-the-month award
management • Special commendation
• Job rotation • Bigger desk
• Encouragement of learning and • Bigger office or cubicle
continuous improvement

12–17
Online and IT-Supported Awards
• Information Technology and Incentives
 Enterprise incentive management (EIM)
 Software that automates planning, calculation,
modeling, and management of incentive
compensation plans
 Enabling companies to align their employees
with corporate strategy and goals
• Online Award Programs
 Programs offered by online incentives firms that
improve and expedite the awards process
 Broader range of awards
 More immediate rewards

12–18
Incentives for Salespeople
• Salary Plan
 Straight salaries
 Best for: prospecting (finding new clients),
account servicing, training customer’s sales force,
or participating in national and local trade shows
• Commission Plan
 Pay is a percentage of sales results.
 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 be linked to external
factors rather than to salesperson’s performance
 Can increase turnover of salespeople

12–19
Incentives for Salespeople (cont’d)
• 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.

12–20
Specialized Commission Plans
• 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 (“spiffs”) are paid for directed
activities like selling add-ons or slow-moving
items.

12–21
Incentives for Managers and Executives
• Executive Total Reward Package
 Base salary (cash)
 Short-term incentives (bonuses)
 Long-term incentives (e.g., stock options)

12–22
Short- and Long-Term Incentives
• Short-Term Incentives: The Annual Bonus
 Plans intended to motivate short-term performance
of managers and tied to company profitability.
 Issues in awarding bonuses
 Eligibility basis
 Fund size basis
 Individual performance award
 Long-term incentives
 Stock options
 Performance shares
 Indexed options
 Premium price options
 Stock appreciation rights
 Perks

12–23
TABLE 12–2 Multiplier Approach to Determining Annual Bonus

Company’s Performance (Based on Sales Targets, Weight = 0.50)

Individual Performance
(Based on Appraisal, Weight = .50) Excellent Good Fair Poor

Excellent 1.00 0.90 0.80 0.70

Good 0.80 0.70 0.60 0.50

Fair 0.00 0.00 0.00 0.00

Poor 0.00 0.00 0.00 0.00

Note: To determine the dollar amount of a manager’s award, multiply the maximum possible
(target) bonus by the appropriate factor in the matrix.

12–24
Creating an Executive Compensation Plan
1. Define the strategic context for the executive
compensation program.
2. Shape each component of the package to focus
the manager on achieving the firm’s strategic goals.
3. Check the executive compensation plan for
compliance with all legal and regulatory
requirements and for tax effectiveness.
4. Install a process for reviewing and evaluating
the executive compensation plan whenever
a major business change occurs.

12–25
Team/Group Incentive Plans
• Team (or Group) Incentive Plans
 Incentives are based on team’s performance.

• How to Design Team Incentives

 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 receive the same pay earned by the highest producer.
 All receive the same pay earned by the lowest producer.
 All receive the same pay equal to the average pay
earned by the group.

12–26
Pros and Cons of Team Incentives
• Pros
 Reinforces team planning and problem solving
 Helps ensure collaboration
 Encourages a sense of cooperation
 Encourages rapid training of new members

• Cons
 Pay is not proportionate to an individual’s effort
 Rewards “free riders”

12–27
Organizationwide Incentive Plans
• Profit-Sharing Plans
 Current profit-sharing (cash) plans
 Employees receive cash shares of the firm’s profits
at regular intervals.
 Deferred profit-sharing plans
 A predetermined portion of profits based on the
employee’s contribution to the firm’s profits is
placed in each employee’s retirement account
under a trustee’s supervision.
 Employees’ income taxes on the distributions are
deferred, often until the employee retires.

12–28
 Gainsharing Plans

Scanlon Plan
Components

Philosophy Benefits
Competenc Involvemen
of Identity sharing
e t system
cooperation formula

12–29
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.

12–30
Implementing an Effective Incentive Plan
1. Ask: Does it make sense to use an incentive here?
2. Link the incentive with your strategy.
3. Make sure the program is motivational.
4. Set complete standards.
5. Be scientific in analyzing the effects of the plan.

12–31