Chapter 12: Pay for Performance and Financial Incentives

🧠 Part 1: Why Incentives Matter — Motivation, Performance & Pay

What is an Incentive?

An incentive is extra financial reward given to an employee when their work

goes beyond a set standard. It's basically paying people more when they do
more or do better.

Example: A factory sets a target of assembling 50 units per day. If a worker

produces 65 units, they earn a bonus on top of their basic salary.

Frederick Taylor & Scientific Management

In the late 1800s, Frederick Taylor (an engineer) noticed a problem in

factories he called "systematic soldiering" — workers were deliberately
working slowly because they saw no benefit in working harder. He noticed
some workers had so much energy left after a 12-hour shift that they'd go
home and work on their houses!

Taylor's solution had 3 parts:

1. Set a "fair day's work" — a clear, measurable output standard for

every job.

2. Use observation and analysis to find the most efficient way to do

work.

3. Use incentive pay to reward workers who exceeded the standard.

💡 Part 2: Theories of Motivation (Why Do People Work Hard?)

Understanding motivation helps managers design better incentive plans. The

chapter covers four key theories:

1. Herzberg's Two-Factor Theory

Herzberg divided work factors into two categories:

Hygiene Factors (Extrinsic) Motivator Factors (Intrinsic)

Salary, working conditions, job Challenging work, recognition,

security achievement
Hygiene Factors (Extrinsic) Motivator Factors (Intrinsic)

If present → causes satisfaction &

If poor → causes dissatisfaction
motivation

Key insight: Just paying someone well stops them from being unhappy, but
it doesn't necessarily make them motivated. To truly motivate, you need to
give them meaningful, challenging work.

Example: A software developer won't quit if they get a decent salary

(hygiene), but they'll be truly motivated if they're working on an exciting,
challenging project (motivator).

2. Edward Deci's Theory (Intrinsic vs. Extrinsic Motivation)

Deci argued that some behaviors are naturally driven by internal

satisfaction (intrinsic motivation). If you suddenly start offering money for
something a person already loves doing, it can actually reduce their
motivation because they feel controlled.

Example: A teacher who loves teaching might lose some passion for it if
they're told "we'll pay you a bonus for each student who scores above 80%"
— it shifts their focus from genuine teaching to chasing numbers.

Bottom line: Some tasks are best motivated by challenge and recognition;
others respond well to financial rewards. Managers need to judge which is
which.

3. Vroom's Expectancy Theory

Victor Vroom said motivation depends on three things:

 Expectancy (E): "If I work hard, will I actually perform well?"

(Confidence)

 Instrumentality (I): "If I perform well, will I actually get the reward?"
(Trust)

 Valence (V): "Do I even want that reward?" (Desire)

Formula: Motivation = E × I × V

If any one of these is zero, motivation is zero.

Example:

 A salesperson doesn't believe extra effort will increase sales (E=0) →

Not motivated.

 A worker doesn't trust management will actually pay the bonus (I=0) →
Not motivated.

 A worker doesn't care about the reward offered (V=0) → Not motivated.

Implication for managers: Train employees so they're confident (E↑),

have fair and transparent reward systems (I↑), and find out what rewards
employees actually value (V↑).

4. B.F. Skinner's Reinforcement / Behavior Modification Theory

Skinner said: behavior is shaped by its consequences.

 Behavior that leads to a reward → gets repeated.

 Behavior that leads to a punishment → gets avoided.

Example: A call center agent who gets praised every time they resolve a
complaint quickly will keep doing so. If ignored or penalized for taking extra
time, they'll rush through calls.

Managers can deliberately schedule rewards (daily, weekly, randomly)

to reinforce the behaviors they want.

📋 Part 3: Types of Employee Incentive Plans

The chapter covers six broad types:

🔹 A. Individual Incentive Plans

1. Piecework Plans

Workers are paid a fixed amount per unit produced.

 Straight Piecework: Paid strictly per unit, no minimum guaranteed

wage.

Example: A tailor paid Tk. 50 for each shirt stitched.

  Standard Hour Plan: Worker gets a base hourly rate, but earns a
percentage bonus for producing beyond the set standard within an
hour.

Example: If the standard is 10 units/hour but a worker makes 12, they get a
20% bonus on that hour's pay.

Pros: Simple, fair, powerful motivator. Cons: Workers resist changes in

standards; quality may suffer as people rush; may violate minimum wage
laws; workers get unhappy if they can't earn incentives.

2. Merit Pay

A permanent salary increase based on past performance.

Example: An employee with an "outstanding" rating gets a 10% raise added

permanently to their base salary.

Modern variation — Lump-Sum Merit Pay: Instead of raising the base

salary permanently, the bonus is given as a one-time cash payment. This
is better for the company because they don't pay it year after year.

Example: Instead of raising a Tk. 30,000/month employee by 5% forever,

they get a Tk. 18,000 one-time bonus. It feels big but doesn't become a
permanent liability.

3. Incentives for Professional Employees

Professionals (lawyers, engineers, doctors, economists) are harder to

motivate with just piecework. Their incentives include:

 Bonuses, stock options, profit sharing

 Better vacation time, flexible hours

 Improved pension plans

 Home office equipment

 Dual Career Ladders — instead of forcing engineers into

management to get promoted, they can advance along a technical
track and earn more while staying in their field.
4. Non-Financial / Recognition-Based Awards

Recognition alone can powerfully boost performance — sometimes even

more than money.

Three types:

 Social recognition: Simple verbal praise, approval from a manager or

peer.

"Great job on that report, Ahmed!"

 Performance-based recognition: Employee of the Month, public

awards.

 Performance feedback: Showing employees a graph of their own

progress over time.

🔹 B. Incentives for Salespeople

Salespeople are usually compensated through one of these methods:

1. Straight Salary

Fixed monthly pay, no commissions.

 Best for: Situations where selling is not the main job — e.g., finding
new clients, training customers, attending trade shows.

 Pro: Stable income for the salesperson.

 Con: No financial push to sell more.

2. Commission-Only Plan

Pay = a percentage of sales made.

Example: A real estate agent earns 2% on every property sold.

 Pro: Directly ties income to results; proportional cost to revenue.

 Con: Income is unstable; can cause salespeople to neglect after-sales

service; high turnover.

3. Combination Plan (Most Common)

Salary + Commission.
  Gives a floor (safety net) so salespeople aren't desperate in slow
months.

 Commission rewards extra performance.

Example: Base salary of Tk. 20,000/month + 1% commission on all sales.

4. Commission-Plus-Drawing Account

Salesperson earns commissions, but can draw (borrow) against future

commissions during slow periods.

Example: During Ramadan when sales are slow, a salesperson draws Tk.
5,000 in advance, then repays it from the next month's commissions.

5. Commission-Plus-Bonus

Mostly commission-based, but small bonuses given for specific activities —

like selling slow-moving or unpopular products.

🔹 C. Incentives for Managers and Executives

1. Short-Term Incentives: Annual Bonus

Bonuses tied to the company's profitability over the past year.

Three questions in designing these:

 Who is eligible? (All managers? Only senior ones?)

 How big is the bonus pool? (Based on profits, percentage of salary?)

 Split-award plan: The bonus is split — part based on individual

performance, part based on company performance.

Example: A manager gets 60% of their bonus based on their department's

results and 40% based on company-wide profit.

2. Long-Term Incentives

These are designed to retain executives and align their interest with long-
term company growth. Common tools:

Tool What It Means

Right to buy company stock at a fixed price in the

Stock Options
future. If stock rises, executive profits.
Tool What It Means

Stock given to executive, but they can't sell it for

Restricted Stock
several years (retention tool).

Performance-
Contingent Restricted Shares only given if performance targets are met.
Stock

Stock Appreciation Instead of buying stock, executive receives cash

Rights (SARs) equal to how much the stock price rose.

Executive gets "units" similar to shares; receives

Phantom Stock Plans cash equal to appreciation — without actually
owning real shares.

Option value tied to a market index; executive only

Indexed Options
profits if stock outperforms the index.

Large payment given to executives if the company

Golden Parachutes
is taken over/sold — to protect them from job loss.

🔹 D. Team / Group Incentive Plans

Instead of rewarding individuals, the whole team earns incentives based on

collective performance.

How to calculate team pay:

 All members get paid what the highest performer earned.

 All members get paid what the lowest performer earned.

 All members get the average of the group's earnings.

Pros:

 Encourages teamwork and cooperation.

 New members get trained faster (team is invested in their success).

 Promotes joint problem solving.

Cons:

 "Free riders" — lazy workers benefit from hard workers' efforts.

  Individual effort isn't directly rewarded.

Example: A group of 5 factory workers share a bonus based on the total

output of their assembly line. Even if one person slacked, everyone shares
the reward — or penalty.

🔹 E. Organization-Wide Incentive Plans

These involve the entire company sharing in success or loss.

1. Profit-Sharing Plans

A portion of company profits is distributed to all employees.

 Current/Cash Plans: Employees get a cash share (usually 15–20% of

profits) quarterly or annually.

Example: If a company earns Tk. 10 crore in profit, it distributes Tk. 1.5–2

crore among all employees.

 Deferred Profit-Sharing Plans: Instead of cash now, the profit share

goes into a retirement trust account for each employee. They
receive it when they retire.

2. Scanlon Plan & Gainsharing Plans

The Scanlon Plan was an early form of gainsharing built on 4 pillars:

1. Philosophy of Cooperation — Management and workers work

together.

2. Identity — Workers understand and care about the company's

mission.

3. Competence — Hire and develop skilled, committed people.

4. Involvement System + Sharing of Benefits — Workers suggest

improvements, and savings are shared.

Gainsharing Plans (broader): Employees are rewarded when the company

achieves productivity/cost-saving goals. The gains are shared between the
company and the employees.

Example: If a factory reduces waste and saves Tk. 5 lakh/month due to

worker suggestions, employees get a share of those savings.
3. At-Risk Variable Pay Plans

A portion of the employee's normal pay is put "at risk."

 If they meet or exceed goals → they earn it back plus a bonus.

 If they fail to meet goals → they lose that portion of pay.

Example: An employee's normal pay is Tk. 20,000. Under an at-risk plan, Tk.
2,000 (10%) is held back. If they hit targets → they get the Tk. 2,000 back +
a bonus. If they miss targets → they only receive Tk. 18,000.

This is powerful but risky — employees must truly believe they can achieve
the targets (back to Vroom's Expectancy Theory!).

4. Employee Stock Ownership Plan (ESOP)

The company sets up a trust fund and contributes its own stock (up to 15%
of compensation) into individual employee accounts each year. Employees
receive this stock when they retire or leave.

Why it's great:

 For employees: Builds a sense of ownership; they become part-

owners. Also, no taxes on ESOP earnings until retirement.

 For the company: Gets a tax deduction on contributed shares; can

borrow against ESOP trust; increases loyalty and reduces turnover.

 For shareholders: Can diversify their assets by selling stock to the

ESOP trust.

Example: BRAC Bank contributes shares worth 10% of each employee's

salary into their ESOP account every year. After 20 years, an employee
retires with significant company stock — making them a true stakeholder.

Chapter Summary

Plan Type Who It Covers Key Idea

Factory/production
Piecework Pay per unit produced
workers
Plan Type Who It Covers Key Idea

Permanent raise for past

Merit Pay Most employees
performance

Salary, commission, or
Sales Incentives Salespeople
combination

Short-term
Managers Annual bonus tied to profit
Bonuses

Long-term
Executives Stock options, restricted stock
Incentives

Team Plans Groups/teams Reward collective output

Profit Sharing All employees Share in company profits

Scanlon/
All employees Share in productivity savings
Gainsharing

Portion of pay contingent on

At-Risk Pay All levels
goals

ESOP All employees Ownership stake in the company

The core message of the chapter is simple: pay alone doesn't motivate —
the design of how you pay matters enormously. The right incentive
plan depends on the nature of the work, the employees, and what behavior
you're trying to encourage.