Mgmt 383 Chapter 13 Variable Pay & Executive Compensation Spring 2009

Mgmt 383Mgmt 383

Chapter 13Chapter 13

Variable Pay & Executive Variable Pay & Executive CompensationCompensation

Spring 2009Spring 2009

Variable PayVariable Pay

• Variable PayVariable Pay – compensation linked – compensation linked to individual, group or organizational to individual, group or organizational performance.performance.• The emphasis is on the linking of rewards The emphasis is on the linking of rewards

with performancewith performance• The philosophical argument is between The philosophical argument is between

merit-basedmerit-based compensation and compensation and seniority-seniority-basedbased compensation. compensation.

Basic Assumptions of Variable Basic Assumptions of Variable PayPay

• Some people do better work than others. Some people do better work than others. • Employees who do more for the organization Employees who do more for the organization

should receive more.should receive more.• A portion of certain employees’ total A portion of certain employees’ total

compensation should be predicated on compensation should be predicated on rewarding above-satisfactory performance. rewarding above-satisfactory performance.

• Some jobs contribute more to organizational Some jobs contribute more to organizational success than others.success than others.

• New venture team v. custodial department.New venture team v. custodial department.

Reasons for IncentivesReasons for Incentives

• Link strategic goals and employee performance.Link strategic goals and employee performance.• Achieve HR objectives such as increasing Achieve HR objectives such as increasing

retention, reducing turnover, recognizing training retention, reducing turnover, recognizing training success, or reward safety.success, or reward safety.

• Reward employees financially for their Reward employees financially for their contribution to organizational results.contribution to organizational results.

• Recognize different levels of employee Recognize different levels of employee performance and reward employees.performance and reward employees.

The Golden Rule of Variable The Golden Rule of Variable PayPay

The most important factor in the success of any incentive program is that it must be consistent with both the culture and the financial resources of the organization.

RewardsRewards

• Remember behavior modification.Remember behavior modification.• It is important to make sure that what is being It is important to make sure that what is being

rewarded is really what is needed, because rewarded is really what is needed, because people tend to produce what is measured and people tend to produce what is measured and rewarded.rewarded.

• Never assume that everyone wants the same Never assume that everyone wants the same type of incentive rewards.type of incentive rewards.

Types of Variable PayTypes of Variable Pay

• IncentivesIncentives - compensation offered as reward - compensation offered as reward for efforts (for efforts (resultsresults) beyond normal ) beyond normal performance expectations.performance expectations.• Individual IncentivesIndividual Incentives - do not require (or - do not require (or

encourage) cooperation among individuals.encourage) cooperation among individuals.• Group/Team IncentivesGroup/Team Incentives - requires entire group to - requires entire group to

cooperate to attain reward (may cause intragroup cooperate to attain reward (may cause intragroup conflict).conflict).

• Organizational IncentivesOrganizational Incentives the entire organization the entire organization is rewarded.is rewarded.

Individual IncentivesIndividual Incentives

• Conditions/criteria:Conditions/criteria:• Individual performance must be isolated and Individual performance must be isolated and

identifiable.identifiable.• Independent work must be performed. Results Independent work must be performed. Results

must not be too interdependent with other must not be too interdependent with other workers.workers.

• Individual competitiveness must be desired.Individual competitiveness must be desired.• The organizational culture must emphasize The organizational culture must emphasize

individual achievement.individual achievement.

Individual IncentivesIndividual Incentives

• Types of individual incentives:Types of individual incentives:• Straight Piece-RateStraight Piece-Rate - - number of units produced.number of units produced.• Differential Piece-RateDifferential Piece-Rate - - rate increases with rate increases with

higher levels of production.higher levels of production.• BonusesBonuses – – one-time,one-time, lump sum, payment that does lump sum, payment that does

not become part of the employees base pay.not become part of the employees base pay.• AttendanceAttendance

• CertificationsCertifications

• Production quotasProduction quotas

• Commissions/sales compensationCommissions/sales compensation

Individual Incentives: Individual Incentives: Sales Sales CompensationCompensation

• Sales CompensationSales Compensation – the three most common – the three most common approaches:approaches:• Salary OnlySalary Only• Straight CommissionStraight Commission - - set percentage of salesset percentage of sales• Salary-Plus Commission or BonusSalary-Plus Commission or Bonus

• Sales Performance Metrics - Sales Performance Metrics - Establishing clear Establishing clear performance measures:performance measures:

• Sales to quotaSales to quota• Sales relative to other sales staffSales relative to other sales staff• Sales from new customersSales from new customers• New product salesNew product sales• Control of sales expensesControl of sales expenses• Account retentionAccount retention• Customer satisfactionCustomer satisfaction

Individual Incentives: Individual Incentives: Special Special Incentive ProgramsIncentive Programs

• Special Incentive ProgramsSpecial Incentive Programs• Performance Awards [nonmonetary] – Performance Awards [nonmonetary] – incentives for incentives for

significant performance.significant performance.• TravelTravel

• MerchandiseMerchandise

• Gift certificatesGift certificates

• Recognition Awards – Recognition Awards – given to acknowledge specific given to acknowledge specific efforts or activities (customer service, e.g.)efforts or activities (customer service, e.g.)

• Employee of the YearEmployee of the Year

• Service Awards - Service Awards - length of servicelength of service

Practical AdvicePractical Advice

Keep it simple!Keep it simple!

• A variable pay program will NOT A variable pay program will NOT accomplish its intended purpose if it is too accomplish its intended purpose if it is too complicated or complex to be understood complicated or complex to be understood by employeesby employees

Group/Team IncentivesGroup/Team Incentives

• Conditions/criteria:Conditions/criteria:• Significant interdependence exists; team work Significant interdependence exists; team work

and cooperation are essential.and cooperation are essential.• Cannot readily identify exactly who is Cannot readily identify exactly who is

responsible for differing level of performance.responsible for differing level of performance.• Management wants to create or reinforce Management wants to create or reinforce

teamwork and cooperation.teamwork and cooperation.

Design of Group/Team Design of Group/Team IncentivesIncentives

• Distribution of Group/Team Incentives :Distribution of Group/Team Incentives :• Same size for all (76%)Same size for all (76%)• Different size for each team member (24%)Different size for each team member (24%)

• Timing of Group/Team Incentives Timing of Group/Team Incentives ::• Monthly (2%)Monthly (2%)• Quarterly (25%)Quarterly (25%)• Biannually (17%)Biannually (17%)• Annually (56%)Annually (56%)

Design of Group/Team Design of Group/Team IncentivesIncentives

• Decision Making about Amount of Decision Making about Amount of Group/Team IncentivesGroup/Team Incentives • Specific dollar amount, lump sum (56%)Specific dollar amount, lump sum (56%)• Percentage of base pay (44%)Percentage of base pay (44%)

Group/Team IncentivesGroup/Team Incentives• Problems with Group/Team Incentives:Problems with Group/Team Incentives:

• Internal equity problems.Internal equity problems.• Equal amounts perceived as “unfair” by hard workers. Equal amounts perceived as “unfair” by hard workers. • Free riders.Free riders.

• Poor performing individual can preclude the group Poor performing individual can preclude the group from gaining the reward. from gaining the reward.

• Group resistance (group dynamics).Group resistance (group dynamics).• Goal displacement (marketing wanting more Goal displacement (marketing wanting more

features to increase sales, production wanting features to increase sales, production wanting simpler designs to reduce costs).simpler designs to reduce costs).


• Work Team MetricsWork Team Metrics• Productivity quotasProductivity quotas• Timeliness goalsTimeliness goals• Cost savings goalsCost savings goals


• Gain Sharing Gain Sharing -- rewarding greater than rewarding greater than expected gains in profits or productivity.expected gains in profits or productivity.• Like profit sharing it is self-funding.Like profit sharing it is self-funding.• Methods of payment:Methods of payment:

• Flat rate (every body gets the same).Flat rate (every body gets the same).• Same percentage of base salary for all employees.Same percentage of base salary for all employees.• Percentage of gains attributed to each category of Percentage of gains attributed to each category of

employee (production workers, production supervisors, employee (production workers, production supervisors, purchasing agents receiving ,etc.)purchasing agents receiving ,etc.)

• Percentage of gains based on individual performance Percentage of gains based on individual performance (individual must have satisfactory performance for (individual must have satisfactory performance for eligibility)eligibility)

Group/Team IncentivesGroup/Team Incentives• Gain Sharing Gain Sharing

• Variations:Variations:• ImproshareImproshare - - group piece rategroup piece rate (total hours and output (total hours and output

in physical units).in physical units).

• Scanlon PlanScanlon Plan (1927) (1927)

• Department committees screen and evaluate cost-Department committees screen and evaluate cost-saving suggestions.saving suggestions.

• Direct incentive rewards to all employees involved Direct incentive rewards to all employees involved in realizing the suggestions.in realizing the suggestions.

Organizational IncentivesOrganizational Incentives

• Profit Sharing (a Profit Sharing (a self-fundingself-funding incentive) incentive) • Objectives:Objectives:

• Improve productivityImprove productivity

• Recruit employeesRecruit employees

• Improve product and service qualityImprove product and service quality

• Enhance employee moraleEnhance employee morale

• Methods of determining “Profit:”Methods of determining “Profit:”• Fixed percentage of profits.Fixed percentage of profits.

• Sliding percentage based on sales or ROA.Sliding percentage based on sales or ROA.

• Unit profits.Unit profits.


• Profit Sharing Profit Sharing • Eligibility: Eligibility: allall employees employees (nonexempt, exempt, (nonexempt, exempt,

executives).executives).• Methods of allocation:Methods of allocation:

• Equally to Equally to all all employees.employees.

• Percentage of base salary (employee earnings).Percentage of base salary (employee earnings).

• Based on a combination of employee earnings and Based on a combination of employee earnings and years of service.years of service.

• Based on employee contribution.Based on employee contribution.


• Factors diminishing profit sharing’s Factors diminishing profit sharing’s effectiveness.effectiveness.• Profits are not under completely under the Profits are not under completely under the

employees’ control.employees’ control.• Employees may wait a long time to receive Employees may wait a long time to receive

their rewards.their rewards.• Productivity improvement are made in August 2008, Productivity improvement are made in August 2008,

profits are not shared until July 2009.profits are not shared until July 2009.

• Management may resist disclosing financial Management may resist disclosing financial records.records.

• Note:Note: Profit Sharing requires full financial Profit Sharing requires full financial disclosure of profit information to employees.disclosure of profit information to employees.


• Employee Stock Ownership Programs Employee Stock Ownership Programs (ESOPs) (ESOPs) - - employees are reward by shares of employees are reward by shares of stock in the company.stock in the company.• Advantages:Advantages:

• Firm receives favorable tax treatment for earnings Firm receives favorable tax treatment for earnings earmarked for the ESOP.earmarked for the ESOP.

• Gives employees a sense of ownership, or at least a Gives employees a sense of ownership, or at least a sense that they have a “piece of the action.”sense that they have a “piece of the action.”

Executive CompensationExecutive Compensation

• Executives are technically those individuals Executives are technically those individuals who hold positions in the top two levels of who hold positions in the top two levels of an organization.an organization.• CEOCEO• CFOCFO• COOCOO• Senior Vice-PresidentsSenior Vice-Presidents


(1) Executive Salaries(1) Executive Salaries• Only accounts for 40%-60% of an executive's total Only accounts for 40%-60% of an executive's total

compensation.compensation.• Often performance-basedOften performance-based

(2) (2) Supplemental BenefitsSupplemental BenefitsExecutive health plansExecutive health plans

Life insuranceLife insurance

TrustsTrusts


(3) Executive Perquisites (3) Executive Perquisites noncash items:noncash items:• Free physical examinationsFree physical examinations• Company carCompany car• Free financial counselingFree financial counseling• First-class air travelFirst-class air travel• Club membershipClub membership• Personal liability insurancePersonal liability insurance• Estate planningEstate planning• Travel for spouseTravel for spouse• Golden parachutesGolden parachutes• Silver parachutesSilver parachutes


(4) Executive Bonus Plans (Annual)(4) Executive Bonus Plans (Annual)• To be effective, it must be tied to specific To be effective, it must be tied to specific

measures:measures:• ROIROI• EPSEPS• Net profitsNet profits

• Often creates a short-term perspectiveOften creates a short-term perspective

(5) Stock Options(5) Stock Options individuals have the right to individuals have the right to purchase stock at a lower fixed cost for a purchase stock at a lower fixed cost for a specified period of time. Designed to create a specified period of time. Designed to create a long term perspective.long term perspective.


• Golden parachutesGolden parachutes - - massive severance massive severance compensation in the event the executive loses his/her compensation in the event the executive loses his/her job.job.• Example: Former Home Depot CEO Bob Nardelli received Example: Former Home Depot CEO Bob Nardelli received

a golden parachute of approximately $210 million in 2006. a golden parachute of approximately $210 million in 2006. Home Depot's market valuation declined 40 % during Home Depot's market valuation declined 40 % during Nardelli's tenure.Nardelli's tenure.

• August 5, 2007, he became chairman and CEO of the August 5, 2007, he became chairman and CEO of the newly privatized Chrysler.newly privatized Chrysler.

• Silver parachutesSilver parachutes - - severance and benefits severance and benefits programs for nonexecutives if job loss is due to programs for nonexecutives if job loss is due to acquisition.acquisition.

Documents

Mgmt 383 Chapter 13 Variable Pay & Executive Compensation Spring 2009