CH-12 Recognizing Employee Contributions with Pay – Human Resource Management : Book Guide

Chapter 12 - Recognizing Employee Contributions with Pay Please click here to access the new HRM Failures case associated with this chapter. HRM Failures features real-life situations in which an HR conflict ended up in court. Each case includes a discussion questions and possible answers for easy use in the classroom. HRM Failures are not included in the text so that you can provide your students with additional real-life content that helps engrain chapter concepts. Chapter Summary This chapter focuses on the design and administration of programs to reward individuals for their contribution to organizational success. The design often amounts to combinations of individual, group, and organiza¬tional incentives. Rewards must also be designed for the particular organization and the needs and motives of its employees. Since pay is a powerful motivator (although certainly not the only one), pay systems' design is critical to organization success. Learning Objectives After studying this chapter, the student should be able to: 1. Discuss how pay influences individual employees and describe three theories that explain the effect of compensation on individuals. 2. Describe the fundamental pay programs for recognizing employees’ contributions to the organization’s success. 3. List the advantages and disadvantages of the pay programs. 4. Describe how organizations combine incentive plans in a balanced scorecard. 5. Discuss issues related to performance-based pay for executives. 6. Explain the importance of process issues such as communication in compensation management. 7. List the major factors to consider in matching the pay strategy to the organization’s strategy. Extended Chapter Outline Note: Key words appear in boldface and are listed in the "Chapter Vocabulary" section. Opening Vignette: High Performance is Important (and So is How You Get There) This vignette describes the changing view of performance being taken by some companies. This new view is not focused solely on financial performance, but also on how that financial performance is being achieved. The case touches on the new CEO of Citigroup and his intentions of linking executive performance measures with more balanced scorecard measures of performance. These measures provide an indication of how financial success is being achieved so as to avoid extremely risky choices that have caused havoc on the US economy and business in recent years. The case also overviews a change in WalMart’s philosophies on how to direct and focus the behaviors of executives. WalMart has recently faced a number of legal compliance issues that can and will cause long-term harm to the firm. Discussion Question 1. Why are companies beginning to pay more attention to non-financial measures of performance today? Answer: Society today requires organizations to not only make money, but to pay attention to how that money is being made. Student’s responses will likely reflect their own views of ethics and moral choices, but should recognize that the business climate today requires not just good financial performance, but financial performance that is earned by way of fair and ethical means. Companies are increasingly focusing on non-financial measures of performance to: 1. Ensure Sustainable Success: To avoid risky decisions that might harm long-term stability. 2. Improve Reputation: Address legal and compliance issues and enhance corporate reputation. 3. Enhance Employee Engagement: Align behavior with company values and ethics. 4. Balance Risk and Reward: Prevent overemphasis on short-term financial gains at the expense of overall health. 5. Encourage Holistic Performance: Foster a comprehensive view of organizational success beyond just financial metrics. I. Introduction—Organizations have a relatively large degree of discretion in deciding how to pay. Differences in performance (by an individual, group, or the organization), seniority, or skills are used as a basis for differentiating pay among employees. Regardless of cost differences, different pay programs can have very different consequences for productivity and return on investment. II. How Does Pay Influence Individual Employees? Besides the equity theory, described in the previous chapter, there are other theories that influence compensation's effects. A. Reinforcement Theory—In Thorndike's Law of Effect, a response followed by a reward is more likely to recur in the future. The importance of a person's actual experience in receiving the reward is critical. If high performance is followed by a reward, high performance is likely to be repeated. B. Expectancy Theory— This theory says that motivation is a function of valence, instrumentality, and expectancy. C. Agency Theory— This theory focuses on divergent interests and goals of the organization's stakeholders and the ways that compensation can be used to align these interests and goals. Today, most stockholders are removed from the day to day operation of companies. This separation has many advantages, but it also creates costs—the interests of the princi¬pals (owners) and their agents (managers) may no longer converge. Agency costs are as follows: 1. Although shareholders seek to maximize their wealth, management may spend money on things such as prequisites or “empire building”. 2. Managers and shareholders may differ in their attitudes toward risk. 3. Decision making horizons may differ, since managers will likely emphasize short term gains to ensure promotion and visibility, perhaps at the cost of long term success. D. Agency costs may be minimized by the principal choosing a contracting scheme that helps align the interests of the agent with the interests of the principals. These approaches can be behavior oriented (e.g., merit pay) or outcome oriented (e.g., stock options, profit sharing, commissions). Outcome¬-oriented approaches link the rewards of the organization and individual. However, agents are often risk averse and may demand a compensating wage differential. Behavior¬-oriented contracts do not transfer risk and therefore do not require a compensating wage differential. Deciding what to use is based on the following: 1. Risk aversion among agents makes outcome oriented contracts less likely. 2. Outcome Uncertainty—Profit is an example of an outcome. Agents are less willing to have their pay linked to profits to the extent that there is a risk of low profits. They would therefore prefer a behavior-oriented contract. 3. Job Programmability—As jobs become less program¬mable (less routine) outcome oriented contracts are more likely. 4. Measurable Job Outcomes—When outcomes are more measurable, outcome oriented contracts are more likely. 5. Ability to Pay—Outcome oriented contracts contribute to higher compensation costs because of the risk premium. 6. Tradition—A tradition of using (or not using) outcome-oriented contracts will make such contracts more (or less) likely. III. How does pay influence Labor Force Composition?—There is increasing recognition that individual pay programs may also affect the nature and composition of an organization’s workforce. Different pay systems appear to attract people with different personality traits and values. Organizations that link pay to individual performance may be more likely to attract individualistic employees, whereas organizations relying more heavily on team rewards are more likely to attract team-oriented employees. IV. Pay for Performance Programs—Table 12.1 in the text provides an overview of some programs and potential contributions. The programs differ by payment method, frequency of payout, and ways of measuring performance. Potential consequences of such programs are performance motivation of employees, attraction of employees, organization culture, and costs. Contingencies that may influ¬ence whether a pay program fits the situation are management style, and type of work. A. Merit pay programs, annual pay increases are usually linked to performance appraisal ratings. A merit bonus is merit pay paid in the form of a bonus instead of a salary increase. 1. The size and frequency of pay increases are most often deter¬mined by performance rating (since better performing employees should be rewarded more than low performers – see Table 12.2 for an example) and position in range (compa ratio – see Table 12.4). Compa ratio is used to control compensation costs and maintain the integrity of the pay structure. Table 12.3 demonstrates an example of a merit increase grid, which combines an employee’s performance rating with the employee’s position in a pay range to determine the size and frequency of his or her pay increases. Table 12.3 indicates how compa ratio targets and performance ratings might be combined. Competing Through Technology Paying for ‘Hot Skills’: The Case of Information Technology This case describes the current salary increase situation in the market. Jobs that involve so called “hot skills” are offering much higher than average salary increases – for example, with a market average increase of about 3%, individuals with mobile application development skills are commanding upwards of 9%. The case also describes the competition among tech companies like Google, Facebook and Twitter to retain employees by offering lucrative increases and performance based compensation packages. Discussion Question 1. What is the reason for larger salary increases for information technology employees? Answer: Student responses here will vary, but should recognize the relationship between salary increase levels and the basic principles of supply and demand. These employees are presently in high demand and as such, are receiving large increases in order to allow their employers to retain them, or competitors to lure them away. Larger salary increases for information technology employees are driven by several factors: 1. High Demand: Specialized IT skills, like mobile app development, are in high demand due to the rapid growth in technology and digital services. 2. Talent Scarcity: There is a limited pool of qualified professionals with these "hot skills," making them more valuable to employers. 3. Competitive Market: Tech companies compete aggressively to attract and retain top talent, driving up salaries. 4. Impact on Innovation: Skilled IT employees play a crucial role in driving technological innovation and maintaining competitive advantages. 5. Skill Shortages: The fast-evolving tech landscape creates a shortage of individuals with the latest skills, further increasing their market value. 6. Increased Responsibility: High-demand skills often come with greater responsibilities and complexities, justifying higher compensation. 7. Company Investment: Companies are willing to invest more in these employees to secure a critical edge in the market. 8. Retention Strategies: Higher salaries are part of strategies to prevent turnover and keep valuable employees. 2. Why do companies like Google choose to lead the market in paying these (and other) occupations? Answer: Again each student will likely have an opinion for this question. It is important for them to recognize however, that recognition as an industry leader affords Google the opportunity to attract (and hopefully retain) the best of the best in terms of talent – something that is crucial for them to retain their crown. Companies like Google lead the market in paying for specialized occupations for several reasons: 1. Talent Acquisition: High salaries attract top talent, essential for innovation and maintaining a competitive edge. 2. Retention: Competitive pay helps retain skilled employees, reducing turnover and associated costs. 3. Innovation: Investing in top-tier talent drives technological advancements and creative solutions. 4. Market Leadership: Being a market leader in compensation helps establish the company as a desirable place to work. 5. Skill Scarcity: Offering higher pay for rare skills ensures access to the best professionals in a competitive market. 6. Company Reputation: Generous compensation enhances the company’s reputation, attracting more high-quality candidates. 7. Productivity and Performance: Well-compensated employees are often more motivated and productive. 8. Strategic Advantage: High pay can secure crucial skills needed for strategic projects and initiatives. 9. Employee Satisfaction: Competitive salaries contribute to higher employee satisfaction and loyalty. 10. Industry Standards: Leading in pay sets industry standards and pressures competitors to offer similar compensation. 2. In general, merit pay programs have the following characteristics: a. They identify individual differences in performance, which are assumed to reflect differences in ability or motivation. b. The majority of information on individual performance is collected from the immediate supervisor. c. There is a policy of linking pay increases to performance appraisal results. d. The feedback under such systems tends to occur infrequently, often once per year at the formal performance review session. e. The flow of feedback tends to be largely unidirectional, from supervisor to subordinate. 3. Deming, who is a critic of merit pay, argues that it is unfair to rate individual performance because "apparent differences between people arise almost entirely from the system that they work in, not the people themselves." Examples of system factors are co workers, the job, materials, equipment, customers, management, supervision, and environmental conditions. These factors are the responsibility of management. a. Deming also argues that the focus on merit pay discourages teamwork. b. Deming suggests that the link between individual performance and pay should be eliminated. The consequence of this might be that high performers would leave the organization. An appropriate balance between group and individual incentives should be designed. c. Another criticism is the way they measure performance. If this is not done fairly and accurately, employees will perceive the whole process to be unfair. Some of the most important aspects of justice that employees assess are distributive (based on how much they receive) and procedural (what process was used to decide how much). Table 12.4 lists questions involved in procedural justice and pay decisions. d. A last criticism is that merit pay may not really exist. High performers are not paid significantly more than mediocre or even poor performers in most cases. For example, with a merit increase budget of 4 to 5 percent, suppose high performers receive 6 percent raises, versus 3.5 to 4 percent raises for average performers. Many employees do not believe that there is any payoff to higher levels of performance (Figure 12.2). Communication should be used to indicate that small differences can equate to large differences over time. e. The accumulation effect just described can also be seen as a drawback if it contributes to an entitlement mentality. B. Individual incentives reward individual performance, but payments are not rolled into base pay, and performance is usually measured as physical output rather than by subjective ratings. Monetary incentives increased production by 30 percent in a study by Locke. Individual incentives are, however, relatively rare because: 1. Most jobs have no physical output measure. 2. There are many potential administrative problems such as setting and maintaining acceptable standards. 3. Individual incentives may do such a good job of motivating employees that they do whatever they get paid for and nothing else. 4. Individual incentives typically do not fit in with the team approach. 5. They may be inconsistent with goals of acquiring multiple skills and proactive problem solving. 6. Some incentive plans reward output at the expense of quality or customer service. Competing Through Sustainability: Increasing Labor Cost Flexibility Using Profit Sharing This case describes how US automakers were able to simultaneously reduce their labor costs (especially during downturns in profitability) while concurrently offering performance-based incentives to their workers. Through the use of a profit-sharing plan, the automakers were able to negotiate base-pay reductions with the UAW union. This plan provides workers with additional incentive pay when the companies are profitable, but does away with that added expense when profits take a downturn making the company and its profitability more sustainable in the long run. Discussion Questions 1. What are the advantages and disadvantages of profit sharing from worker and company perspectives? Answer: Workers – advantage is opportunity to share in the success of the company.. A disadvantage is having to accept a loss of the incentive during downturns. For the company the advantage is being able to provide incentives to workers without the concern of a commitment to high wages even during downturns in profits. The only real disadvantage would be having to pay higher levels of incentives during propfitable periods (but is that really a disadvantage??). 2. How are theories of motivation relevant? Answer: There are a number of ways this discussion could go. One potential direction is that the profit sharing plan should provide workers with an incentive to make sure the company is successful – as the company’s profits increase, so dos their incentive pay. Theories of motivation are highly relevant to the implementation of profit-sharing plans like those used by US automakers. Here’s how they apply: 1. Expectancy Theory: This theory posits that employees are motivated when they believe their efforts will lead to desired outcomes. Profit-sharing aligns with this theory by linking performance with financial rewards, thus motivating employees to work harder to achieve higher profits. 2. Equity Theory: Employees are motivated by fairness and equity. Profit-sharing can address this by ensuring that employees receive a fair share of the company’s profits, enhancing their perception of fairness and equity in compensation. 3. Goal-Setting Theory: This theory emphasizes setting specific, challenging goals to drive performance. Profit-sharing plans often involve setting profit targets that encourage employees to focus on achieving these goals to earn additional rewards. 4. Reinforcement Theory: According to this theory, behavior can be shaped by rewards and punishments. Profit-sharing serves as a positive reinforcement, rewarding employees for contributing to company profitability and encouraging continued effort. 5. Maslow’s Hierarchy of Needs: Profit-sharing addresses higher-level needs such as esteem and self-actualization by providing employees with financial rewards that contribute to their overall sense of achievement and fulfillment. 6. Herzberg’s Two-Factor Theory: Profit-sharing can enhance job satisfaction by addressing motivational factors (e.g., achievement, recognition) rather than just hygiene factors (e.g., base salary). This helps to improve overall job satisfaction and performance. By integrating these motivational theories, profit-sharing plans can effectively align employee efforts with organizational goals, boosting motivation and performance while managing labor costs. Profit Sharing and Ownership 1. Under profit sharing, payments are based on a measure of organization performance (profits) and do not become part of the employees’ base salary. a. An advantage is that profit sharing may encourage employees to think more like owners and take a broad view of what needs to be done, labor costs are reduced in difficult economic times, and organizations may not have to rely on layoffs. There is a downside risk in that there may be no profits in a given period. b. A second advantage is that because payments do not become part of base pay, labor costs are automatically reduced during difficult economic times, and wealth is shared during good times. c. The drawback is that workers may perceive their performance has little to do with profit but is more related to top management decisions over which they have little control. Therefore, most employees are unlikely to see a strong connection between what they do and what they earn under profit sharing (instrumentality perceptions are not likely to be reinforced). They may also be disturbed when plans do not pay out when no profit is made. d. Another motivational problem is that most plans are deferred. Dupont eliminated a profit sharing plan when employees in some divisions received less than those in comparable divisions and returned to a system of fixed base salaries with no variable (risk) component. An alternate solution is to have plans that contain upside, but not downside. When profits are high, employees share in the gain, but when profits are low, they are not penalized. This, of course, eliminates the advantage of controlling labor costs in difficult economic times. e. In summary, although profit sharing may be useful as one component of a compensation system, it may need to be complemented with other pay programs that more closely link pay to outcomes that individuals or teams can control. In addition, profit sharing runs the risk of contributing to employee dissatisfaction or higher labor costs, depending on how it is designed. Evidence-Based HR This vignette talks about open-book management. This is a technique that involves disclosing financial information to employees and teaching them basic finance principles in order to involve them in cost-saving and revenue-generating decisions and idea creation. The evidence presented in the case seems to support the potential success of such programs. There are a couple of potential fears and drawbacks – for example, that financial information could end up in the hands of competitors. Exercise Have students research and find a companies that uses open-books management and have them compare the performance and cost structure of that firm with a competitor who does not use this same style of management. Have them discuss the potential benefits of this style of management – not just in terms of financial performance, but from a motivational and human resource management point of view. 2. Ownership also encourages employees to focus on the success of the organization as a whole, but, like profit sharing, may not result in motivation for high individual performance. Employees may not realize gain until they sell their stock, often when they are leaving. Reinforcement theory standpoint is that performance motivation may be especially low. a. One method to achieve employee ownership is through stock options, which gives employees the opportunity to buy the company’s stock at a previously fixed price. For example, if a share is offered to employees at $10 a share in 2012, and the stock price reaches $30 per share in 2017, they have the option to "exercise his or her options" and sell the stock at a profit. Stock options are typically reserved for executives, although more companies have offered options to all employees, such as Pepsi Cola, Merck, McDonald’s, Wal-Mart, and Proctor & Gamble. Some studies suggest that higher organi-zation performance occurs when top and midlevel managers are eligible for long term incentives, although results are not clear regarding lower level employees. 3. Employee stock ownership plans (ESOPs) are employee ownership plans that give employers certain tax and financial advantages when stock is granted to employees. The number of employees in such plans increased from 4 million in 1980 to over 10 million in 1999. a. On the negative side, ESOPs can carry significant risk for employees. ESOPs must, by law, invest at least 51 percent of their assets in the company's stock. This results in less diversification and more risk, so if the company does not do well and pensions are funded by an ESOP, employees risk significant loss. b. ESOPs can be attractive to organizations since they have tax and financing advantages and can serve as a takeover defense (under the assumption that employee owners will be "friendly" to management). c. Some degree of participation in a select number of decisions is mandatory, but overall participation in decision making appears to vary significantly across organizations with ESOPs. Some studies that the positive effects of ownership are larger in cases where employees have greater participation. C. Gainsharing, Group Incentives, and Team Awards 1. Gainsharing programs are based on group or plant performance (rather than organization wide profits) that does not become part of the employee’s base salary. One type of gainsharing, the Scanlon plan, provides a monetary bonus to employees (and the organization) if the ratio of labor costs to the sales value of production is kept below a certain standard. 2. Table 12.10 shows a modified (i.e., costs in addition to labor are included) Scanlon plan. Because actual costs ($850,000) were less than allowable costs ($907,500) in the first and second periods, there is a gain of $57,500. The organization receives 45 percent of the savings, and the employees receive the other 55 percent, although part of the employees’ share is set aside in the event that actual costs exceed the standard in upcoming months. 3. Conditions that should be in place for gainsharing to be effective include: a. management commitment b. the need to change or a strong commitment to continuous improvement c. management's acceptance and encouragement of employee input d. high levels of cooperation and interaction e. employment security f. information sharing on productivity and costs g. goal setting h. commitment of all involved parties to the process of change and improvement i. agreement on a performance standard and calculation that is understandable, seen as fair, and closely related to managerial objectives. 4. Group incentives and team awards typically pertain to a smaller work group. Group incentives tend to measure performance in terms of physical output, whereas team award plans may use a broader range of performance measures. Drawbacks are that individual competition may be replaced by competition between teams. In addition, dimensions must be perceived as fair by employees, and these standards must not exclude important dimensions such as quality. D. Balanced Scorecard—Some companies find it useful to design a mix of pay programs. Relying exclusively on merit pay or individual incentives may result in high levels of work motivation but unacceptable levels of individualistic and competitive behavior and too little concern for broader plant or organization goals. Relying too heavily on profit sharing and gainsharing plans may increase cooperation and concern for the welfare of the entire plant or organization, but it may reduce individual work motivation to unacceptable levels. Table 12.11 shows how a mix of measures might be used be a manufacturing form to motivate improvements in a balanced set of key business drivers. V. Managerial and Executive Pay—Because of their significant ability to influence organization performance, top managers and executives are a strategically important group whose compensation warrants special attention. One concern appears to be that in some companies, rewards for executives are high regardless of organizational performance. A. Executive pay can be linked to organizational performance (from an agency theory perspective) by making some portion of executive pay contingent on company profitability or stock performance. This may mean less emphasis on non-contingent pay and more emphasis on outcome oriented contracts, both short term and long-term. B. Organizations vary a great deal in the extent to which they use both short term and long term incentive programs. Greater reliance on short-term bonuses and long-term incentives (relative to base pay) resulted in substantial improvements in return on assets (Table 12.12). C. There has been increased pressure from regulators and shareholders to better link pay and performance. The Securities and Exchange Commission (SEC) requires companies to report compensation level for the five highest paid executives and the company’s performance relative to that of competitors over a five-year period. In 2006, the SEC put additional rules into effect that require better disclosure of the value of executive perquisites and retirement benefits. VI. Process and Context Issues—Consider employee participation in decision making and its potential consequences. A. Involvement in the design and implementation of pay policies has been linked to higher pay satisfaction and job satisfaction. Agency theory suggests that employees may set goals in their own favor; however, monitoring would be less costly and more effective since employees know their workplace best. Integrity in Action: Making Sure Executives Get Paid Only for Real Performance: The Role of Clawbacks This case discusses the new role of “clawback” provisions - future recovery of past compensation payouts made to an executive who is later found to have violated ethics rules or to have otherwise behaved inappropriately – in bolstering the image of US drug makers to constituency groups like institutional investors. Discussion Question 1. To what degree do you think clawbacks will make detrimental executive behaviors less likely? Answer: Student responses will vary. However, it is important to recognize that these provision allow for some “teeth” in enforcing ethical behavior standards. Clawbacks and Executive Behavior: Clawback provisions can reduce the likelihood of detrimental executive behaviors by holding executives accountable for misconduct and ethical violations. Knowing that past compensation could be recovered if unethical actions are discovered serves as a strong deterrent. However, their effectiveness depends on rigorous enforcement and clear definitions of what constitutes misconduct. 2. Are there other ways to achieve the same objective? Answer: Again, responses may vary here. One issue to bring up is the notion of balanced scorecard approaches to gauging executive performance. Having other means of determining who is and is not performing well in the company is one other possible proactive avenue to alleviating this problem. Alternative Approaches: Besides clawbacks, companies can implement several measures to achieve similar objectives: • Enhanced Transparency: Regular audits and public disclosures can deter unethical behavior by increasing scrutiny. • Strong Ethical Culture: Promoting a culture of integrity and ethical behavior can reduce misconduct. • Performance Reviews: Integrating ethical behavior into performance evaluations ensures that executives are assessed on both their results and their adherence to ethical standards. • Training and Development: Providing ongoing ethics training reinforces expectations and supports ethical decision-making. Overall, while clawbacks can be effective, a multifaceted approach combining policies, culture, and education often yields the best results in fostering ethical behavior among executives. Competing Through Globalization: Capping Executive Bonuses in Europe: Is it a Good Idea? This vignette describes a move in the European Union to cap the bonuses of bankers to one times their annual salary. The reason for this is to prevent the risk taking behavior that recently resulted in EU governments having to bail out banks, leaving taxpayers holding the bill. The fear involved with this move is that EU bankers will leave EU-domiciled banks. One way to alleviate the fear is to increase base salary, which carries its own problem – increased fixed costs for the banks. A model to limit executive compensation from Switzerland is also described. This model is stricter than rules in the US and is believed to be set to send a signal of an anti-business climate in Switzerland. Discussion Question 1. What are the potential costs and benefits of the bonus cap to Swiss companies, employees, and society? Answer: This is a question that will likely be linked to the student’s fundamental philosophies concerning being liberal or conservative and as such, their responses will vary. Costs and Benefits of the Bonus Cap: 1. Costs to Swiss Companies: • Talent Retention: Capping bonuses might lead to difficulty attracting and retaining top talent, as executives may seek higher compensation elsewhere. • Increased Base Salaries: To offset the bonus cap, companies may need to increase base salaries, leading to higher fixed costs. 2. Benefits to Swiss Companies: • Risk Reduction: Reducing bonus incentives can mitigate excessive risk-taking, potentially leading to more stable financial practices. 3. Costs to Employees: • Reduced Incentives: Executives might feel less motivated if their potential earnings are limited, possibly impacting performance. 4. Benefits to Employees: • Increased Salary Stability: A focus on base salary rather than variable bonuses can provide more predictable income. 5. Costs to Society: • Economic Impact: Reduced competitiveness of Swiss banks might shift financial business to other regions, affecting the local economy. 6. Benefits to Society: • Stability and Accountability: A cap on bonuses can lead to more responsible banking practices, reducing the risk of future financial crises and protecting taxpayers. B. Communication is critical since change in any part of the compensation system is likely to give rise to employee concerns. In making any changes, it is crucial to determine how best to communicate reasons for the changes to employees. C. Pay and Process: Intertwined Effects—It is suggested that changing the way workers are treated may boost productivity more than the way they are paid. Researchers showed that productivity and profitability were both enhanced by the addition of employee participation in decisions, beyond the improvement derived from monetary incentives such as gainsharing. VII. Organization Strategy and Compensation Strategy: A Question of Fit— In choosing a pay strategy, one must consider how effectively it will further the organization’s overall business strategy. Table 12.15 suggests some matches of strategies. A Look Back In this chapter we discussed the potential advantages and disadvantages of different types of incentive or pay for performance plans. We also saw that these pay plans can have both intended and unintended consequences. Designing a pay for performance strategy typically seeks to balance the pros and cons of different plans to reduce the chance of unintended consequences. To an important degree, pay strategy depends on the particular goals and strategy of the organization and its units. Questions 1. Does money motivate? Use the theories and examples discussed in this chapter to address this question. Answer: According to the Reinforcement Theory, money is a motivator. It states that “a response followed by a reward is more likely to recur in the future.” If employees know they will be rewarded for high performance, they will continue to perform well. If the rewards stop, the performance will drop. The Expectancy Theory states that monetary rewards increase motivation and performance, but the increased motivation will be extrinsic, and intrinsic motivation will decrease. Monetary rewards are a motivator according to the Agency Theory, but is focused on the risk-reward trade-off. 2. Think of a job that you have held. Design an incentive plan. What would be the potential advantages and disadvantages of your plan? If your money was invested in the company, would you adopt the plan? Answer: Students answers will vary. Look for evidence that students understand how incentive plans encourage certain types of employee behaviors. Incentives send signals about the priorities upon which employees are expected to focus. Incentive Plan: For a sales role, implement a commission-based plan with bonuses for exceeding targets and tiered rewards for top performers. Advantages: Motivates higher sales, aligns pay with performance, and drives company revenue. Disadvantages: Can lead to aggressive tactics, potential for burnout, and may neglect team collaboration. Investment Decision: If my money were invested, I would adopt the plan, provided safeguards are in place to manage aggressive behavior and ensure long-term employee satisfaction. Chapter Vocabulary These terms are defined in the "Extended Chapter Outline" section. Expectancy theory Principal Agents Merit bonus Merit increase grid Profit sharing Stock options Employee stock ownership plans (ESOPs) Gainsharing Discussion Questions 1. To compete more effectively, your organization is considering a profit sharing plan to increase employee effort and to encourage employees to think like owners. What are the potential advantages and disadvantages of such a plan? Would the profit sharing plan have the same impact on all types of employees? Is the size of your organization an important consideration? Why? What alternative pay programs should be considered? Answer: The advantages are that employees will be more inclined to think like owners and will probably broaden their view about job duties and what needs to be done. Labor costs will decline in poor economic times, and layoffs may not be necessary. Disadvantages are that employees may not believe that they have much power to control outcomes and will be disenchanted when there is no profit and therefore no profit sharing. The plan would not have the same impact on all employees. Of particular concern would be high performers with high achievement motivation. They may find the plan frustrating, since they are not rewarded for individual effort. Size of an organization should not be an important consideration because profit-sharing is based more on productivity and profits of the company, not how the profits will be split up (e.g. the more employees there are, the less money each employee gets). Alternatives might be programs such as stock options or ESOPs. The company might add some component of individual and/or group incentives such as gainsharing. 2. Gainsharing plans have often been used in manufacturing settings, but can also be applied in service organizations. How could performance standards be developed for gainsharing plans in hospitals, banks, insurance companies, and so forth? Answer: Performance standards should be developed with the help and teamwork of managers and employees. These standards must be perceived as fair, reasonable, and equitable. Costs are possible to measure in some departments, but other departments may need to rely on measures that are oriented to process, including components of quantity, quality, and timeliness of service. In service organizations, customer satisfaction with service would be extremely important. 3. Your organization has two business units. One unit is a long¬-established manufacturer of a product that competes on price and has not been subject to many technological innovations. The other business unit is just being started. It has no products yet, but it is working on developing a new technology for testing the effects of drugs on people via simulation instead of through lengthy clinical trials. Would you recommend that the two business units have the same pay programs for recognizing individual contributions? Why? Answer: No, the plan should not be the same, since the business and risk are very different. Incentives for the new organization might include stock options, since salaries and benefits may need to be low in start up. In other words, employees, to be attracted to join, may be willing to take risk for the possibility of a large reward. There may also be a plan in place PTO reward individual research efforts that result in large profits, patents, and so on, by a share of the proceeds (this is labeled “intrapreneurship”). 4. Beginning with the opening vignette and continuing throughout the chapter, we have seen many examples of companies (e.g., General Motors, Citigroup, Walmart) making changes to how they pay for performance. Do you believe the changes at these companies make sense? What are the potential payoffs and pitfalls of their new pay strategies? Answer: Student answers may vary. Changes at Companies: The adjustments made by companies like General Motors, Citigroup, and Walmart to their pay-for-performance strategies generally aim to align compensation with organizational goals and financial realities. These changes often involve integrating more non-financial performance measures, adopting profit-sharing models, or capping bonuses. Potential Payoffs: 1. Enhanced Alignment: By linking pay to both financial and non-financial performance metrics, companies can better align employee incentives with overall business objectives. 2. Increased Motivation: Profit-sharing and performance-based bonuses can boost employee motivation and engagement by tying rewards directly to company success. 3. Cost Flexibility: Adjusting pay structures to include variable components allows companies to manage labor costs more flexibly in response to economic fluctuations. Potential Pitfalls: 1. Short-Term Focus: Performance-based pay may encourage employees to focus on short-term gains rather than long-term sustainability, leading to risky behavior or neglect of important but less quantifiable aspects of their roles. 2. Unintended Consequences: Changes in pay structures, such as capping bonuses, might inadvertently lead to reduced employee morale or drive top talent away if not implemented with a clear strategy and communication plan. 3. Implementation Challenges: Effective execution of new pay strategies requires careful planning and monitoring to ensure that they achieve the desired outcomes without creating new issues. Overall, while these changes can offer significant benefits, they must be carefully designed and managed to avoid potential drawbacks and ensure alignment with broader organizational goals. Self-Assessment Exercise Refer to the text for the self-assessment exercise. Exercising Strategy: Saving the Twinkie: Bankruptcy for Investors, But Bonuses for Executives? Hostess’s pay decisions, enacted pre-bankruptcy liquidation, are being reviewed by their bankruptcy judge. While this is not an uncommon practice, cried of foul play from creditors, employees and other stakeholders applied enough pressure to have the decisions looked at and eventually rolled back. The vignette describes several instances of these types of practices which are defended as being necessary to give executives incentives to stick around through a bankruptcy. Questions 1. What happens to investors during a bankruptcy like this one? Answer: This is a question that has no real happy answer. Students should recognize that investors in companies seeking bankruptcy protection will likely not be able to recoup their investment in the ailing firm. Investors: During bankruptcy, investors often face significant financial losses as the company's assets are liquidated to pay off creditors, potentially leaving little or nothing for shareholders. 2. Do you believe the executives in this case should receive bonuses? Why or why not? Answer: A yes or no answer can both be defended here. Yes they should – the company needs to retain all the talent it can through the bankruptcy in order to attempt to survive. No they should not, investors and employees are losing out – why should executives reap benefits during these trying times? Executives' Bonuses: Executives should generally not receive bonuses during bankruptcy unless their performance directly contributes to the successful restructuring or recovery of the company, as bonuses can be seen as inappropriate when stakeholders are suffering losses. Managing People: ESOPs: Who Benefits? This vignette describes employee stock ownership plans (ESOP’s). ESOP’s are being embraced by smaller firms, especially those struggling to find buyers during the weak economy. Under typical plans, an owner’s interest in a business is bought out, in part or in whole—often through a bank loan—with the stock being held in trust. Employees then cash in their shares as they retire. Critics believe these plans have employees gambling with their retirement savings. Questions 1. Is an ESOP good for employees? Answer: This question will draw support from both sides of the philosophical aisle. Some students will believe they are very beneficial, while others will likely side with those who feel they are encouraging employees to gamble with their retirement. An ESOP (Employee Stock Ownership Plan) can be beneficial for employees by providing them with ownership stakes in the company, which can foster a sense of ownership and potentially increase job satisfaction and engagement. It also offers the opportunity for financial gain through stock appreciation and can be a valuable retirement benefit. However, there are risks, such as employees' retirement savings being tied to the company's performance. If the company faces financial difficulties or fails, the value of the stock can decline significantly, impacting employees' retirement funds. Therefore, while ESOPs have potential advantages, they also require careful management to mitigate risks. 2. Does an ESOP motivate employees “better”? Answer: Here again, this answer will draw different responses. There is no right or wrong answer here. An ESOP can enhance motivation by giving employees a stake in the company’s success, which may align their interests with organizational goals. Employees might feel more engaged and committed, as they directly benefit from the company's performance. However, the effectiveness of this motivation can vary based on individual perceptions and the overall health of the company. 3. What happens to employees’ retirement income if they are at an ESOP company that runs into financial problems? What happens to the same employees, if instead, they work at a non-ESOP company that runs into financial problems? Answer: As with any investment or business, there is risk involved in these plans – it is the risk-return tradeoff. If these employees worked for non-ESOP firms, their retirement would be more structured. At an ESOP company experiencing financial troubles, employees’ retirement income can be severely impacted because their retirement savings are tied to the company's stock, which may lose value. If the company faces bankruptcy or severe financial distress, the value of their ESOP shares could significantly decrease, reducing their retirement funds. What happens to employees in a non-ESOP company that runs into financial problems? In a non-ESOP company, employees’ retirement income is usually less affected by the company’s financial issues, especially if they have diversified retirement plans like 401(k)s or pensions. These plans are not directly tied to the company’s stock and are generally protected from company-specific financial problems. HR in Small Business: Employees Own Bob’s Red Mill This vignette describes Bob’s Red Mill Natural Foods and the incentive plans they use. Questions 1. Which types of incentive pay are described in this case? Are these based on individual, group, or company performance? Answer: The case indicates the company has an ESOP and profit-sharing plan. The ESOP plan by nature is a company performance based plan. The profit-sharing plan is also based on firm performance. 2. Would you expect the motivational impact of stock ownership or profit sharing to be different at a small company like Bob’s Red Mill than in a large corporation? Explain. Answer: Answers here will vary based on student experiences. However, smaller company’s like Bob’s Red Mill allow more line-of sight for employees to see direct effects of their contributions to bottom-line performance of the firm, which translates into $$ for the employee. The motivational impact of stock ownership or profit sharing is likely to be different in a small company like Bob’s Red Mill compared to a large corporation. In a small company, employees often have a closer connection to the company's success and may see a more direct correlation between their efforts and the company’s performance. This close-knit environment can enhance the motivational impact of stock ownership or profit sharing, as employees may feel a stronger sense of ownership and direct impact on the company's outcomes. In contrast, in a large corporation, employees might feel more disconnected from the broader organizational goals, which can dilute the motivational impact of similar incentives. 3. Suppose Bob’s Red Mill brought you in as a consultant to review the company’s total compensation. Explain why you would or would not recommend that the company add other forms of incentive pay, and identify any additional forms of compensation you would recommend for the company’s employees. Answer: Answers here will also vary. At present, the company appears to only have firm-performance based incentive plans. Advice should take into consideration what the company’s management wants to give incentive to do. To bolster individual performance, individual performance based plans should be considered, etc. Recommendations for Additional Forms of Incentive Pay: If I were consulting for Bob’s Red Mill, I would recommend evaluating the current compensation structure to ensure it aligns with the company’s values and goals. Adding other forms of incentive pay could be beneficial, particularly if they are designed to reinforce the company’s culture and objectives. Forms of Incentive Pay to Consider: 1. Performance-Based Bonuses: To reward individual or team achievements that align with company goals. 2. Recognition Programs: Regular, non-monetary recognition to acknowledge and celebrate employee contributions. 3. Skill Development Opportunities: Offering educational benefits or training programs that can lead to career advancement, thereby increasing employee satisfaction and long-term engagement. These incentives, combined with stock ownership or profit sharing, can create a more comprehensive compensation strategy that fosters both immediate and long-term motivation. Additional Activities Twitter Focus Bob Moore, founder and president of Bob’s Red Mill Natural Foods, called together employees on his 81st birthday to tell them he was giving them the company. Moore had set up an employee stock ownership plan, placing company stock in a trust fund, and established a profit-sharing plan. All employees with three years of service were immediately fully vested in the plans. As they retire, employees will receive cash for their stock shares. Instead of selling the business to one of many potential suitors, Moore gave the company to the employees because of their commitment to the company and to its mission of providing foods that make consumers healthier. Question What do you think about Bob’s decision? If you founded your own company, would you consider giving to your employees upon your retirement? Answer: Bob Moore’s decision to give Bob’s Red Mill to his employees through an ESOP and profit-sharing plan reflects a deep commitment to his team and a desire to reward their dedication. This approach can foster strong employee loyalty, increase motivation, and align employees’ interests with the long-term success of the company. It also ensures that the company's mission and values are preserved. If I founded my own company: I would consider a similar approach upon retirement if I wanted to reward employees who have contributed significantly to the company's success and if it aligned with the company’s values. Such a decision would ensure that employees who helped build the company benefit directly from its success and contribute to its future growth. However, I would also carefully assess the financial and operational implications to ensure that the transition would be smooth and sustainable. Teaching Suggestions Students will typically be quite interested in this chapter, since they tend to see significant personal career implications. Beyond the discussion, research, and case suggestions below, an instructor might use a problem solving approach by groups to discover what students would like to learn about and design projects that evolve from such discussions. 1. Risk aversion was one factor discussed regarding agency theory. You might introduce a discussion with students about individual perceptions regarding risk taking. They are likely aware of the high failure rate of small businesses. What do they personally consider "acceptable risk"? What factors would their personal perception of acceptable risk depend on (e.g., spouse, children, etc.)? What type of employee do they believe a high risk possibility for a high profit situation would attract, and what are the motivational implications? 2. One student project would be for students to benchmark human resource strategies through rewards. Student groups may each interview a manager responsible for compensation to describe nontraditional rewards (those different from merit plans or general increases). Groups could report back to the class the "benchmark" strategy they discovered, as well as any evidence that may be available on its success (this will likely provide an opportunity to discuss the difference between anecdotal and empirical evidence). 3. A resource is the Harvard Business School case on Merck and Co., Inc. (9 491 005 and teaching note 5 491 008) by K. J. Murphy. Merck and Co., Inc., a major pharmaceutical company, is in the process of reviewing and evaluating its personnel policies and practices. Employee interviews revealed that rewards for excellent performance were not adequate: outstanding performers received salary increases that were, in many cases, only marginally better than those given to average performers. In many cases, outstanding performance was not even clearly identified. The objective is to have students wrestle with a common malady of performance appraisal systems: the tendency of managers to assign uniform ratings to employees regardless of performance. Alternative appraisal systems should be suggested and discussed. Another resource is the case of Merck and Co., Inc. B (9 491 006) by K. J. Murphy, teaching note (5 491 008) and supplement (9 491 007). In late 1986, Merck revised its performance review and pay practices. The most important change was a shift from an absolute rating system to a forced distribution system in which managers were forced to adhere to a given distribution of performance ratings. Other major changes included revised rating categories, revised performance categories, and a shift in timing of performance evaluations. A discretionary award program was also introduced. The objective is to have students discuss the costs and benefits of the revised performance plan, paying particular attention to the relative performance evaluation aspects of the new plan. Is it better than the plan it replaced? Is pay more closely related to performance under the new plan? Discussion Questions 1. Should the performance appraisal and salary administration system have been revised? Why or why not? Answer: Yes, the performance appraisal and salary administration system should have been revised. The original system's tendency to assign uniform ratings regardless of actual performance diluted the effectiveness of performance-based rewards and demotivated high performers. The shift to a forced distribution system addresses this issue by differentiating performance levels more clearly, which helps ensure that outstanding performance is recognized and rewarded appropriately. This approach aligns pay more closely with performance, potentially improving employee motivation and retention. 2. Consider your student group to be the Employee Relations Review Committee. What changes in the performance appraisal and salary administration system would you recommend? How should changes be implemented? Carefully consider the consequences of your recommendations. Answer: • Implement a 360-Degree Feedback System: Incorporate feedback from peers, subordinates, and supervisors to provide a more comprehensive evaluation of performance. • Set Clear Performance Metrics: Develop specific, measurable goals aligned with company objectives to ensure clarity in performance expectations. • Introduce Continuous Feedback: Replace the annual review with regular feedback sessions to address issues promptly and adjust goals as needed. Implementation Steps: • Pilot Program: Start with a small group to test the new system and gather feedback. • Training: Provide training for managers and employees on the new system and feedback processes. • Communicate Changes: Clearly communicate the reasons for the changes and how they will benefit employees. Consequences: • Positive: Improved performance differentiation, increased employee motivation, and better alignment with company goals. • Negative: Potential resistance to change, increased administrative workload, and the need for ongoing management training. 3. What did you learn about managing human resources from reading and analyzing this case? Answer: This case highlights the importance of aligning performance appraisals and compensation with actual performance to motivate employees effectively. It demonstrates that uniform ratings and inadequate rewards can undermine high performers and affect overall morale. Revising the performance appraisal system to differentiate between levels of performance and providing appropriate rewards can enhance motivation, retention, and productivity. Effective implementation requires careful planning, clear communication, and ongoing support to ensure successful adoption and minimize potential issues. 4. Case: Direct Response Group Restructures. Direct Response Group (DRG) was a direct response insurance company with work structured for the mass market. DRG competed with insurance and financial services companies such as Prudential and Allstate. DRG offered a full line of life and health insurance and property and casualty insurance to individuals via mail, phone, television commercials, newspaper inserts, and other response methods. Between 85 percent and 150 percent of a product's first year premium was spent in marketing costs before a single policy was sold. DRG had identified and developed several target markets, including veterans, credit card holders, credit union members, and senior citizens. For the past several years, margins had declined due to underwriting risks and higher costs to acquire new customers. Sales were no longer enough to offset lapsed policies, let alone grow the business. As a result, DRG felt that they had to redefine how they approached their customers from both a sales and service perspective. Currently, customer interactions suffered from the curse of departmentalization. The business was handed off one stage at a time until someone got back to the customer. Since there was a lack of responsibility for any individual customer, interactions with customers were seldom used to find out more about the customer and to probe for unmet needs. DRG has started to implement a customer management team (CMT) concept. The CMT is viewed as the centerpiece of the customer driven strategy—a component that would enable DRG to move from its product driven, mass marketing strategy, to a customer driven strategy of "caring, listening, satisfying, one by one." The first CMT provides sales and service to a group of 40,000 customers from the veterans' business in 16 states where DGR marketed life, health, and property and casualty products. The CMT sells customers new products, provides some services directly, such as policy changes, and acts as an interface and advocate while other departments provide services, such as claims and underwriting. CMT members were selected and trained specifically for this program. Employees are paid market wage rates. They can receive a bonus for "up selling" customers (getting them to take on additional coverage or purchase new products). The team consists of 10 managers who had worked in the telemarketing area and were licensed to sell insurance products. In addition to the 10 agents, the team includes one member from the marketing, operations, and systems areas. Teams are expected to be self managing. They control goal setting, allocating work assignments, and scheduling. You are overseeing the new CMT. You notice that employees tend to resist sharing information with one another that could be helpful in serving customers. Some employees are being too enthusiastic in trying to sell new products to customers who are not interested. From a compensation perspective, what do you think needs to be done to make the CMT work? Suggested Approach: Students should focus both on individual incentives and group incentives (for example, directed to the level of the self managed team). Sales should be rewarded, of course, but there clearly must be a mechanism to trace and reward service to the customer. 5. Case: Wells Fargo Employee Recognition Program. Wells Fargo Bank had a year of record breaking profits in 1988. Throughout the company, bottom line oriented managers and their staffs were steeped in the importance of "return to the shareholder." A renewed focus on the customer was evident in ambitious new customer service standards. Extra effort and constant change became the norm. A decision was made to implement an all employee reward program for the final quarter of 1988. The objectives of this program included the following: •To recognize contributions made by employees as a group. •To recognize individuals who had made exceptional contributions. •To reinforce the qualities most valued in Wells Fargo employees. •To have fun. •To retain an awareness and an appreciation for the program over an extended period of time. Wells Fargo developed a program with several elements phased in over about eight months. The program involved three phases: all ¬employees cash awards, peer recognition through cash bonuses, and corporate recognition of those receiving the most peer recognition. The theme of the program, "In Good Company," was chosen because it was upbeat and positive and recognized the importance of the team effort as well as the effort of individuals. To recognize all employees as a group, the program design included a $550 pretax cash award to be given to every salaried employee (16,000 employees) below the senior vice president level with at least one year of service. An award of $50 (pretax) was given to 3,000 hourly employees with a year of service. The cash awards were announced and given to employees by managers in staff meetings. Managers had no prior knowledge of the event. Each employee also received the first issue of the "In Good Company" newsletter with the check. The newsletter explained the $500 and announced the peer recognition phase of the program. Most of the newsletter focused on the qualities most valued in a Wells Fargo employee. To answer employee questions about the awards, an "In Good Company" hotline took calls throughout the duration of the program. The peer recognition part of the program involved giving a coupon worth $35 to each employee with a year of service. With the coupon were instructions for awarding $35 to a co worker. The rules provided were that an employee could not award the coupon to themselves, no coupons could be given to employees who were senior vice presidents or above, and coupons could not be awarded to contract workers or temporaries. Any other employee could be given a coupon, even those who did not have a year of service and had not qualified for any other part of the program. On each coupon, employees were asked to mark the valued quality that the awardee had demonstrated (e.g., "this coupon is a way of saying thanks for inspiring me to excel"). Employees were given three weeks from the date of distribution to return the coupons to payroll for payment. Coupons received after that date were paid, but were not counted for the corporate recognition part of the program. Coupon recipients were tracked by Social Security number to calculate the number of coupons each received and to determine qualifications for corporate recognition. Employees who received the most coupons were singled out for additional recognition. Most of those who qualified were from the administrative/clerical ranks of the company. Employees who received the most coupons qualified to select a gift from "101 Awards." The awards list was constructed to appeal to a wide variety of tastes, lifestyles, and priorities. Examples of the awards included a week off with pay, payment of an individual's mortgage for a month, grooming for a pet for a year, and four movie tickets a month for a year. The "101 Award" winners were recognized at a cocktail party and dinner hosted by the CEO, president, vice chairman, and group heads in each winner's reporting structure. Questions 1. What are the strengths and weaknesses of the Wells Fargo recognition program? What improvements would you suggest? Answer: Strengths: • Inclusivity: The program recognized all employees, ensuring widespread participation and engagement. • Peer Recognition: Allowing employees to award each other reinforced positive behaviors and teamwork. • Variety in Rewards: Offering a range of awards from cash to experiences catered to diverse employee preferences. Weaknesses: • Cash Awards: The program’s initial cash awards, while appreciated, may not be as impactful long-term. • Coupon System Complexity: The peer recognition system with coupons might be cumbersome and less impactful if not all employees actively participate. • Limited Long-Term Impact: The program's effectiveness in sustaining motivation over time might be limited if not regularly updated or complemented by other initiatives. Improvements: • Streamline Peer Recognition: Simplify the peer recognition system to ensure ease of participation and immediate impact. • Continuous Recognition: Implement ongoing recognition mechanisms beyond annual awards to maintain motivation. • Enhance Communication: Improve communication about the program's purpose and benefits to ensure alignment with employee expectations. 2. What part of the program has the strongest link to employee motivation? Why? Answer: The peer recognition component of the program has the strongest link to employee motivation. It allows employees to acknowledge each other’s contributions and behaviors directly, which can foster a sense of camaraderie and mutual respect. This personal recognition often feels more meaningful and immediate compared to top-down recognition, driving increased engagement and job satisfaction. 3. Assume Wells Fargo has now experienced a year of losses. Cash is not available for the recognition program. How could the program be modified or changed to continue to meet the program objectives? (The example on ARPs may be very helpful for students in addressing this case). Answer: If cash is not available, the program could be adapted in the following ways: • Non-Monetary Recognition: Increase the focus on non-monetary rewards such as additional time off, flexible working conditions, or personalized thank-you notes from managers. • Employee-Led Initiatives: Encourage employees to recognize each other through informal channels or peer-led events, leveraging internal resources and creativity. • Recognition Events: Host virtual or low-cost events celebrating achievements and providing certificates or symbolic awards. • Skill Development Opportunities: Offer training or development opportunities as rewards, which can enhance skills and career growth. These adjustments can help maintain the program's objectives of recognition and motivation without relying on cash incentives. Source: Adapted from J. McNitt, "In Good Company: An Employee Recognition Plan with Staying Power," Compensation and Benefits Management, Spring 1990, pp. 242 246. 6. Students may debate the issue of executive compensation with the additional information provided. In addition, the following presents a position against executive compensation as it is now managed: The argument against the current system of executive compensation consists of two points. First, American CEOs are paid too much and their salaries bear no relation to the performance of their companies. Second, critics suggest that the irrational system of executive incentives saps the competitiveness of U.S. companies and is a major contributor to U.S. economic woes. The average pay of an American CEO is $2.4 million a year. Only a paltry 4 percent of the salary differential among executives can be explained by the performance of their companies. Graef Crystal, author of In Search of Excess: The Overcompensation of American Executives, says that CEOs get paid hugely in good years, then merely wonderfully in bad years. For example, Crystal points to option repricing schemes in which the price at which an option can be exercised ("the strike price") is lowered as the stock falls. These schemes reward managers even when the performance of the company slips (Frank Lorenzo of Texas Air received this type of option). In Crystal's view, American CEO compensation is an insider's game; everyone wins except the shareholders. CEOs tend to control their compensation by appointing friends to the board of directors, paying them handsomely, and having the favor returned when it is time to ratify a compensation plan. The Business Week article cited did note that there is now more resistance on boards to this sort of activity; however, this resistance appears minimal when one views the 1993 salary increases. 1. What position do you hold about executive compensation? Why? Answer: The argument against current executive compensation highlights significant issues, including excessive pay disconnected from performance and questionable practices like option repricing. I hold the position that executive compensation often does not align with company performance, leading to potential misalignments between executive incentives and shareholder interests. High pay packages can undermine employee morale and public trust, especially when executives are rewarded during economic downturns or poor company performance. Reform is needed to ensure that compensation is more closely tied to performance metrics that benefit both the company and its shareholders. 2. Formulate a "pro" position for current executive compensation. Answer: A "pro" position for current executive compensation might argue that competitive pay is necessary to attract and retain top talent in a highly competitive market. Executives are responsible for making critical decisions that drive company success and are often subject to high levels of stress and accountability. The compensation packages, including bonuses and stock options, are designed to align their interests with the long-term success of the company, motivating them to work towards maximizing shareholder value. Additionally, high compensation packages can reflect the high demand for skilled executives who can lead companies through complex challenges and competitive markets. 3. What type of compensation plan should executives be provided that would motivate them to do the best possible job for the shareholders? Do you believe that this accountability is the only one that executives have? Answer: To motivate executives effectively and align their interests with shareholders, the compensation plan should include: • Performance-Based Bonuses: Tied to specific, measurable outcomes such as financial performance, market share growth, or strategic milestones. • Equity Compensation: Stock options or restricted stock units (RSUs) that vest over time and are linked to long-term company performance, ensuring executives benefit from sustained success rather than short-term gains. • Clawback Provisions: Mechanisms to recover bonuses or stock options if performance metrics are later found to be based on inaccurate or misleading information. • Balanced Scorecards: Incorporate a mix of financial and non-financial metrics, such as customer satisfaction, innovation, and employee engagement, to provide a comprehensive view of executive performance. Executives also have accountability beyond shareholders, including ethical conduct, regulatory compliance, and social responsibility. They must balance financial performance with the well-being of employees, customers, and the broader community, ensuring sustainable and ethical growth. Source: Adapted from A. R. Brownstein, and M. J. Panner, "Who Should Set CEO Pay? The Press? Congress? Shareholders?" Harvard Business Review, May/June 1992, pp. 28 32+. 7. Have students discuss the advantages and disadvantages of Employee Stock Ownership Plans (ESOPs). One good source for reference is "Avis Employees Find Stock Ownership Is Mixed Blessing" by J. Hirsch, The Wall Street Journal, May 2, 1995, p. B1. HRM Failures Top Case 12: Equal Pay for Equal Performance As Goodyear employee Lilly Ledbetter approached retirement from her plant-supervisor job after 19 years of service, she discovered that she had been paid significantly less than her male counterparts. She had started at the same base pay as the males, but she did not receive merit raises on par with them. The result was that she was paid significantly less than all 15 of her male peers, reducing her retirement compensation. She filed and won her suit for pay discrimination, but it was overturned on appeal by the U.S. Supreme Court in 2007. The high court said the statute of limitations had run out on Ledbetter and stated she should have initiated a claim within 180 days after receiving her first inequitable paycheck. Other legal observers differed, saying the Court was interpreting the 180-day standard too strictly. They pointed to the widespread practice of the federal district courts, which defined the standard as 180 days after the latest incident of alleged pay discrimination—in other words, restarting the clock after each discriminatory paycheck. Congress reversed the Supreme Court ruling by passing the Lilly Ledbetter Fair Pay Act in 2009. President Barack Obama signed the bill into law on January 29, 2009—the first piece of legislation of his administration. The law prohibits discrimination in both pay and benefits and gives employees 180 days after their last discriminatory paycheck to file a claim. The law has implications for employers: •Maintain complete records on employee pay and benefits •Document all employment decisions, including hirings, promotions, job classifications and terminations. •Be able to justify any gender-based pay differences within the same job category •Refrain from telling employees not to discuss their pay or ask about pay—and don’t take action on people who do. Question Goodyear Tire & Rubber allegedly prohibited employees from discussing wages. As an HR professional, what advice would you give regarding wage discussions? Possible answers •Refrain from making a company rule prohibiting the discussion of pay (such a rule could be viewed as barring free speech). •It is best not to introduce the topic of employees discussing their pay with each other. At the same time, assume that, among employees, maturity and common sense generally prevail. •If asked about pay, state that salaries are a private matter between the employee and the organization. As an HR professional, here’s my advice regarding wage discussions: 1. Encourage Transparency: Promote an open and transparent pay environment. Encourage employees to discuss their wages and benefits openly. This transparency can help prevent pay discrimination and foster trust within the organization. 2. Document Everything: Ensure that all pay and employment decisions are well-documented. This includes justifications for pay differences, promotions, and other employment actions. Detailed records can help defend against any claims of discrimination. 3. Educate Managers and Employees: Provide training for managers and employees on the importance of equal pay and the legal requirements related to wage discussions. Ensure everyone understands the policies and practices in place to prevent discrimination. 4. Review and Adjust Policies: Regularly review and update pay policies to ensure they comply with legal requirements and industry best practices. Make sure policies on wage discussions are clear and compliant with laws such as the Lilly Ledbetter Fair Pay Act. 5. Protect Against Retaliation: Clearly state and enforce a policy against retaliation. Employees should feel safe to discuss wages or raise concerns about pay disparities without fear of negative consequences. 6. Conduct Pay Audits: Regularly conduct internal pay audits to identify and address any disparities. Use these audits to make necessary adjustments and ensure fair pay practices are in place. By fostering an environment where wage discussions are encouraged and ensuring transparent and fair pay practices, organizations can better comply with legal standards and promote a fair workplace. Case: Ledbetter v. Goodyear Tire & Rubber Co., Inc., 550 U.S. 618 (2007), Lexis 6295. Solution Manual for Human Resource Management Raymond Noe, John Hollenbeck, Barry Gerhart, Patrick Wright 9780077164126