Chapter 10: Pay for Performance Plans

Question 1

What is “pay-for-performance” plan?

Answer 1

Pay that varies with some measure of individual or organizational performance, such as merit pay, lump sum bonus plans, skill-based pay, incentive plans, variable pay plans, risk sharing, and success sharing.

Question 2

Define merit pay (and recognize its pros and cons)

Answer 2

Merit pay - A reward that recognizes outstanding past performance. It can be given in the form of lump sum payments or as increments to the base pay period merit programs are commonly designed to pay different amounts (often at different times) depending on the level of performance.
1. Con - it is expensive, some argue it doesn’t achieve the desired goal of improving employee and corporate performance.
2. Pro - merit pay does have a small but significant impact on performance. High performance ratings are nearly always statistically related to high merit increases and the reverse holds too.

Question 3

Define merit bonuses

Answer 3

Merit bonus (lump sum bonus/lump sum reward) - payment of entire increase (typically merit based) at one time. Because amount is not factored into base pay, any benefits tied to base pay do not increase.

Question 4

Define spot awards

Answer 4

One time award for exceptional performance; Also called spot bonus.
1. Usually these payouts are awarded for exceptional performance, often on special projects or for performance that so exceeds expectations as to be deserving of an add-on bonus.

Question 5

List individual incentive plans

Answer 5

Straight piece work system, standard hours plan, Bedeaux plans, Taylor plan, Merrick system.

Question 6

Specify how individual incentive plans differ from merit pay and bonuses

Answer 6

• Individual incentive plans differ from the merit and lump sum payments because they offer a promise of pay for some objective, pre established level of performance.
• All incentive plans have one common feature: an established standard against which worker performance is compared to determine the magnitude of the incentive pay. For individual incentive systems, this standard is compared against individual worker performance.

Question 7

Define Piecework

Answer 7

Piecework most frequently implemented, rate determination is based on units of production per time period, and wages vary directly as a function of production level.

Question 8

Define Standard hour plan

Answer 8

generic term for plans setting the incentive rate based on completion of a task in some expected period of time.

Question 9

Define Bedeaux

Answer 9

Provides variation on straight piece work and standard hour plans. Instead of timing an entire task, a Bedeaux plan requires division of a task into simple actions and determination of the time required by an average skilled worker to complete each action.

Question 10

Define Taylor plan

Answer 10

establishes 2 piece rates. One rate goes into effect when a worker exceeds the published standard for a given period of time. The second rate is established for production below standard, and this rate is lower than the regular wage

Question 11

Define Merrick plan

Answer 11

operates in the same way as Taylor plan, except that three piece work rates are set 1. for high production exceeding 100% of the standard, 2. medium for production between 83 and 100% of the standard, and 3. low for production less than 83% of the standard.

Question 12

Summarize the advantages and disadvantages of individual incentive plans

Answer 12

Pros:
1. Substantial impact that raises productivity, lowers production costs, and increases earnings of workers.
2. Less direct supervision is required to maintain reasonable levels of output than underpayments by time.
3. In most cases, systems of payment by results, if accompanied by improved organizational and work measurement, enable labor costs to be estimated more accurately than under payment by time period this helps cost and budgetary control.
Cons:
1. greater conflict may emerge between employees seeking to maximize output and managers concerned about deteriorating quality levels.
2. Attempts to introduce new technology may be resisted by employees concerned about the impact on production standards.
3. Reduced willingness of employees to suggest new production methods for fear of subsequent increases in production standards.
4. Increase complaints that equipment is poorly maintained, hindering employees efforts to earn larger incentives.
5. Increase turnover among new employees discouraged by the unwillingness of experienced workers to cooperate in on the job training.
6. Elevated levels of mistrust between workers and management.

Question 13

What are team-incentive plans?

Answer 13

• Group incentive restricted to team members with payout usually based on improvements in productivity, customer satisfaction, financial performance, or quality of goods and services directly attributed to the team.
• Gain sharing (group incentive) plans: incentive plans that are based on some measure of group performance rather than individual performance. Taking data on a past year as a base, group incentive plans may focus on cost savings (for example the Scanlon, Rucker, and Improshare plans) or on profit increases (profit sharing plans) as a standard for distributing a portion of the accrued funds among relevant employees.

Question 14

Summarize team incentive plans advantages and disadvantages.

Answer 14

Pros:
1. positive impact on organization and individual performance about 5 to 10% per year
2. easier to develop performance measures than it is for individual plans
3. signals that cooperation, both within and across groups, is a desired behavior
4. teamwork meets with enthusiastic support from most employees
5. may increase participation of employees in decision making process
Cons:
1. line of sight may be lessened, that as employees may find it more difficult to see how their individual performance affects their incentive payouts
2. may lead to increased turnover among top individual performers who are discouraged because they must share with lesser contributors
3. increase compensation risk to employees because of lower income stability. May influence some applicants to apply for jobs and firms where base pays larger compensation component.

Question 15

Team incentive plans corporate examples.

Answer 15

1. GE Information System - a team based incentive that also links to individual payouts. Team and individual performance goals are set. If the team hits its goal, the team members earn their incentive only if they hit their individual goals. The incentive is 12 to 15% of monthly base pay.
2. Corning Glass - Again sharing program (goal sharing) where 75% of the payout is based on unit objectives such as quality measures, customer satisfaction measures, and production targets. The remainder is based on corning’s return on equality
3. 3M - operates with an earning at risk plan. Base pay is fixed at 80% of market. Employees have a set objective to meet for pay to move to 100% of market. Additionally there is a modest profit sharing component
4. DuPont Fibers -earnings at risk plan where employees receive reduced pay increases over five years resulting in 6% lower base pay. If department meets annual profit goals, employees collect all 6%. Variable payout ranges from 0 (reach less than 80% of the goal) to 19% ( 150% of goal)

Question 16

Summarize common problems associated with team incentive plans: team variety, the “level problem”, and the three Cs.

Answer 16

• Variety: one of the problems with team compensation is that teams come in many varieties. There are full-time teams (work group organized as a team). There are part-time teams that cut across functional departments (experts from different departments pulled together to improve customer relations). There are even full-time teams that are temporary (cross functional teams pulled together to help ease the transition into a partnership or joint venture). With so many varieties of teams, it’s hard to argue for one consistent type of compensation plan.
• Level Problem: a second problem with rewarding teams is called the level problem. If we define teams at the very broad level - the whole organization being an extreme example - much of the motivational impact of incentives can be lost.
• Three Cs: complexity, control, and communication.
1. Complexity: some plans are simply too complex
2. Control: tied to fairness, example of control is Praxair, a worldwide provider of gases extracted from the atmosphere, Praixair works hard to make sure all team pay comes from performance measures under the control of the team. Example mother nature destroys a construction site this is out of the control of the employees, they are not penalized for it.
3. Communication: team based pay plans simply are not well communicated. Employees asked to explain their plans often flounder because more effort has been devoted to designing the plan then deciding how to explain it. Conversely, the more transparent the plan, the more employees trust management

Question 17

Types of Variable-Pay Plans

Answer 17

Cash profit sharing, stock ownership or options, balanced scorecard, productivity/gain sharing and team/group incentives

Question 18

Cash profit sharing

Answer 18

Cash profit sharing:
1. Award based on organizational profitability.
2. Shares a percentage of profits (typically above a target level of profitability).
3. Usually an annual payout.
4. Can be cash or deferred 401K.
Pros:
Simple, easily understood
low administrative cost
Cons:
profit influenced by many factors beyond employee control
may be viewed as an entitlement
limited motivational impact
why?
To educate employees about business operations
to foster teamwork or one for all environment

Question 19

Stock ownership or options:

Answer 19

award of stock shares or options
Pros:
options awards have minimal impact on the financial statements of the company at the time they are granted
it properly communicated, can have powerful impact on employee behavior
tax deferral to employee
Cons:
indirect pay/performance link
employees may be required to put up money to exercise grants
why?
To recruit top quality employees when organization has highly uncertain future (startups, high tech, or biotech industries)
to address employee retention concerns

Question 20

Balanced scorecard

Answer 20

awards that combine financial and operating measures for organization, business unit, and/or individual performance
award pool based on achieving performance targets
multiple performance measures may include: 1. Non financial/operating: quality improvements, productivity gains, customer service improvements 2: financial: EPS, ROE, ROA, revenues
Pros:
communicates organizational priorities
Cons:
Performance criteria may be met, but if financial targets are not met, there may be reduced payout or no payout at all
can be complicated
Why?
To focus employees on the need to increase shareholder value
to focus employees on organization, division, and/or individual goals
to link payouts to a specific financial and/or operational target

Question 21

Productivity/gain sharing

Answer 21

awards that share economic benefits of improved productivity, quality, and other measurable results
focus on group, plant, department, or division results
designed to capitalize on untapped knowledge of employees
Pros:
clear performance reward link
productivity and quality improvements
employees knowledge of business increases
foster teamwork, cooperation
Cons
can be administratively complicated
unintended effects like drop off in quality
management must open the books
payouts can occur even if companies financial performance is poor
why?
To support a major productivity/quality incentive (such as TQM or reengineering closed parentheses
to foster teamwork environment
to reward employees for improvements and activities that they control

Question 22

Team/group incentives

Answer 22

award determined based on team/group performance goals or objectives
payout can be more frequent than annual and can also extend beyond the life of the team
payout may be uniform for team/group members
Pros:
reinforces teamwork and team identity/results
effective in stimulating ideas and problem solving
minimizes distinctions between team members
may better reflect how work is performed
Cons:
May be difficult to isolate impact of team
not all employees can be placed on a team
can be administratively complex
may create team competition
difficult to set equitable targets for all teams
why?
To demonstrate an organizational commitment to teams
to reinforce the need for employees to work together to achieve results

Question 23

Chapter 10 also covers long-term incentive plans. For this section, you only need to be able to list and define the nine long-term incentive plans included on Exhibit 10.17

Answer 23

Level 1: low risk/reward
1. Time based restricted stock: an award of shares that actually are received only after the completion of a predefined service period. Employees who terminate employment before the restricted lapses must return their shares to the company.
2. Performance accelerated restricted stock: restricted stock granted only after attainment of specific performance objectives.
3. Stock purchase plan: opportunity to buy shares of company stock either at prices below market price or with favorable financing.
Level 2: medium risk/reward
4. Time vested stock option: this is what most stock options are - the right to purchase stock at a specific price for a fixed period of time.
5. Performance vested restricted stock: this is a grant of stock to employees upon attainment A defined performance objectives.
6. Performance accelerated stock option: an option with a vesting schedule that can be shortened if specific performance criteria are not met.
Level 3: high risk/reward
7. Premium price stock option: I stock option that has an exercise point about market value at the time of grant. This creates an incentive for employees to create value for the company, see the stock price rise, and thus be eligible to purchase the stock.
8. Indexed stock option: an option whose exercise price depends on what the peers companies’ experiences are with stock prices. If industry stock prices are generally rising, it would be difficult to attribute any similar rise in specific improvements beyond general industry improvements.
9. Performance vested stock option: one that vests only upon the attainment of a predetermined performance objective.