Compensation Compensation Pay for PerformancePay for Performance

Key Topics – Pay for Key Topics – Pay for PerformancePerformance

Types of incentive plansTypes of incentive plans

Merit pay and motivation Merit pay and motivation

Sales incentive programsSales incentive programs

Corporate-wide gainsharing and profit Corporate-wide gainsharing and profit sharing planssharing plans

Variable PayVariable Pay

Variable PayVariable Pay Tying pay to some measure of individual, Tying pay to some measure of individual,

group, or organizational performance.group, or organizational performance.

Sales IncentivesSales Incentives

Straight Commission

Sales Incentive PlansSales Incentive Plans

Straight Salary

Salary and CommissionCombinations

Incentive Plans for Incentive Plans for SalespersonsSalespersons

Straight Salary PlanStraight Salary Plan Compensation plan that permits salespeople to be Compensation plan that permits salespeople to be

paid for performing various duties that are not paid for performing various duties that are not reflected immediately in their sales volume.reflected immediately in their sales volume.

Advantages:Advantages: Encourages building customer relationships.Encourages building customer relationships.

Provides compensation during periods of poor sales.Provides compensation during periods of poor sales.

Disadvantage:Disadvantage: May not provide sufficient motivation for maximizing May not provide sufficient motivation for maximizing

sales volume.sales volume.

Incentive Plans for Incentive Plans for SalespersonsSalespersons

Straight Commission PlanStraight Commission Plan Compensation plan based upon a percentage of Compensation plan based upon a percentage of

sales. sales. DrawDraw is a cash advance that must be paid back as is a cash advance that must be paid back as

commissions are earned.commissions are earned. Disadvantages:Disadvantages:

Emphasis is on sales volume rather than on profits.Emphasis is on sales volume rather than on profits.

Customer service after the sale is neglected.Customer service after the sale is neglected.

Earnings tend to fluctuate widely between good and poor Earnings tend to fluctuate widely between good and poor periods of business.periods of business.

Temptation to grant price concessions to get sales.Temptation to grant price concessions to get sales.

Incentive Plans for Incentive Plans for SalespersonsSalespersons

Combined Salary and Commission PlanCombined Salary and Commission Plan A compensation plan that includes a straight salary A compensation plan that includes a straight salary

and a commission component (“leverage”).and a commission component (“leverage”). Advantages:Advantages:

Combines the advantages of straight salary and straight Combines the advantages of straight salary and straight commission forms of compensation.commission forms of compensation.

Offers greater design flexibilityOffers greater design flexibility

Can be used to develop the most favorable ratio of selling Can be used to develop the most favorable ratio of selling expense to sales.expense to sales.

Motivates sales force to achieve specific company Motivates sales force to achieve specific company marketing objectives in addition to sales volume.marketing objectives in addition to sales volume.

Incentives for Professional Incentives for Professional EmployeesEmployees

Profit sharing and stock ownershipProfit sharing and stock ownership

Double-track wage systemsDouble-track wage systems

Managerial and Executive IncentivesManagerial and Executive Incentives

Bonuses and merit increasesBonuses and merit increases

Performance incentive bonusesPerformance incentive bonuses

Executive perquisites (perks)Executive perquisites (perks)

Executive CompensationExecutive Compensation

The Executive Pay PackageThe Executive Pay Package Base salaryBase salary Short-term incentives or bonusesShort-term incentives or bonuses Long-term incentives or stock plansLong-term incentives or stock plans BenefitsBenefits Perquisites (perks)Perquisites (perks)

Executive CompensationExecutive Compensation JustificationsJustifications

Large financial incentives reward superior Large financial incentives reward superior performance.performance.

Business competition is pressure-filled and Business competition is pressure-filled and demanding.demanding.

Good executive talent is in great demand.Good executive talent is in great demand.

Effective executives create shareholder Effective executives create shareholder value.value.

Types of Long-Term Incentive Plans

Stock options Rights granted to executives to purchase shares of their organization’s stock at an established price for a fixed period of time. Stock price is usually set at market value at the time the option is granted.

Stock appreciation rights (SARs)

Cash or stock award determined by increase in stock price during any time chosen by the executive in the option period; does not require executive financing.

Stock purchase Opportunities for executives to purchase shares of their organization’s stock valued at full market or a discount price, often with the organization providing financial assistance.

Phantom stock Grant of units equal in value to the fair market value or book value of a share of stock; on a specified date the executive will be paid the appreciation in the value of the units up to that time.

Restricted stock Grant of stock or stock units at a reduced price with the condition that the stock not be transferred or sold (by risk of forfeiture) before a specified employment date.

Performance units Grants analogous to annual bonuses except that the measurement period exceeds one year. The value of the grant can be expressed as a flat dollar amount or converted to a number of “units” of equivalent aggregate value.

Performance shares

Grants of actual stock or phantom stock units. Value is contingent on both predetermined performance objectives over a specified period of time and the stock market.

Executive Compensation: Executive Compensation: Ethics and AccountabilityEthics and Accountability

Incentive payments are excessive compared Incentive payments are excessive compared with return to stockholders.with return to stockholders.

Time periods for judging and rewarding Time periods for judging and rewarding performance are too short.performance are too short.

Quarterly earnings growth is emphasized at the Quarterly earnings growth is emphasized at the expense of research and development.expense of research and development.

Emphasis is placed upon equaling or exceeding Emphasis is placed upon equaling or exceeding executive salary survey averages.executive salary survey averages.

Benefits do not relate closely to individual Benefits do not relate closely to individual performance.performance.

Executive Compensation Executive Compensation ReformReform

Current Reform MeasuresCurrent Reform Measures The Internal Revenue Service (IRS) is looking for tax-The Internal Revenue Service (IRS) is looking for tax-

code violations in executive pay packages and will code violations in executive pay packages and will make executive pay a part of corporate audits.make executive pay a part of corporate audits.

The Securities and Exchange Commission issued pay The Securities and Exchange Commission issued pay disclosure rules which require companies listed on the disclosure rules which require companies listed on the New York Stock Exchange and NASDAQ to disclose New York Stock Exchange and NASDAQ to disclose the true size of their top executive pay packages.the true size of their top executive pay packages.

The Financial Accounting Standards Board (FASB) now The Financial Accounting Standards Board (FASB) now requires that stock options be recognized as an requires that stock options be recognized as an expense on income statements.expense on income statements.

Executive Compensation Executive Compensation Reform (cont’d)Reform (cont’d)

Other Reform Measures:Other Reform Measures: The adoption of performance formulas that peg The adoption of performance formulas that peg

executive compensation to organizational executive compensation to organizational benchmarks other than stock pricebenchmarks other than stock price

Shareholder resolutions that allow shareholders Shareholder resolutions that allow shareholders the right to vote on executive pay packagesthe right to vote on executive pay packages

Greater accountability by compensation Greater accountability by compensation committees to justify large executive pay committees to justify large executive pay awards or severance or retirement packagesawards or severance or retirement packages

Group Incentive PlansGroup Incentive Plans Team Incentive PlansTeam Incentive Plans

Compensation plans where all team members Compensation plans where all team members receive an incentive bonus payment when receive an incentive bonus payment when production or service standards are met or production or service standards are met or exceeded.exceeded.

Establishing Team Incentive PaymentsEstablishing Team Incentive Payments Set performance measures upon which incentive Set performance measures upon which incentive

payments are basedpayments are based Determine the size of the incentive bonus.Determine the size of the incentive bonus. Create a payout formula and fully explain to Create a payout formula and fully explain to

employees how payouts will be distributed. employees how payouts will be distributed.

Team Incentive Plans Team Incentive Plans (cont’d)(cont’d)

AdvantagesAdvantages Team incentives support group planning and problem Team incentives support group planning and problem

solving, thereby building a team culture.solving, thereby building a team culture. The contributions of individual employees depend on The contributions of individual employees depend on

group cooperation.group cooperation. Team incentives can broaden the scope of the Team incentives can broaden the scope of the

contribution that employees are motivated to make.contribution that employees are motivated to make. Team bonuses tend to reduce employee jealousies and Team bonuses tend to reduce employee jealousies and

complaints over “tight” or “loose” individual standards.complaints over “tight” or “loose” individual standards. Team incentives encourage cross-training and the Team incentives encourage cross-training and the

acquiring of new interpersonal competencies.acquiring of new interpersonal competencies.

Team Incentive Plans Team Incentive Plans (cont’d)(cont’d)

DisadvantagesDisadvantages Individual team members may perceive that Individual team members may perceive that

“their” efforts contribute little to team success “their” efforts contribute little to team success or to the attainment of the incentive bonus.or to the attainment of the incentive bonus.

Intergroup social problems—pressure to limit Intergroup social problems—pressure to limit performance and the “free-ride” effect may performance and the “free-ride” effect may arise.arise.

Complex payout formulas can be difficult for Complex payout formulas can be difficult for team members to understand.team members to understand.

Group Incentive Plans Group Incentive Plans (cont’d)(cont’d)

Gainsharing PlansGainsharing Plans Programs under which both employees and the Programs under which both employees and the

organization share the financial gains organization share the financial gains according to a predetermined formula that according to a predetermined formula that reflects improved productivity and profitability.reflects improved productivity and profitability.

Scanlon PlanScanlon Plan Rewards come from employee participation in improving productivity and reducing costs.

Rewards come from employee participation in improving productivity and reducing costs.

Rucker Plan (SOP)

Rucker Plan (SOP)

Shared rewards come from the difference between labor costs and sales value of production.

Shared rewards come from the difference between labor costs and sales value of production.

ImproshareImproshare Gainsharing based on increases in productivity of the standard hour output of work teams.

Gainsharing based on increases in productivity of the standard hour output of work teams.

Gainsharing Incentive PlansGainsharing Incentive Plans

Earnings-at-riskEarnings-at-riskEncourages employees to achieve higher output and quality standards by placing a portion of their base salary at risk of loss.

Encourages employees to achieve higher output and quality standards by placing a portion of their base salary at risk of loss.

Scanlon Plan Suggestion Process

Scanlon Plan Suggestion Process

Enterprise Incentive PlansEnterprise Incentive Plans Profit SharingProfit Sharing

Any procedure by which an employer pays, or Any procedure by which an employer pays, or makes available to all regular employees, in makes available to all regular employees, in addition to their base pay, current or deferred addition to their base pay, current or deferred sums based upon the profits of the enterprise.sums based upon the profits of the enterprise.

Challenges:Challenges: Agreement over the percentages of shared of profits Agreement over the percentages of shared of profits

and the forms of distribution (cash or deferred) of and the forms of distribution (cash or deferred) of profits between company and employeesprofits between company and employees

Annual variations and possibility of no payout due to Annual variations and possibility of no payout due to financial condition of companyfinancial condition of company

Maintaining motivational connection of profit-sharing Maintaining motivational connection of profit-sharing to performance of employeesto performance of employees

Enterprise Incentive Plans Enterprise Incentive Plans (cont’d)(cont’d)

Stock OptionsStock Options Granting employees the right to purchase a Granting employees the right to purchase a

specific number of shares of the company’s specific number of shares of the company’s stock at a guaranteed price (the option price) stock at a guaranteed price (the option price) during a designated time period.during a designated time period.

The value of an option is subject to stock The value of an option is subject to stock market conditions at the time that option is market conditions at the time that option is exercised.exercised.

Enterprise Incentive Plans Enterprise Incentive Plans (cont’d)(cont’d)

Employee Stock Ownership Plans (ESOPs)Employee Stock Ownership Plans (ESOPs) Stock plans in which an organization contributes Stock plans in which an organization contributes

shares of its stock to an established trust for the shares of its stock to an established trust for the purpose of stock purchases by its employees.purpose of stock purchases by its employees.

The employer establishes an ESOP trust that qualifies as The employer establishes an ESOP trust that qualifies as a tax-exempt employee trust under Section 401(a) of a tax-exempt employee trust under Section 401(a) of the Internal Revenue Codethe Internal Revenue Code

Stock bonus plans are funded by direct employer Stock bonus plans are funded by direct employer contributions of its stock or cash to purchase its stock.contributions of its stock or cash to purchase its stock.

Leveraged plans are funded by employer borrowing to Leveraged plans are funded by employer borrowing to purchase its stock for the ESOP.purchase its stock for the ESOP.

Employee Stock Ownership Employee Stock Ownership PlansPlans

Rewards and Risks of ESOPSRewards and Risks of ESOPS

AdvantagesAdvantages DisadvantagesDisadvantages

Liquidity and valueLiquidity and value

Pride of ownershipPride of ownership

Deferred taxesDeferred taxes

Single funding basisSingle funding basis

Not insuredNot insured

Retirement benefitsRetirement benefits

Pay-for-performance: many challengesPay-for-performance: many challenges Meeting the challenges requires planning Meeting the challenges requires planning

Should be part of larger compensation systemShould be part of larger compensation system Should fit with overall strategic plan of org.Should fit with overall strategic plan of org.

Pay-for-performance at four levels:Pay-for-performance at four levels: Individual, group, plant, organization wideIndividual, group, plant, organization wide

If P-f-P plan becomes entrenchedIf P-f-P plan becomes entrenched Employees will expect them regularlyEmployees will expect them regularly

P-f-P for executives and salespeople P-f-P for executives and salespeople requires additional thoughtrequires additional thought

Summary and ConclusionsSummary and Conclusions