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This document contains Chapters 3 to 4 CHAPTER 3 Traditional Bases for Pay: Seniority and Merit Learning Objectives 1. Describe seniority and longevity pay practices. 2. List at least three elements of merit pay. 3. Give examples and definitions of performance appraisal methods. 4. Explain at least three ways compensation professionals can strengthen the pay-for-performance link and summarize each one. 5. Discuss three possible limitations of merit pay programs. Outline I. Seniority and Longevity Pay A. Overview B. Historical Overview C. Who Participates? D. Effectiveness of Seniority Pay Systems E. Design of Seniority Pay Plans F. Advantages of Seniority Pay G. Fitting Seniority Pay with Competitive Strategies II. Merit Pay A. Overview B. Who Participates C. Exploring the Elements of Merit Pay III. Performance Appraisal A. Types B. Trait Systems C. Comparison Systems D. Behavioral Systems E. Goal-Oriented Systems F. Exploring the Performance Appraisal Process IV. Strengthening the Pay-for-Performance Link A. Activities B. Link Performance Appraisals to Business Goals C. Analyze Jobs D. Communicate E. Establish Effective Appraisals F. Empower Employees G. Differentiate Among Performers V. Possible Limitations of Merit Pay Programs A. Potential Problems B. Failure to Differentiate Among Performers C. Poor Performance Measures D. Supervisors’ Biased Ratings of Employee Job Performance E. Lack of Open Communication between Management and Employees F. Undesirable Social Structures G. Factors Other Than Merit H. Undesirable Competition I. Little Motivational Value VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses.
• MAIN POINTS TO TAKE HOME Seniority pay is a fixed pay system that rewards employees based on the amount of time they have accrued in their position. Merit pay rewards employees on measurable accomplishments as displayed on the job. Merit pay requires having an effective appraisal system that is linked to pay. Companies should seek to incorporate merit pay into their compensation structure in order to encourage superior performance. Merit pay systems are by no means infallible, and require active employee monitoring by compensation professionals in order to reward workers for performing at exemplary levels.
Lecture Outline I. Seniority and Longevity Pay A. Overview 1. Reward employees with periodic additions to base pay according to length of service 2. Assume that: a. Employees become more valuable over time b. Good employees may leave if not compensated fairly 3. Rationale based on the human capital theory 4. Human capital theory based on belief that: a. Employees’ knowledge and skills generate productive capital b. Knowledge and skills can be developed through formal education and training B. Historical Overview 1. National Labor Relations Act of 1935 (NLRA) a. President Franklin D. Roosevelt’s response to: i. Economic disaster caused by the Great Depression of 1929 ii. Desire for balance of power between labor and management b. Established the collective bargaining system 2. Collective Bargaining a. Led to job control unionism b. Collective bargaining units to: i. Negotiate formal work contracts ii. Provide quasi-judicial grievance procedures to adjudicate disputes between union members and employers c. Union shops i. Establish workers’ rights and obligations ii. Describe and delineate jobs d. May determine specific type of seniority system used to decide job i. Scheduling ii. Transfer iii. Layoffs iv. Compensation v. Promotions 3. Seniority pay systems a. Essentially provide automatic pay increases b. Performance assessments tend to be subjective c. The automatic pay adjustments were used to protect public sector employees from political quirks C. Who Participates? 1. Most unionized private and public sector organizations a. Union rank-and-file and clerical workers b. Public sector positions include: i. Administrative ii. Professional iii. Managerial 2. Public employers include: i. Municipal governments ii. State governments iii. Federal government D. Effectiveness of Seniority Pay Systems 1. Virtually no systematic research demonstrating seniority pay system plans’ effectiveness or prevalence in the private sector 2. Will probably disappear from for-profit companies in the future due to: a. Increased global competition b. Rapid technological advances c. Skill deficits of new and current workers 3. Until recently, public sector employers had less reason to change pay systems, since their purpose is service not profit a. Since 1949, federal pay based on the General Schedule b. Its effectiveness is now under scrutiny c. The federal government has extensively considered the strategic importance of moving beyond seniority-based pay d. The current pay system has not been modified yet E. Design of Seniority Pay and Longevity Pay Plans 1. Seniority pay a. Object is to reward job tenure through permanent increases to base salary b. Employees start at set base pay then receive time-designated pay increases c. Employees can reach a maximum pay level for a position, but are expected to be promoted and qualify for a new, higher pay structure d. Aging “baby boomer” generation which would make these plans cost prohibitive 2. Longevity pay a. Rewards employees who have reached pay grade maximums and who are not likely to move into higher grades b. Used by state and local governments as an incentive to: i. Reduce employee turnover ii. Reward employees for continuous years of service c. Can take the form of: i. A percentage of base pay ii. A flat dollar amount iii. A special step increase based on the number of years the employee has spent with the organization d. Federal employees are subject to longevity pay via the General Schedule (GS) system (refer to Salary Table 2013 GS) i. Classifies federal government jobs into 15 steps (GS 1 through GS 15) ii. Is based on such factors as skill, education, and experience levels iii. Jobs that require high levels of specialized education, have significant influence on public policy, or require executive decision making are classified separately (e.g., Senior Level, Scientific and Professional, Senior Executive Service) iv. Employees are eligible for 10 within-grade step pay increases which can take approximately 18 years to achieve v. Waiting periods within each step are: Steps 1–3 = 1 year per step; Steps 4–6 = 2 years per step; Steps 7–9 = 3 years per step F. Advantages of Seniority Pay Plans 1. Employees may perceive that they are treated fairly because they earn pay increases by an objective standard instead of supervisory judgment 2. Set pay increases facilitate the administration of pay programs for employers 3. Avoids the perception, by employees, of favoritism G. Fitting Seniority Pay with Competitive Strategies 1. Seniority pay does not fit well with the imperatives of competitive strategies because employees can count on receiving the same pay raises regardless of performance 2. Seniority pay does not fit well with the imperatives of competitive strategies because employees can count on receiving the same pay raises regardless of whether or not companies are meeting their differentiation or cost goals 3. With the exception of companies that are shielded from competitive pressures (e.g., public utilities), it is likely that companies that intend to remain competitive will set aside seniority pay practices 4. Although seniority pay plans reflect employees’ increased worth, they measure such contributions indirectly rather than based on tangible contributions or the successful acquisition of job-related knowledge or skills II. Merit Pay A. Overview 1. Pay programs that assume that employees’ compensation over time should be determined, at least in part, by differences in job performance 2. Permanent increases are based on performance 3. Rewards excellent effort or results 4. Motivates future performance 5. Helps employers retain valued employees 6. Usually expressed as a percentage of: a. Hourly wages of nonexempt employees b. Annual salaries of exempt employees 7. In 2013, employees earned average merit increase of 2.8 percent and 2.5 percent 8. The highest performers earned 4.6 percent to base pay, average performers earned 2.6 percent, and the lowest performers earned 0.2 percent B. Who Participates? 1. Merit pay is one of the most commonly used forms of compensation in the United States 2. Fits into the U.S. cultural ideal of rewarding individual achievement 3. Used more in the private for-profit sector than the not-for-profit and public sectors C. Exploring the Elements of Merit Pay 1. Based on objective and subjective indicators of an employee’s job performance 2. Periodic review, by supervisors, of employees’ job performance compared to performance standards and goals 3. Accurate performance appraisals are key to effective merit pay programs 4. To be effective, standards and goals must be realistic and employees must be prepared to meet job goals with respect to their skills and abilities 5. Employees must perceive a strong relationship between attaining performance standards and pay increases 6. Important considerations for deciding on using merit pay a. Adequate funds should be available to fulfill promises to compensate employees (more in chapter 8) b. Adjustments to base pay should be made according to changes in the cost of living or inflation before awarding merit pay raises i. Inflation represents the increases in the cost of goods and services ii. To minimize the effects of inflation cost-of-living adjustments (COLAs) are added to base pay c. Merit pay raises should be based on performance d. Two important factors i. Commitment of top management ii. Job design e. Do employees have control over their performance without outside influences that can affect the attainment of performance goals? f. Have employers set explicit performance standards that specify the procedures or outcomes against which employees’ job performance can be clearly evaluated? 6. The amount of merit increase should: a. Reflect prior job performance b. Motivate employees toward improved performance c. Be meaningful to employees; “just-meaningful pay increase” which refers to the minimum pay increase that employees will see as making a meaningful change in compensation III. Performance Appraisal A. Types of Performance Appraisal Plans 1. Trait systems 2. Comparison systems 3. Behavioral systems 4. Goal-oriented systems B. Trait Systems 1. Are based on having raters evaluate each employee’s traits or characteristics such as: a. Quality of work b. Quantity of work c. Appearance d. Dependability e. Cooperation f. Initiative g. Judgment h. Leadership responsibility i. Decision-making ability j. Creativity 2. Appraisals are typically scored using descriptors ranging from unsatisfactory to outstanding 3. They are easy to construct, use, and apply to a wide range of jobs 4. They are easy to quantify 5. They are common in companies that rely on customer service 6. Drawbacks a. Can be highly subjective b. These systems rate individuals on subjective personality factors rather than objective job performance data C. Comparison Systems 1. Types a. Ranking b. Forced distribution c. Paired comparison 2. Ranking a. Designed to evaluate an employee’s performance against the performance of other employees b. Performance ratings are then ranked from best to poorest c. Can be based on overall performance or individual traits d. Pay increases are based on ranking 2. Forced distribution performance appraisal systems a. Assign employees to groups that represent the entire range of performance (such as best, moderate, and poor performers) b. Used to minimize the tendency for supervisors to rate most employees as excellent performers, because of supervisors’ self-promotion motives c. Used by some supervisors to avoid alienating employees by judging them negatively d. Can be problematic when the actual distribution is substantially different from the forced one
• Example: Distorted Ratings due to Forced Distribution Supervisor required to use the following forced distribution scale 15% well below average 25% below average 40% average 15% above average 5% well above average If 35 percent of the employees’ actual performance ratings were “above average” or “well above average” then 15 percent of those employees’ performances would be underrated because only 20 percent can be rated as above average or better.
4. Paired comparisons a. Each employee is compared to all others b. Each employee is ranked according to the number of times they are identified as being the better performer c. This method is best suited for small groups of employees who perform the same or similar jobs 5. Drawbacks a. These methods tend to encourage subjective judgments b. The chance for rater errors and biases increase c. Small differences in performance between employees may become exaggerated if supervisors feel compelled to distinguish among levels of employee performance D. Behavioral Systems 1. Rate employees on the extent to which they display successful job performance behaviors 2. These objective job behavioral methods, when developed and applied correctly, provide results that are relatively free of rater errors and biases 3. Three main types a. Critical incident technique (CIT) b. Behaviorally-anchored rating scales (BARS) c. Behavioral observation scales (BOS) 4. CIT a. Requires job incumbents and their supervisors to identify performance incidents that distinguish successful performance from unsuccessful ones i. On-the-job behaviors ii. Behavioral outcomes b. Supervisors then observe employees and record their performance on these critical job aspects c. Employees are then rated on how often they display the behaviors in each critical incident (refer to Table 3-7) d. Requires extensive observations and documentation that: i. Identifies successful and unsuccessful job performance behaviors ii. Is recorded by both employees and supervisors 5. BARS a. Similar to CIT, except the incidents are written as expectations instead of achieved behaviors b. Only the most representative behaviors are documented; generally eight to ten behaviors c. Each behavior is then numerically scaled d. Advantages i. Most highly defensible in court because it is based on actual observable job behaviors ii. Encourages all raters to make evaluations in similar ways e. Disadvantages i. Difficult to maintain the volume of data ii. Each job must have distinct appraisal documents iii. As jobs change, so must documentation 6. BOS a. Displays illustrations of positive incidents (or behaviors) of job performance for various job dimensions b. Evaluators rate the employee on each behavior according to the extent to which the employee performs in a manner consistent with each behavioral description c. Scores are then averaged to provide an overall rating number d. Developed similar to BARS, except that only positive behaviors are recorded e. Difficult and time consuming to develop and maintain, especially for the supervisor who must observe the behaviors E. Goal-Oriented Systems 1. Management by objectives (MBO) perhaps is the most effective performance appraisal technique because: a. Supervisors and employees determine objectives for employees to meet b. Employees rate themselves on how well they think they met the objectives 2. Used mainly for managerial and professional positions 3. Evaluates employees’ progress toward strategic planning objectives 4. Employees are expected to meet the objectives during the rating period 5. At the end of the rating period, employees will write a report explaining their progress 6. Supervisors appraise performances based on accomplishment of the objectives 7. Can promote effective communication between employees and supervisors 8. Drawbacks a. Companies generally do not fully describe the scope of managerial positions b. Time consuming c. Requires extensive communication between supervisor and employee d. Focuses on specific goals at the exclusion of other vital outcomes, which is referred to as a “results at any cost” mentality 9. Often they are components of broader development programs
• Example: Goal-Oriented Systems ExxonMobil Blends goal-oriented systems with performance discussions between managers and employees in the HR function HR career paths are marked by assignments of increasing responsibility Employees progress from analyst to supervisory and management positions and are facilitated by a strong commitment to mentoring and coaching HR functions are integrated into many different businesses
F. Exploring the Performance Appraisal Process 1. Purposes a. Represents a company’s way of telling employees the company’s expectations of them b. Informs employees how well they are meeting those goals 2. Typical process includes supervisors a. Monitoring employees’ performance b. Documenting observations on appraisal forms c. Sharing appraisals with employees d. Basing merit pay increases on job performance 3. Issues a. Merit pay increases based on factors other than job performance can lead to charges of illegal pay discrimination (violation of the Equal Pay Act of 1963), except for: i. A seniority system ii. A merit system iii. Quality or quantity of production iv. Any factor other than gender
Example: Illegal Pay Discrimination • Two female sawyers v. Cascade Wood Components Company • Male sawyers received pay increases before more experienced female sawyers • Cascade could not prove the raises were awarded because of: • Differences in job performance • Seniority • A merit system based on quality or quantity of production • Anything other than gender • Courts found Cascade in violation of Equal Pay Act
b. Appraisals must be based on job-related factors not on any discriminatory factors 4. Four activities to promote nondiscriminatory performance appraisal practices a. Conduct job analyses to ascertain characteristics necessary for a content valid performance appraisal system i. Accurately define parameters of the job ii. Define behaviors necessary to perform the job effectively iii. Content validity displays the connection between a. and b. (above) iv. Periodically review the appraisal instrument for validity
• Example: Legislation and Performance Appraisal Brito v. Zia Company (478 F2d 1200, CA 10, 1973) Zia violated Title VII because: A disproportionate number of protected class individuals were laid off, based on low performance appraisal scores Zia could not prove the appraisal instrument was valid because it did not assess any job-related criteria based on quality or quantity of work
b. Incorporate these characteristics into a rating instrument c. Train supervisors to use the rating instrument properly d. Set up formal appeal mechanisms and have upper-level personnel review the ratings to insure accuracy and effectiveness i. Allowing employees to question ratings opens a dialogue with supervisors ii. Employees may point out overlooked performance or explain why a performance was below standard 5. Sources of performance appraisal information a. Five main sources are the employee’s: i. Self ii. Supervisor iii. Coworkers iv. Subordinates (if applicable) v. Customers or clients (if applicable) b. 360-degree performance appraisals i. Are performance appraisal systems that rely on many appropriate sources of performance related information ii. Help companies develop a more complete understanding of current employee performance iii. Help companies reduce the costs of: Recruiting Hiring iv. Criteria for determining appropriateness of the information source Is the evaluator aware of the objectives of the employee’s job? Has the evaluator frequently observed the employee? Is the evaluator qualified to determine if the performance is satisfactory? v. The use of 360-degree performance appraisals is on the rise in the United States because: Downsizing - organizational structures are becoming less hierarchical Managers and supervisors are responsible for a larger number of employees, affording less appraisal time for each These instruments are more conducive to the increased prevalence of work teams, since employees can rate each other Companies are able to get and use feedback from customers, which increases customer satisfaction 6. Errors in the performance appraisal process a. Rating errors reflect differences between human judgment processes versus objective, accurate assessments uncolored by bias, prejudice, or other subjective, extraneous influences b. Rating errors occur because raters must make subjective judgments c. Most common types of raters’ errors include: i. Bias errors ii. Contrast errors iii. Errors of central tendency iv. Errors of leniency or strictness d. Bias errors i. Happen when rater evaluates employees based on a negative or positive opinion of the employee rather than on the employee’s actual performance ii. Four types First-impression effect Halo effects (positive and negative) Similar-to-me effect Illegal discriminatory iii. First-impression effect—a manager would have a tendency to make an initial judgment about an employee, and allows that to affect their appraisal iv. Halo effects—rater generalizes behavior on one aspect of the job to all aspects of the job v. Similar-to-me effect Tendency on the part of raters to favorably judge employees whom they perceive as similar to themselves Supervisors rate more favorably employees similar to them in such things as attitudes, values, backgrounds, or interests vi. Illegal discriminatory bias occurs when supervisors allow an employee’s race, gender, nationality, or religion influence their performance ratings e. Contrast errors i. Take place when the rater compares the employee to other employees rather than to specific performance standards ii. This is an error because the employee is required to perform only at minimally acceptable standards f. Errors of central tendency i. Occur when a supervisor rates all employees as average or close to average ii. Most often committed when raters are forced to justify only extreme behavior iii. It usually is a good idea to require justification at every level of the scale and not just the extremes g. Errors of leniency or strictness i. Reflect the tendency to rate every employee at the high end or low end of the scale, regardless of actual performance ii. With a leniency error, managers rate employees’ performances more highly than they would rate them using objective criteria iii. Leniency errors cause employees to believe they are going to receive larger pay raises than deserved iv. The opposite occurs with errors of strictness v. These errors mitigate the beliefs that effort varies positively with performance, and that performance influences the amount of pay raises IV. Strengthening the Pay-for-Performance Link A. Activities 1. Link performance appraisals to business goals 2. Analyze jobs 3. Communicate 3. Establish effective appraisals 4. Empower employees 5. Differentiate among performers B. Link Performance Appraisals to Business Goals 1. Employee performance should be linked to the company’s competitive strategy 2. For example, everyone in the marketing department working on a specific product should get a merit raise if sales goal are met C. Analyze Jobs 1. Job analysis is important for establishing internally consistent compensation systems (more in chapter 6) 2. Supervisors should match the employees’ performance to the job description a. Descriptions are a product of job analyses b. Descriptions note the duties, requirements, and relative importance of a job within the company 3. May help to reduce arbitrary decisions about merit increases by clarifying the performance standards D. Communicate 1. Employees must clearly understand the link between performance and merit increases 2. Employees need to trust the system and the evaluators E. Establish Effective Appraisals 1. Should be tied to employee’s future performance goals and career plans 2. Deficiencies in performance should include methods to remedy 3. Performance standards should be used for establishing performance targets F. Empower Employees 1. Encourage employee self-appraisals 2. Supervisors as coaches a. By ensuring that employees have access to the resources to perform their job b. By allowing employees to interpret and respond to work problems as they occur G. Differentiate Among Performers 1. Merit increases should consist of meaningful increments 2. Merit increases should clearly reflect differences in actual job performance 2. Rewards can be other than base pay increases like: a. Additional vacation days b. Higher company discounts V. Possible Limitations of Merit Pay Programs A. Eight Potential Problems 1. Failure to differentiate among performers 2. Poor performance measures 3. Supervisors’ biased ratings of employee job performance 4. Lack of open communication between management and employees 5. Undesirable social structures 6. Factors other than merit 7. Undesirable competition 8. Little motivational value B. Failure to Differentiate among Performers 1. Poor performers may receive merit increases even though they’re not warranted 2. Poor performers may view increases as entitlements 3. Superior performers may lose motivation to excel C. Poor Performance Measures 1. May be too subjective 2. Developing performance measures for every job is difficult and expensive D. Supervisors’ Biased Ratings of Employee Job Performance 1. Supervisors are subject to a number of errors when they make subjective assessments 2. These errors can undermine the credibility of the performance evaluation process and give employees the perception that pay does not reflect performance E. Lack of Open Communication between Management and Employees 1. Lack of good communication can lead employees to mistrust the performance appraisal process 2. Mistrust can lead to accusations of bias F. Undesirable Social Structures 1. Pay grades can reflect status differentials 2. Permanent merit increases may rigidify the relative pay status of employees over time 3. Lower-paid employees may resent never being able to “catch-up” G. Factors Other Than Merit 1. Supervisors may subconsciously use age or seniority instead of merit 2. Supervisors may let personal feeling determine pay increases 3. Company politics that puts focus on supervisors’ agendas or goals instead of work goals H. Undesirable Competition 1. Between individual employees for limited funds 2. Between individuals in team settings, which may hinder teamwork I. Little Motivational Value 1. When employers and employees disagree on what is a “large enough” increase 2. When the yearly increase seems negligible on each paycheck CHAPTER 4 Incentive Pay Learning Objectives 1. Explain two reasons why companies use incentive pay. 2. Concisely provide a contrast between incentive pay methods and traditional pay methods. 3. List three categories of incentive pay plans. 4. Define individual incentive plans and give one example. 5. Provide the definition group incentives and summarize two examples of group incentive plans. 6. Discuss the advantages and disadvantages of group incentive plans. 7. Offer a definition of company-wide incentive plans with an example. 8. List and summarize five factors in the design of incentive pay programs. Outline I. Exploring Incentive Pay II. Contrasting Incentive Pay with Traditional Pay III. Individual Incentive Plans A. Defining Individual Incentives B. Types of Individual Incentive Plans C. Piecework Plans D. Management Incentive Plans E. Behavioral Encouragement Plans F. Referral Plans G. Advantages of Individual Incentive Plans H. Disadvantages of Individual Incentive Plans IV. Group Incentives A. Defining Group Incentives B. Types of Group Incentive Plans C. Team-based or Small Group Incentive Plans D. Gain Sharing Plans E. Scanlon Plan F. Rucker Plan G. Improshare H. Comparison of Plans I. Advantages of Group-Incentive Plans J. Disadvantages of Group-Incentive Plans V. Companywide Incentives A. Defining Companywide Incentives B. Types of Companywide Incentive Plans C. Profit Sharing Plans D. Calculating Profit Sharing Awards E. Advantages of Profit Sharing Plans F. Disadvantages of Profit Sharing Plans G. Employee Stock Option Plans VI. Designing Incentive Pay Programs A. Five Key Considerations B. Group versus Individual Incentives C. Level of Risk D. Complementing or Replacing Base Pay E. Performance Criteria F. Time Horizon VII. Discussion Questions and Suggested Answers VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses IX. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses. Lecture Outline I. Exploring Incentive Pay 1. Compensation, other than base wages or salaries, which fluctuates according to employees’ attainment of some standard such as: a. A pre-established formula b. Individual or group goals c. Company earnings 2. Also known as variable pay, rewards employees for partially or completely attaining predetermined work objectives 3. Effectiveness based on three assumptions a. Individual employees and work teams differ in how much they contribute to the company, and in how well they do it b. The company’s overall performance depends on the performance of its employees c. How well it attracts, retains, and motivates high performers d. How well it rewards all employees for their relative performance 4. Adds to base pay as a one-time payment 5. Usually, employees receive a combination of recurring base pay and incentive pay, with base pay representing the greatest portion of core compensation 6. Designed to: a. Control costs i. By replacing annual merit or seniority increases, or fixed salaries ii. With pay raises based on a rise in productivity, profits, or other measure of business success b. Motivate employee productivity 7. Increased use for: a. Production workers b. Technical employees c. Service workers d. Professionals e. Managers f. Executives 8. Employees’ earnings potential is increased
Examples: Incentive Program • Lincoln Electric Company • Awards based on five performance criteria • Quality • Output • Dependability • Cooperation • Ideas • Job importance based on job evaluation techniques, five criteria • Skill • Responsibility • Mental aptitude • Physical application • Working conditions • The company has awarded incentive payments for the last 75 years in both good and bad economies. The average annual incentive payment per employee amounts to 40 percent of annual salary
Examples: Incentive Program • H. Lee Moffitt Cancer Center and Research Institute, at the University of South Florida • Goals are to improve patient care and control costs • Incentives tied to the company’s: • Net income or operating surplus • Quality of care measures • Patient satisfaction scores • Operating efficiencies
II. Contrasting Incentive Pay with Traditional Pay 1. Traditional pay plans based on: a. Fixed hourly wage or annual salary that is determined by: i. Relative worth of positions to the company ii. The going industry rate b. Raises based on: i. Seniority ii. Past performance iii. Supervisor’s appraisals iv. Percentage of base pay, currently from two to six percent c. Merit pay performance standards should be: i. Measurable ii. Objective
Example: Incentive Pay Plan • Taco Bell Restaurants • Offer managers biannual bonus based on attainment of: • Target profit levels • Quality of customer service • Store sales • These incentives are used to motivate managers as they know about them ahead of time
d. Incentive pay programs replace all, or a portion, of base pay to: i. Control payroll expenditures ii. Link pay with performance 2. Incentive pay a. Designed to reward employees and teams for performance b. Classified into three categories i. Individual-incentive plans ii. Group-incentive plans iii. Company-incentive plans c. Levels tend to be based on even more objective criteria d. Awards are communicated in advance, merit awards are not
Example: Typical Performance Measures per Incentive Plan • Individual-incentive plan • Quantity of work output • Quality of work output • Monthly sales • Work safety record • Work attendance • Group-incentive plan • Customer satisfaction • Labor cost savings • Materials cost savings • Reduction in accidents • Services cost savings • Companywide incentive plan • Company profits • Cost containment • Market share • Sales revenue
III. Individual Incentive Plans A. Defining Individual Incentives 1. A system to reward employees for meeting work-related performance standards, such as: a. Quality b. Productivity c. Customer satisfaction d. Safety e. Attendance 2. Appropriate when: a. Performance can be measured objectively, like: i. Units produced ii. Sales volume iii. Reduction in error rate b. Employees have sufficient control over work outcomes i. Factors like frequent equipment breakdowns and delays in receiving raw materials are not under employees’ control ii. Employees are not likely to be diligent when they encounter these types of interferences c. The incentives do not create a level of unhealthy competition among workers
• Example: Unhealthy Competition Company limits awards to 10 percent of employees who have demonstrated high levels of performance If performance is judged on quantity not quality, quality might suffer High performers might receive intimidation from low performers Unions may use these intimidation tactics to prevent plan standards from being raised
B. Types of Individual Incentive Plans 1. Piecework plans 2. Management incentive plans 3. Behavior encouragement plans 4. Referral plans C. Piecework Plans 1. Two common types a. Rewards based on individual production against an objective standard b. Rewards based on individual performance standards that include both objective and subjective criteria 2. Rewards based on individual hourly production against an objective output standard a. Usually found in manufacturing settings like: i. Textiles ii. Apparel b. Usually includes guaranteed hourly rate and incentives c. Quality may also be a consideration d. Used when the time to production is short and the cycle repeats continuously e. Awards are not granted for producing defective products 3. Rewards based on individual performance standards that include both objective and subjective criteria a. Usually found in service industries b. Units produced represent the objective standard c. Quality (i.e., customer service) is the subjective standard and is determined by supervisors’ interpretations and judgments 4. Two advantages to companies using piecework plans in manufacturing settings a. Incentive effect b. Sorting effect 5. Incentive effect refers to a worker’s willingness to work diligently to produce more quality output 6. Sorting effect refers to an employee’s choice to stay versus leave for another job, probably one without an incentive pay contingency D. Management Incentive Plans 1. Awards bonuses to managers when they meet or exceed objectives based on: a. Sales b. Profit c. Production d. Other measures for their: i. Division ii. Department iii. Unit 2. Is based on superiors communicating the amount of incentive pay managers can receive if goals are met 3. Differ from piecework plans in that: a. Piecework plans base rewards on one specific objective b. Management incentive plans often require multiple complex objectives 4. Management by Objectives (MBO) a. Best known management incentive plan b. Is an outcome-oriented performance appraisal technique for merit pay systems i. Superiors make subjective assessments of performances ii. Assessments determine permanent merit pay increases c. When used in an incentive program, the award amounts and goals needed to receive them are communicated ahead of time E. Behavioral Encouragement Plans 1. Awards employees for specific behavioral accomplishments like: a. Good attendance b. Safety records 2. Employees are generally informed of possibilities ahead of time to motivate them to reach the goals 3. Have the potential to save companies substantially more money than the cost of these awards F. Referral Plans 1. Companies rely on referral bonuses to enhance the recruitment of highly qualified employees 2. Employees awarded bonus for referring new customers 3. Employees awarded bonus for referring new employees if the new hires remain employed for a designated period (e.g., 30 days)
• Example: Referrals Recruiting Nurses Tremendous shortage of nurses Some hospitals offer $15,000 sign-on bonuses to nurses and a $5,000 referral bonus to those who referred them
4. Based on the idea that referring employees’ familiarity with the organizational culture will lead them to refer prospects who would fit into the culture G. Advantages of Individual Incentive Plans 1. Can promote the relationship between pay and performance 2. Can promote an equitable distribution of compensation within companies 3. Equitable pay enables companies to retain the best performers 4. These plans are compatible with the individualistic cultures H. Disadvantages of Individual Incentive Plans 1. Have the potential to promote inflexibility 2. Supervisors set performance standards 3. Loses motivational effect when goals are too low or too high 4. May encourage undesirable workplace behaviors
Example: Disadvantage • Predetermined maximum incentive award . . . . $500 • Predetermined standard for award . . . . . . . . . 15% above productivity level • No incentive to work above 15%
IV. Group Incentives A. Defining Group Incentives 1. An employee incentive pay program that rewards employees for their collective performance 2. Not used for each employee’s individual performance 3. Used more now because, since the 1980s a. U.S. companies have realized the improved quality of the team-based Japanese automobile companies that were manufacturing cars in this country b. U.S. companies have realized that team-based job design promotes innovation in the work place
Example: Group Incentive Plan • RubberMaid • Manufactures plastic household products • Product innovation has become the rule since the implementation of project teams • Teams might include employees from: research and development, finance, marketing, and manufacturing
4. Team-based pay plans should: a. Emphasize cooperation between and within teams b. Compensate employees for additional responsibilities c. Encourage team members to attain predetermined objectives for the team 5. Merit, seniority, or individual incentives do not encourage, and may limit effective team behaviors 6. Used to encourage team members to learn new skills and assume broader responsibility 7. All group members contribute, even though the individual contributions might not be equal 2. The plan reinforces teamwork 3. The plan cultivates loyalty to the company 4. The plan increases productivity
Example: Unequal Contributions to a Team • Boeing • Aircraft manufacturer • 200 manufacturing teams build the 777 jumbo jet • Teams that install the interior trim features are not quite as essential as the teams ensuring the aerodynamic integrity of the aircraft
Example: Loyalty • Volvo’s Uddevalla manufacturing facility • Renowned quality of Volvo automobiles has been attributed to using teams effectively • Each team is responsible for: • Managing itself • Managing its own budget • Hiring its own team members
B. Types of Group Incentive Plans 1. Two main types a. Team-based or small group incentive plans b. Gain sharing plans C. Team-based or Small Group Incentive Plans 1. Each team member receives a financial reward upon completion of the group goal 2. Types of teams that fall under team incentive plans a. Work (process) teams i. Organizational units that perform the work of the organization on an ongoing basis ii. Membership is relatively permanent iii. Members work full time in the team iv. Goal is to maintain consistency of performance v. Performance sharing b. Project teams i. Group of people assigned to complete a one-time project ii. Well-defined roles in specific parts of the project iii. Either full time or in addition to other responsibilities c. Parallel teams or task forces i. Employees assigned to work on a specific task in addition to normal work duties ii. Operate on a temporary basis iii. Used to evaluate existing systems and processes, select new technology, and improve existing products 3. The kinds of programs are defined according to the performance criteria a. Customer satisfaction b. Safety records c. Quality d. Production records 4. Rewards allocated three ways a. Equal incentive payments to all team members b. Differential payments to team members based on their contributions to the goal c. Differential payments determined by a ratio of each team members’ base pay to the total base pay of the group 5. Equal incentive payments to all team members a. Reinforces cooperation among team members, except when team members perceive differences in members’ contributions or performance 6. Differential payments to team members based on their contributions to the goal a. Can hinder cooperative behavior b. Can be modified to include both individual and team incentives 7. Differential payments determined by a ratio of each team members’ base pay to the total base pay of the group a. Rewards each team member in proportion to their base pay b. Assumes that employees with higher base pay contribute more to the company, so they should be rewarded accordingly D. Gain Sharing Plans 1. Defined as group incentive systems that provide employees an incentive based on improved company performance in areas such as: a. Increased productivity b. Increased customer satisfaction c. Lower costs d. Better safety records 2. Reflects management philosophy that emphasizes employee involvement and suggestions 3. Most appropriate where work place technology does not constrain productivity improvements 4. Not appropriate for companies that have variable annual profits, because excess cash for bonuses is limited 5. Three main components a. Leadership philosophy, which refers to a cooperative organizational climate that promotes high levels of trust, open communication, and participation b. Employee involvement systems, drives organizational productivity and includes improvement suggestions and problem-solving ideas c. Bonuses, which are awarded when actual productivity exceeds targeted productivity levels 6. Bonuses a. Are based on a formula that the employer believes fairly measures employees and will result in improvements in company performance b. Are awarded on a monthly basis c. Generally range between 5–10 percent of an employee’s base annual pay d. AmeriSteel’s gain sharing plan pays between 35–45 percent of base pay 7. There has been no comprehensive, soundly designed investigation on the effectiveness of gain sharing programs 8. Causes of plan failures a. Organizational factors b. External environment factors c. Financial information factors d. Factors such as poor communications, highly competitive product markets, variable corporate profits 9. Three most common forms a. Scanlon plan b. Rucker plan c. Improshare E. Scanlon Plan 1. Developed by Joseph Scanlon in 1935 a. Emphasized employee involvement b. Did not involve monetary rewards c. Based on the belief that employees will: i. Exercise self-direction and self-control if they are committed to company objectives ii. Accept and seek out responsibility if given the opportunity 2. Current plan’s main components a. Includes monetary rewards to employees for productivity improvements b. Assumes that companies will be able to: i. Offer higher pay to workers ii. Generate increased profits for stockholders iii. Lower prices for consumers c. Emphasis on teamwork to reduce costs, assisted by management-supplied information on production concerns d. A two-tiered cost-savings suggestion system i. Production-level committees ii. Companywide screening committees e. Production-level committees i. Usually include a supervisor and one worker ii. Communicate the suggestion program and its reward features to employees iii. Encourage and assist workers making suggestions and formally records suggestions for consideration iv. Forward appropriate suggestions to companywide screening committee v. May reject suggestions that are not feasible, if they put the reasons in writing f. Companywide screening committees i. Review employees’ suggestions from the production committee ii. Serve as the communication link between employees and management iii. Review the company’s performance each month g. Monetary rewards for productivity improvements i. Based on a ratio of labor costs and sales value of production (SVOP) ii. SVOP is the sum of sales revenue plus the value of goods in inventory iii. Scanlon Ratio = Labor Costs/SVOP h. Smaller Scanlon ratios indicate that labor costs are lower relative to SVOP F. Rucker Plan 1. Developed by Allan W. Rucker in 1933 2. Emphasizes employee involvement and provides monetary incentives 3. Uses a value-added formula to measure productivity, which is the difference between the value of the sales price and the value of materials used to make the product (refer to Table 4-6) 4. Larger Rucker ratio indicates that the value added is greater than the total employment costs 5. Rucker Ratio = Value added/Total employment costs
Example: Rucker Plan’s Value-Added Formula • The making and selling of bread • Farmer grows wheat and sells to miller (added value = farmer’s income – costs of seed, fertilizer, fuel, and other supplies) • Miller processes wheat and sells to baker (added value = cost of wheat – price received from baker) • Baker mixes wheat flour with other ingredients, bakes bread, and sells to retailer (added value = cost of ingredients and baking process – price of bread sold to retailer) • Retailer transports, advertises, and displays bread to consumers (added value = cost of bread from baker – price sold to consumer)
G. Improshare 1. Invented by Mitchell Fein in 1973 2. Defined as “Improved Productivity through Sharing” it measures productivity physically rather than in terms of dollar savings 3. Aims to produce more products with fewer labor hours 4. Emphasis on providing employees with an incentive to finish products 5. Improshare bonuses are based on a labor hour ratio formula a. A standard based on analyzing the historic relationship between the number of labor hours needed to complete a product is determined b. Productivity is then measured as a ratio of the standard hours compared to the actual hours it takes to produce the product now c. Unlike the Scanlon and Rucker Plans, employee participation is not a feature and workers receive bonuses on a weekly basis 6. Includes a buy-back provision a. The provision is a maximum productivity improvement pay out level that is placed on productivity gains b. When the productivity goal is consistently reached or exceeded i. The productivity improvement is bought back by the company and given to employees’ as a one-time payment ii. New, higher maximum productivity levels are set iii. Any bonus money generated by the improvements are placed in a reserve c. The company must ensure that the new productivity levels are reachable d. In union settings, management’s discretion may be challenged when union leadership believes that management is exploiting workers by making it more difficult for them to receive bonuses H. Comparison of the Scanlon, Rucker, and Improshare Plans 1. Program goals a. Scanlon: productivity improvement b. Rucker: productivity improvement c. Improshare: productivity improvement 2. Basis for savings a. Scanlon: labor costs b. Rucker: labor costs + raw materials costs + service costs c. Improshare: completing work at or before target standard 3. Employee involvement a. Scanlon: required b. Rucker: required c. Improshare: NA 4. Type of involvement a. Scanlon: screening and production committees b. Rucker: screening and production committees c. Improshare: NA 5. Bonus pay-out frequency a. Scanlon: monthly b. Rucker: monthly c. Improshare: weekly 6. Increasingly, companies combine gain-sharing plans with other approaches to boost productivity and cost savings I. Advantages of Group-Incentive Plans 1. Companies can more easily develop performance measures for group plans than individual plans a. There are fewer groups and individuals b. Therefore, companies need fewer resources to develop the performance measures 2. Judging the quality of the final product helps ensure market competitiveness 3. Greater group cohesion J. Disadvantages of Group-Incentive Plans 1. May lead to higher employee turnover because of the free-rider effect a. Employee contributions to the group vary because of skill, ability, experience, or motivation b. The most productive employees may leave when equal rewards are given for unequal contributions 2. Dissatisfaction may be heightened where incentive compensation represents the lion’s share of core compensation V. Companywide Incentive Plans A. Defining Companywide Incentives 1. Instituted in the 19th century as a way for companies to ease workers’: a. Dissatisfaction with low pay b. Belief that company management paid them substandard wages while earning substantial profits 2. Defined as systems that reward employees when the company exceeds minimally acceptable performance standards 3. Advocates believe that well-designed programs make workers’ and owners’ goals more compatible as workers strive toward increasing company profits or value B. Types of Companywide Incentive Plans 1. Profit sharing plans 2. Employee stock option plans C. Profit Sharing Plans 1. Pay a portion of company profits to employees, separate from: a. Base pay b. Cost-of-living adjustments c. Permanent merit pay increases 2. Two basic kinds a. Current profit sharing plans b. Deferred profit sharing plans 3. Current profit sharing plans a. Award cash to employees typically on a quarterly or annual basis as part of their core compensation b. Are subject to IRS taxation when earned 4. Deferred profit sharing plans (more in Chapter 10) a. Place cash awards in trust accounts for employees for retirement b. Are not taxed until the employee withdraws money from their account, usually at retirement c. Can withdraw money early, but will be subject to a stiff tax penalty D. Calculating Profit Sharing Awards 1. Fixed first-dollar-of-profits formula 2. Graduated first-dollar-of-profits formula 3. Profitability threshold formulas 4. Fixed first-dollar-of-profits formula a. Based on a specific percentage of either pre- or post-tax annual profits b. Contingent upon successful attainment of a company goal 5. Graduated first-dollar-of-profits formula a. Based on percentages of pre- or post-tax profits b. The percentage increases as profits increase c. Motivates employees to strive for extraordinary profit targets by sharing even more of the incremental gain with them
Example: Graduated Profit Sharing Plan • Employees receive 3 percent of the first $8 million of profits • Employees receive 6 percent of profits over $8 million
6. Profitability threshold formulas a. Fund profit sharing pools when profits fall within predetermined minimum and maximum levels b. Minimum levels are established to ensure a return for shareholders c. Maximum levels are set with the belief that profits above these levels are due to reasons other than employee productivity 7. Three common distribution methods a. Equal payments i. To all employees ii. Promotes cooperation among employees, despite contribution to profits b. Proportional payments based on annual salary i. Presumes that higher salaries equate to more contributions to profit levels ii. Most higher salaries generally relate to higher performance or seniority c. Proportional payments based on contribution to profits i. Generally, based on performance ii. Not widely used, as it may be difficult to quantify each employee’s contribution 8. Profit sharing and core compensation a. Profit sharing amount treated as a bonus when base pay is market competitive b. Profit sharing viewed as pay at risk when i Base pay is below market average ii. The incentive amount is expected to bring base pay up to or above the market average E. Advantages of Profit Sharing Plans 1. Enables employees to share in companies’ profits 2. Allows companies greater financial flexibility 3. During economic downturns, payout levels are significantly lower than during economic boom periods which enables companies to use limited cash reserves where needed F. Disadvantages of Profit Sharing Plans 1. For employees a. Can undermine their economic security, especially when: i. Its provided as a pay at risk award ii. It represents a sizable portion of direct compensation b. May fail to motivate them if they do not see a direct link between their efforts and corporate profits 2. For employers, it may lead to high turnover of productive employees, if awards are predominately small G. Employee Stock Option Plans 1. Overview a. Companies grant employees the right to purchase shares of company stock b. Company represents total equity of a company stock c. Company stock shares represent equity segments of equal value d. Equity interest increases positively with the number of stock shares e. Stock options i. Describe an employee’s right to purchase company stock ii. Employees do not own the stock until they exercise the stock option rights, by purchasing stock at a designated price after a company-chosen time period lapses, usually no more than five years iii. Provide an incentive for employees to work productively with the expectation that collective employees’ productivity will increase the value of company stock over time iv. Employees earn monetary compensation when they sell the stock at a higher price than they originally paid for it 2. Other types of general stock compensation plans a. Employee stock ownership plans (ESOP) (more in Chapter 10) i. Places company stock in trust accounts for employees ii. Similar to deferred profit sharing because these trusts are set aside as a source of retirement income b. Stock compensation plans (more in Chapter 10) i. A form of deferred compensation for executives ii. Are supposed to create a sense of ownership, aligning the interests of the executive with those of the owners or shareholders (more in Chapter 12) VI. Designing Incentive Pay Programs A. Five Key Considerations 1. Should the plan be based on group or individual employee performance? 2. What level of risk will the employees be willing to accept in their overall compensation package? 3. Should the incentive pay replace or complement traditional pay? 4. What criteria should be used to judge performance? 5. Which time horizon for meeting goals would be most effective? a. Long-term? b. Short-term? c. Some combination? B. Group versus Individual Incentives 1. Group incentives are most suitable where: a. The nature of work is interdependent b. The contributions of individual employees are difficult to measure 2. Individual incentives a. Reward employees for meeting or surpassing predetermined individual goals b. Are most suitable for employees whose work is independent not interdependent, such as: i. Meeting production goals ii. Sales quotas 3. Both options require goals that are attainable C. Level of Risk 1. Increases as incentive pay represents a greater proportion of total core compensation 2. Is usually greater among employees with higher level jobs 3. Should be dependent on the extent to which an employee controls the attainment of the desired goal D. Complementing or Replacing Base Pay 1. When complementing base pay, the company awards incentive pay in addition to base pay and fringe benefits 2. Companies may reduce base pay by placing the reduced portion at risk in an incentive plan 3. Depends on the level or risk the employees are willing to accept 4. Depends on how cyclical the business is a. Cycles determine the amount of money available b. Cycles determine the employees’ ability to meet incentive goals 5. During slow business periods a. Increases in base pay in regular merit pay programs can create budget problems b. With incentive pay programs, the pay increases can be tied to the profitability of the company
Example: Incentive Pay and Base Pay • A company offers employees a 10 percent raise each year • Instead it could offer employees a • 4 percent cost-of-living increase • Awarding none of the remaining 6 percent to below average workers • 3 percent to average workers • 6 percent to high performing workers • The 6 percent is no longer a guarantee because that potential salary is placed at risk • Therefore high performers could earn more than 6 percent getting some of the money not earned by the lower producers
E. Performance Criteria 1. Measures used to appraise performance should be quantifiable and accessible 2. Measures should include: a. Company profits b. Sales revenue or units of production 3. Measures should relate to the company’s competitive strategy 4. If more than one measure is relevant, each should be weighed to reflect its relative importance to the company’s competitive strategy
Example: Weighing Performance Measures • When the amount of employees’ incentive pay is based on: • Company performance = 10% • Unit performance = 40% • Individual performance = 50% • The level of risk is minimal • When the amount of employees’ incentive pay is based on: • Company performance = 50% • Unit performance = 35% • Individual performance = 15% • The level of risk is much higher
F. Time Horizon: Short-Term versus Long-Term 1. “Rule-of-thumb” is that short-term is five years or fewer 2. Incentives for lower-level employees are: a. Usually short-term b. Goals are within the control of the employees 3. Incentives for professionals’ and executives’ are generally long-term Instructor Manual for Strategic Compensation: A Human Resource Management Approach Joseph J. Martocchio 9780133457100, 9780135192146
