L06 Pay for performance plans: practical considerations

Question 1

What is merit pay? Name 2 problems

Answer 1

• Permanent increase in base pay depending on current performance evaluation
• 2 problems:
  
  • Does not incentivize future effort but cannot be recalled
  • Expensive because of implied growth

Question 2

What is lump-sum bonus?

Answer 2

• Subsitute to merit pay, not built into base pay
• Advantages:
  
  • Gives incentive to continue current performance level
  • Less expensive than merit pay in the long run

Question 3

What are spot awards? State 1 advantage and 2 disadvantages.

Answer 3

• Discretionary award for good performance, needn’t be formulated, therefore not enforceable.
• Acts as monetary incentive as well as recognition
• Advantage: Extra flexibility in pay scheme
• Disadvantages:
  
  • Incentive strength is weakened due to unclear expectations
  • May create perceptions of unequal treatment

Question 4

Give 5 types of variable-pay plans.

Answer 4

1. Cash profit sharing
2. Stock ownership or options
3. Balanced Scorecard
4. Productivity/gain sharing
5. Team/group incentives

Question 5

What are 4 types of individual incentive plans (matrix)? Give examples

Answer 5

Question 6

2 advantages and 2 disadvantages of individual pay plans

Answer 6

+ Increases productivity, lowers per-unit production costs, increases worker earnings

+ Reduces need for supervision (=monitoring)

• Discourages cooperation (-> Use group pay plans)
• Resistance of workers to new ways of production that lead to revision of their pay plans

Question 7

Why does Balanced Scorecard makes sense for groups but not for individuals?

Answer 7

Because of the accountability principle:

You shouldn’t use incentives for measures individuals cannot influence.

Question 8

What is the Scanlon plan?

Answer 8

• Group analog to Rowan plan:
  
  • Sales value of production (SVOP)
  • Build ratio labor costs/SVOP and compare over time
  • Part of labor costs savings are given as a bonus
  • Why not all of it? -> ß=1 would mean, the workers bear all the risk, i.e. also losses. Workers are risk-averse and have also limited liability

Question 9

Give an example of a Scanlon plan

Answer 9

Question 10

Give 3 advantages and 3 disadvantages of group incentives plans.

Answer 10

+ Encourage cooperation

+ More versatile, many configurations possible to motivate performance in a variety of aspects

+ Encourages employee participation in decision-making

• Exposure to free-riding
• Adverse selection among employees: More productive ones have incentive to leave
• Too many performance dimensions can make it complex and thus reduce motivational power