Chapter 5
Performance Pay Choices
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Learning Outcomes
• Define and discuss the applicability of the main types
of individual performance pay.
• Define and discuss the applicability of the main types
of group performance pay.
• Define and discuss the applicability of the three main
types of organization performance pay.
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Figure 5.1
Performance Pay Choices
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Individual Performance Pay
A pay system under which individuals receive a
specified sum of money for each unit of output
Piece rates they produce or process
The same specified sum of money is paid for
Straight piece rate each piece produced or processed, regardless
of how many pieces are produced or processed
A lower sum of money per piece is paid if employee
Differential piece rate production does not meet the production standard,
and then a higher sum per piece is paid once the
production standard is met
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Advantages of
Piece Rates
• Highly motivational in producing task
behaviour
• Reduce the need for external control of
employees
• Link compensation to output and reduce
employer risk
• Provide specific information about the
“standard” level of output expected
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Piece Rates
Barbers and hairdressers usually charge fees per head.
© [Link]/SerhiiBobyk
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Disadvantages of
Piece Rates
• Can be applied in only a limited number of
circumstances
• Needs to be recalculated each time a major
change occurs
• Setting rate is not a “scientific” process
• Frequently do not motivate maximum effort
• Can decrease production in layoff
environments
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Advantages of
Sales Commissions
• Relatively easy to set and measure
• Less interdependence among sales employees than
production, work output is more distinct
• Less worry about losing jobs
• Reduces the need for other types of control
mechanisms
• Can serve as a source of feedback and as a self-
correcting mechanism
• Reduce employer risk
• Can increase sales
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Disadvantages of
Sales Commissions
• Income may be highly variable
• Commissions may drop in poor economic conditions
• Receive little income as they develop contacts
• Salespeople may resist doing work that does not
directly contribute to new sales
• May encourage overly aggressive sales behaviour;
often produces intense competition and lack of
cooperation
• Apportioning responsibility for making sales can be a
major problem
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Commissions
Three key dimensions
1. Degree of independence
2. Degree of persuasive skills required
3. Length of sales cycle
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Commissions
Four Types of Selling
• Maintenance selling
– Selling established products to existing customers
• Conversion selling
– Selling established products to new customers
• Leverage selling
– Selling new products to existing customers
• New market selling
– Selling new products to new customers
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Assessment Question 5.1
As a salesperson, Claire receives a set percentage
of her overall sales in the form of compensation
without any fixed salary or benefits. Which of the
following best describes Claire’s compensation
plan?
a. straight commission plan
b. leverage commission plan
c. percentage commission plan
d. hybrid commission plan
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Merit Raises
• An increase to an employee’s base bay in
recognition of good job performance
• Advantages
– Focuses attention on overall performance
– Provides feedback to employees
– A means for advancement through the pay range
– Helps to retain outstanding employees
– Can foster perceptions of equity
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Disadvantages of
Merit Raises
• Very expensive since they are permanent
• Requires an effective employee appraisal system
• Need to ensure a noticeable difference in pay
• “Top out”
• Cause antagonism toward supervisor
• Inhibit collaborative behaviour
• Not suitable where work is highly
interdependent
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Merit Bonuses
• A cash payment, provided to recognize good
employee performance, that does not increase
base pay
• Advantages
– More flexible because they are not permanent
– Can be used in conjunction with a merit raise system
– Can be related to financial conditions of firm
– Can be paid out in lump sums and are more visible
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Disadvantages of
Merit Bonuses
• Need valid performance measures
• Not suitable where work is highly
interdependent
• Bonus amount may need to be higher
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Assessment Question 5.2
Applicability of merit pay requires the presence of
certain conditions. Which of the following is NOT
such a suitable condition?
a. Undesirable external influences are readily
manageable
b. Individual performances can be separated out
c. Individual performance varies
d. Performance is not controllable by the
individual
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Promotions
• Advantages
– Brings recognition and a pay raise
– Typically the promotion contains more of the
elements of intrinsically motivating work
– Recognizes contributions employees have made to
the organization
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Disadvantages of Promotions
• Disadvantages
– Lack of promotion opportunity can be
demotivating
– Promotions in lieu of other rewards can result in a
meaningless system if few upper-level vacancies
– Those not promoted can become demotivated
– Promotion not always seen as a reward
– Peter principle
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Special-Purpose Incentives
• An incentive designed to motivate a specific
type of employee behaviour
– Incentives for creativity
• Suggestion systems
– Incentives for attendance
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Advantages and Disadvantages of Special-
Purpose Incentives
• Advantages
– Focuses attention on key employee behaviours
– Depends on specific nature of plan
• Disadvantages
– Employees may focus only on rewarded
behaviours
– Depends on specific nature of plan
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Group Performance Pay
(Slide 1 of 2)
• Gain-Sharing Plans
– A group performance pay plan that shares cost
savings or productivity gains generated by a work
group with all members of that group
• Goal-Sharing
– A group performance pay plan in which a work
group receives a bonus when it meets prespecified
performance goals
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Group Performance Pay
(Slide 2 of 2)
• Other Types of Group Plans
– Competitive bonus
– Pooled performance pay
– Group commissions
– Group piece rates
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Group Performance Pay
5-24
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Advantages of
Gain-Sharing Plans
• Self-funding if designed properly
• Can stimulate higher productivity
• May create positive group norms
• May lead to internalized worker commitment,
and reduce need for external control
• Can increase employee knowledge of the
business
• Can be applied to not-for-profits and
government
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Disadvantages of
Gain-Sharing Plans
• Costs of establishing and administering plan
• Not amenable to changing circumstances
• May focus attention on group’s interests only
• May create more opportunities for labour-
management conflict
• May create “free riders”
• High discontinuation rate
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Advantages of
Goal-Sharing Plans
• More flexible than gain sharing
• Less costly to operate that gain-sharing plans
• Can be adjusted as circumstances require
• Powerful motivational tool for groups and
individuals
• May create positive group norms
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Disadvantages of
Goal-Sharing Plans
• Can be arbitrary in goal levels and bonus
amounts
• No established basis for judging value of meeting
a goal
• Setting appropriate goals can be difficult
• Situational factors can affect goal development
• May cause frustration if efforts fall slightly short
• Can produce conflict
• High discontinuation rate
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Assessment Question 5.3
A retail chain decided to pay a bonus to all
salespeople at the store that had the highest
sales compared to all other stores. What kind of
performance pay plan are they using?
a. group commission
b. pooled performance
c. competitive bonus
d. goal sharing
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Organization Performance Pay Plans
Current Deferred profit- Combination
Profit sharing
distribution sharing (DPSP) profit-sharing
• A formal pay • A profit-sharing • A profit-sharing • A plan that
program in plan that plan in which combines the
which a firm distributes the the profit- current
provides bonus profit-sharing sharing distribution and
payments to bonus to bonuses are deferred profit-
employees employees in allocated to sharing plans by
based on the the form of employee paying some of
profitability of cash or shares, accounts but the profit-
the firm at least not actually sharing bonus
annually paid out until a on a current
• Also known as a later date, (cash) basis and
“cash plan” usually on deferring the
termination or remainder
retirement
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Profit Sharing
Canadian Tire was an early adopter of profit sharing.
Bloomberg/Getty Images
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Advantages of
Profit-Sharing Plans
• When interests are aligned, employees may be
more motivated to improve performance
• Can reduce need for supervision
• Profit sharing is related to company ability to pay
• Leads to higher total employee earnings
• May reduce the need for layoffs
• Greater job satisfaction
• Simpler to set up and administer than plans like
gain-sharing
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Profit-Sharing Plans
• Disadvantages
– May not pay off for employer
– May actually reduce employee performance by
causing free riding
– Unions may oppose
– Requires employers to share financial information
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Employee Stock Plans
Employee stock Employee share Employee stock
Employee stock
bonus purchase option
• Any type of • A plan through • A plan through • A plan through
plan through which which which
which employees employees employees are
employees receive shares may purchase provided with
acquire shares in their shares in their options to
in the firm employer firm employer firm purchase
that employs at no cost to shares in their
them the employee employer at a
fixed price
within a
limited time
period
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Advantages of
Employee Stock Plans
• Can cause employees to • Provides better job
“think like owners” security
• Can create stronger • May lead to improved
understanding and management
concern for overall • Do not require company
company performance, to pay our cash
promote cooperation • Can serve as a catalyst for
• Can provide employees a a more flexible and
say and sense of control entrepreneurial high-
• Can improve involvement type of
compensation package organization
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Disadvantages of
Employee Stock Plans
• Administration carries a lot of cost
• If share price declines, employees may become
demoralized/disgruntled
• Decision-making participation could cause
backlash if not aligned
• Employees may not have funds to invest
• Investing in the employer may be risky
• More complicated for publicly traded
companies
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Assessment Question 5.4
Under a stock bonus plan, which of the following
apply?
a. Employees receive financial advice on stocks
for free
b. Employees receive bonuses equal to the
increase in share price
c. Employees receive shares at 50% discount of
current market share price
d. Employees receive shares at no cost to them
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Other Organization Performance
Pay Plans
Long-term Performance unit Performance share
incentives (LTIs) plan plan
• A type of • A long-term • A long-term
performance pay incentive in which incentive in which
in which the the bonus the bonus
incentives are tied amounts are amounts are
to an organization expressed in units expressed in
performance for which the company shares
horizon that monetary value
ranges beyond will fluctuate,
one year, often depending on
three to five years degree of goal
accomplishment
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Discussion Questions
1. Discuss the key advantages and disadvantages, in
general, of individual level pay for performance pay
systems.
2. Discuss the considerations you would use in
deciding whether to apply gain sharing or goal
sharing to a particular work group.
3. Discuss the considerations you would use in
deciding whether to apply profit sharing or
employee share ownership to a given organization.
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