chapter 10 - pay for performance plans Flashcards
non-regrettable turn-over
is the reason why the goal of compensation is NOT removing turnover. Sometimes turnover is good!
Goal of compensation is ARM (attract, retain, motivate)
rule of thumb for incentives and pay
usually anything under 10% is not going to grab someones attention and change their behavior.
approximately what % of total compensation is paid in variable pay?
10-12%
99% of organizations
use some form of short-term inventive plan and the use of variable oay in general has increase
pay-for-performance: merit pay plans
Merit pay or merit increases link increases in base pay to how performance
Merit pay is widely used; the average merit pay increase in the US for decades was ~3% per year, until 2022-2023, when it increased for the first time in decades due to unprecedented inflation
Many companies use a merit increase matrix to determine merit pay based on not just performance, but a) performance b) merit increase budget and c) position in salary range, which is captured by compa-ratio = employee salary / range midpoint
sample merit matrix and example question
LOOK AT IMAGE IN NOTES:
(X) PERFORMANCE RATING, COMPA RATIO 90-90%, 90-110%, 110-120+%
(Y) EXCEEDS, MEETS, BELOW MEETS (UNDER RATINGS)
Should they get a higher or lowers salary adjustment than someone who is (performance rating) and (compa ratio)
THIS GRAPH AND QUESTION WILL BE ON THE QUIZ/EXAM
Think about it logically - exceeding market vs below market
Chart provided though
Question: What merit increase would you recommend for someone who exceed expectation in their performance and has a Compa-Ratio of 105%
Answer: 5%
Important:
Merit pay increases, unlike variable pay, is added into base pay
Promotional increases range from 5-15%
compa-ratio
relationship of base salary to the midpoint
Base salary $75,000
———— ———– = 102%
Midpoint $73,500
Companies generally strive to have compa-ratios between~90%-110% (~100% is “at market”) and range penetration close to 50%
concerns about merit pay
Issues with Merit Pay:
- Expensive: every year pay increases (compounds)
- Does it really achieve the desired goal of improving employee and corporate performance?
– Small effective – doesn’t really motivate
– Sorting effect
– Morale
– Entitlement - Improving the Outcome of Merit Pay
- Individual performance is a deficient measure when work is interdependent and requires cooperation to obtain results
- Allocate enough money to truly reward performance; make sure size of merit increases differentiates across performance levels or “why bother?”
short term: lump sum bonuses (merit bonuses)
Merit bonuses (or lump sum bonuses) differ from merit pay in that employees receive an end-of-year bonus that does not build into base pay
- Substitute for merit increase %; paid as a lump sum instead of a % increase to base salary
- Based on performance and received as a bonus, not built into base pay, so not “fixed” cost
- Viewed as less of an entitlement than merit pay
- Less expensive than merit pay over the long run (why?)
- Employees are not fond of merit bonuses; giving merit bonuses for several years, a company is essentially freezing base pay
Relative Cost Comparisons Merit and Lump Sum
comparing expenses for merit pay versus lump sum payments (merit bonuses) IMAGE!!!!
merit pay adds on to new base pay and year payouts
over time this increases your pay (ex: 10K in 5 years) where as lump-sum does not
Short Term: Individual Incentive Plans
Individual incentive plans offer a promise of pay for some objective, pre-established level of performance
Use established standard & compare actual performance to determine incentive
Common Types: (sales)
- Commission: Rewards based on volume
- Draw
- Piece-rate plans: Payment based on units produced
Not suitable for roles that individual differences are not desirable (e.g., production line)
Payout frequency: annually, quarterly, monthly or upon the event (e.g., completing a project)
Performance measures: almost anything
Target Incentive: lump sum $ amount or % base salary
Short Term: Team/Group vs. Individual Incentives Plans
Substantial evidence that individual incentive plans boost performance
Individual incentives yield higher productivity gains, but group incentives often are right when team coordination is the issue
Individual incentive plans have better potential for delivering higher productivity
Group plans can suffer from the free rider problem; however, free riders have a harder time loafing when there are clear performance standards
Large Group Incentive Plans - on exam
There are two plan types for incentivizing large groups
- Gain sharing plans use operating measures to gauge performance
- Profit sharing plans use financial measures
- Gain sharing identifies areas where employees have some impact on savings – such as reduced scrap
- Studies report positive results and can lead to the sorting effect - Profit sharing continues to be popular due to its focus on a predetermined index of profitability
- On the downside, most employees do not feel their jobs have a direct impact on profits
Short-Term: Large Team or Group Incentives Plans
Gain-sharing plans:
An incentive plan that engages employees in a common effort to achieve productivity objectives and share the gains
- Looks at cost savings
- Evidence is good that these programs work (USPO, retailers); generally in the 4-5% range
- Creates some “sorting” effect because the best employees want to be rewarded for “individual” performance; low performing employees self-select out
Short-Term: Team or Group Incentives Plans
Profit Sharing Plans:
An incentive plan that engages employees in a common effort to achieve profitability objectives and share the profits
- Dollars given to workers are generated by additional profits gained from operational efficiency
- Focuses on a predetermined index of profitability
- Looks at actual profits, which many employees don’t think they can affect
- Not talked about as much as variable pay, but just as successful in impacting productivity as gain-sharing (3.5-5% increase)
Funding: many team/group incentive plans have thresholds or triggers before they are funded
individuals rather than group incentives produce better productivity, but group incentives are sometimes right when team coordination important
Exhibit 10.15: Types of Group Incentive Plans: Advantages and Disadvantages
group incentives have an interesting effect-
they encourage organizations to be “learning organizations” and to not get stuck in the way things have been done; they encourage employees to think of ways to improve outcomes, not simply maintaining the existing ways things are done
advantages and disadvantagesof group incentives plans
advantages
1 - positive impact on organization and individual performance of about 5 to 10 percent 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 the most employees
5 - may increase participation of employees in decision-making process
disadvntages
1 - line-of-sight may be lessened, that is employees may find it more difficult to see how their individual performance affects their incentive payouts
2 - may lead to increase turnover among top individual performers who are discouraged because they must share with their lesser contributors
3 - increases compensation risk to employees because of lower income stability. may influence some applicants to apply for jobs in firms where bae pay is larger compensation component
Explosive Interest in Long-term Incentive Plans
Long-term incentives (LTIs)
- Focus on performance beyond the one-year timeline (cutoff for short-term incentive plans)
- Growth in such plans is partly due to a desire to motivate longer-term value creation
- There is very little evidence that stock ownership by management leads to better corporate performance
- However, one form of LTI, stock ownership, shows very little evidence that equity (stock) ownership improves performance
Finally, does PFP improve results?
Overall, yes, pay for performance plans seem to have a positive impact on performance if they are designed well
However, too often the plans have:
- Too small a payout for the work expected
- Unattainable (or too easy) goals
- Outdated or inaccurate metrics
- Or too many metrics making it difficult to determine what is important
