HUMAN RESOURCE

MANAGEMENT

REWARDING
PERFORMANCE
LEARNING OBJECTIVES

• Recognize individual and group

contributions to the firm by rewarding
high performers
• Develop pay-for-performance plans
that are appropriate for different levels
in an organization
• Identify the potential benefits and
drawbacks of different pay-for-
performance systems and choose the
plan that is most appropriate for a
particular firm
LEARNING OBJECTIVES
• Design an executive compensation
package that motivates executives to
make decisions that are in the firm’s best
interests
• Weigh the pros and cons of different
compensation methods for sales
personnel and create an incentive plan
that is consistent with the firm’s
marketing strategy
• Design an incentive system to reward
excellence in customer service
PAY-FOR-PERFORMANCE SYSTEMS

Pay-for-performance or incentive systems

reward employee performance on the basis
of these assumptions:
1. Individual employees and work teams differ in
how much they contribute – not only in what
they do it but how they do it
2. Company overall performance depends to a
large extent on the performance of individuals
and groups
3. To attract, retain and motivate high
performers and be fair to all employees a
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company needs to reward employees on the
PAY-FOR-PERFORMANCE:
THE CHALLENGES
• The “do only what you get paid for” syndrome
• Unethical behavior
• Negative effects on the spirit of cooperation
• Lack of control
• Difficulties in measuring performance
• Psychological contracts: A set of expectations based
on prior experience, and it is very resistant to change
• The credibility gap: A phenomenon which believes
that pay-for-performance programs are not fair or that
they do not truly reward performance
• Job dissatisfaction and stress
• Potential reduction of intrinsic drives
MEETING THE CHALLENGES OF
PAY-FOR-PERFORMANCE
SYSTEMS
• Link pay and performance appropriately
• Piece-rate system – A compensation system in which
employees are paid per unit produced.
• Use pay-for-performance as part of a broader HRM
system
• Build employee trust
• Promote the belief that performance makes a difference
• Use multiple layers of rewards
• Increase employee involvement
• Use motivation and nonfinancial incentives
TYPES OF PAY-FOR-PERFORMANCE
PLANS
 TYPES OF PAY-FOR-PERFORMANCE PLANS – INDIVIDUAL

• Individual-based plans
• Merit pay
• An increase in base pay, normally given once a year
• Bonus programs
• A financial incentive sometimes called lump-sum
payments are similar to merit pay programs but differ in
one important respect. Bonuses are given on a one-time
basis and do not raise the employee’s base pay permanently.
Bonuses tend to be larger than merit pay increases because
they involve lower risk to the employer
• Awards
• Awards, like bonuses, are one-time rewards but tend to be
given in the form of a tangible prize, such as a paid vacation,
a television set
• Piece-rate
• A compensation system in which employees are paid per
unit produced.
TYPES OF PAY-FOR-PERFORMANCE PLANS –
INDIVIDUAL
• Advantages
• Rewarded performance is likely to be repeated –
expectancy theory : A theory of behavior holding that
people tend to do those things that are rewarded.
• Individuals are goal oriented and financial incentives can
shape an individual’s goals over time
• Help the firm achieve individual equity
• Fit in with an individualistic culture
• Disadvantages
• Tying pay to goals may promote single-mindedness
• Employees do not believe pay and performance are linked
• They may work against achieving quality goals
• Individual-based plans also work against quality programs
that emphasize teamwork
• They may promote inflexibility.
TYPES OF PAY-FOR-PERFORMANCE PLANS – INDIVIDUAL

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Conditions under which individual-based plans

are most likely to succeed
• When the contributions of individual
employees can be accurately isolated
• When the job demands autonomy
• When cooperation is less critical to
successful performance or when competition
is to be encouraged
 TYPES OF PAY-FOR-PERFORMANCE
PLANS – TEAM BASED
• Team-based plans attempt to support other efforts to
increase the flexibility of the work force within a firm.
• These plans normally reward all team members equally
based on group outcomes.
• Advantages
• Foster group cohesiveness
• Facilitate performance measurement
• Disadvantages
• Possible lack of fit with individualistic cultural values
• Free-riding effect: In any group, some individuals put in more effort
than others. In addition, ability levels differ from one person to the
next. Those who contribute little to the team—either because of low
effort or limited ability—are free riders.
• Social pressures to limit performance
• Difficulties in identifying meaningful groups because of
interdependence in groups
• Inter-group competition leading to a decline in overall performance.
 TYPES OF PAY-FOR-PERFORMANCE
PLANS – TEAM BASED
Conditions under which team-based plans are most likely to succeed-
• When work tasks are so intertwined it is difficult to single out who did
what
• When the firm’s organization facilitates the implementation of team-based
incentives
• Few levels in hierarchy
• Technology allows for the separation of work into relatively self-contained or
independent group
• Employees are committed to their work and are intrinsically motivated
• The organization needs to insist on group goals
• Team-based incentives can help blend employees with diverse backgrounds
and perspectives and focus their efforts on goals important to the
organization
• When the objective is to foster entrepreneurship in self-managed work
groups
 TYPES OF PAY-FOR-PERFORMANCE
PLANS – PLANT-WIDE
Plant-wide plans
Generally referred to as gainsharing programs because they
return a portion of the company's cost savings to the workers,
usually in the form of a lump-sum bonus.
• Advantages • Disadvantages

• Eliciting active • Protection of low performers –

free riders
employee input
• Problems with the criteria used
• Increasing the level of
to identify rewards
cooperation • Too rigid formula can result in
• Fewer measurement employee unrest

difficulties • Improving cost savings will not

necessarily improve profitability
• Improved quality and
• There may be only a few labor-
worker acceptance saving opportunities in a plant
• Management-labor conflict
TYPES OF PAY-FOR-PERFORMANCE
PLANS – PLANT-WIDE

Conditions favoring Plant-Wide Plans:

• Firm size – small to medium sized plants
• Technology – does not limit improvements
• Historical performance – takes into account
different plants’ varying levels of efficiency so
as to not penalize efficient plants
• Corporate culture – less likely to succeed in
firms with a traditional hierarchy, instead can
be used effectively in a firm that is making the
transition from a more autocratic to a more
participative management style
• Stability of product market – demand for
product is relatively stable
TYPES OF PAY-FOR-PERFORMANCE
PLANS – CORPORATE-WIDE
Corporate-wide Plans
• Macro type of incentive program and is based on the
entire corporation's performance
• Profit sharing
• A corporatewide pay-for- performance plan that uses a
formula to allocate a portion of declared profits to
employees. Typically, profit distributions under a profit-
sharing plan are used to fund employees’ retirement
plans.
• Differences between Corporate-wide Plan and Gain
sharing
• No attempt is made to reward workers for productivity
improvements
• They are very mechanistic and use formula to allocate
the portion of declared profits to employees
• Profit distributions are used to fund employees’
retirement plans. As a result, employees seldom receive
profit distributions in cash
TYPES OF PAY-FOR-PERFORMANCE PLANS –
CORPORATE-WIDE
• Corporate-wide Types of Plans
• Profit-sharing plans
• Cash plans
• Employees receive cash shares of the firm’s profits at
regular intervals.
• Deferred profit-sharing plans
• A predetermined portion of profits is placed in each
employee’s account under a trustee’s supervision.
• Employee stock ownership plans (ESOPs)
• A corporatewide pay-for- performance plan that rewards
employees with company stock either as an outright grant or at
a favorable price that may be below market value.
• The trust holds the stock in individual employee accounts and
distributes it to employees upon separation from the firm if the
employee has worked long enough to earn ownership of the
stock.
TYPES OF PAY-FOR-PERFORMANCE PLANS –
CORPORATE-WIDE

• Advantages
• Financial flexibility for the firm
• Increased employee commitment
• Tax advantages

• Disadvantages
• Risk for employees
• High exposure to macroeconomic forces
• Limited effect on productivity
• Long-run financial difficulties.
 TYPES OF PAY-FOR-PERFORMANCE PLANS –
CORPORATE-WIDE
Conditions favoring corporate-wide plans
• Firm size
• Profit sharing and ESOP’s are plans for large organizations
• Interdependence of different parts of the business
• Corporations with multiple interdependent plants or business units
often find corporatewide plans most suitable
• Market conditions
• Suitable in dynamic conditions as the structuring of these incentives
helps the firm cut costs during downturns and employees usually
are not immediately affected by these fluctuations
• The presence of other incentives
• When used in combination with other incentives (for example,
individual and team bonuses), corporatewide programs can promote
greater commitment to the organization by creating common goals
and a sense of partnership among managers and workers
DESIGNING PAY-FOR-PERFORMANCE
PLANS – MANAGERS AND EXECUTIVES

• Bonus

Plans that are designed to motivate short-term performance

of managers and are tied to company profitability

• Salary and short-term incentives

The amount of executives’ base pay increases as firms get
larger

• Long-term incentives
Most executives also receive long-term incentives, either in
the form of equity in the firm (stock-based programs) or a
combination of cash awards and stock.
 DESIGNING PAY-FOR-PERFORMANCE
PLANS – MANAGERS AND EXECUTIVES
• Stock option
• The right to purchase a specific number of shares of company
stock at a specific price during a specific period of time.
• Options have no value (go “underwater”) if the price of the
stock drops below the option’s strike price (the option’s stock
purchase price).
• Golden Parachutes
• It provides a CEO with a large lump-sum payment if he or she
is terminated by the firm. These “parachutes” represent a
contractual obligation on the part of the company to the CEO,
even if the CEO is fired for poor performance
• Perks or perquisites- non-cash incentives
KEY STRATEGIC QUESTIONS TO DESIGN
EXECUTIVE LONG-TERM INCOME PROGRAMS

• How long should the time horizon be for dispensing rewards?

• Should length of service be considered in determining the
amount of the award?
• Should the executive be asked to share part of the costs and,
therefore, increase his or her personal risk?
• What criteria should be used to trigger the award?
• Should there be a limit on how much executives can earn or
a formula to prevent large unexpected gains?
• How often should the awards be provided?
• How easy should it be for the executive to convert the award
into cash?
DESIGNING PAY-FOR-PERFORMANCE PLANS –
SALESPEOPLE

• Straight salary (with no incentives),

• Appropriate when maintaining good customer
relations and servicing existing accounts are the
key objectives, with increased sales a secondary
goal
• Straight commission (in which all earnings are in
the form of incentives)
• Appropriate when the key objective is to generate
greater sales volume through new accounts
• A combination plan that mixes the two
PROS & CONS OF SALES COMPENSATION METHODS
REWARDING EXCELLENCE IN CUSTOMER
SERVICE

• More and more companies are using incentive

systems to reward and encourage better
customer service.
• Common measures of customer satisfaction used
to determine incentive payments are customer
surveys, records of on-time delivery of products
and services, and number of com- plaints
received.
• Customer service rewards may be individual,
team, or plant-based.
SUMMARY AND CONCLUSIONS

• Pay-for-performance: The Challenges

• Meeting the challenges of pay-for-
performance systems
• Types of pay-for-performance
• Designing pay-for-performance plans
for executives and salespeople