Incentives and Performance-Based Rewards
Chapter Outline
• Purposes of Performance-Based Rewards
• Merit Compensation Systems
• Incentive Compensation Systems
• Teams and Group Incentive Reward Systems
• Executive Compensation
• New Approaches to Performance-Based Rewards
Chapter Objectives
• Summarize the purposes of performance-based rewards.
• Discuss merit compensation systems and their limitations.
• Identify and discuss forms and limitations of incentive compensation systems.
• Identify and describe forms and limitations of team and group incentive reward systems.
Chapter Objectives (cont’d)
• Discuss both standard and special forms of executive compensation and summarize criticisms of recent trends in executive compensation.
• Summarize new approaches to performance-based rewards in organizations.
• Understand basic concepts underlying a compensation strategy as applied to incentives and performance-based pay.
Purposes of Performance-
Based Rewards
• The major purposes involve the relationship of rewards to motivation and to performance.
• Specifically, organizations want employees to perform at relatively high levels and need to make it worth it for them to do so.
• When rewards are associated with higher levels of performance, employees will be motivated to work harder in the effort to achieve those awards.
Rewards and Motivation
• It is important that organizations motivate employees to exert effort aimed at accomplishing organizational goals.
• Rewards play an important role in how motivation occurs.
• Expectancy theory suggests that people are motivated to engage in behaviors if they perceive that those behaviors are likely to lead to outcomes they value.
Rewards and Motivation
in Organizations
Agency Theory
• Is concerned with the diverse interests and goals held by the organization’s stakeholders, including its employees and managers, and the methods through which the organization’s reward system can be used to align these diverse interests and goals.
Rewards, Motivation, and
Performance in Organizations
Rewards and Other Employee Behaviors
• Rewards can be used to influence
– Turnover
– Absenteeism/attendance
Merit Compensation Systems
• Merit pay
– Pay awarded to employees on the basis of the relative value of their contributions to the organization
• Merit-pay plans
– Compensation plans that formally base at least some meaningful portion of compensation on merit
Limitations of Merit
Compensation Systems
• They focus almost exclusively on individual performance.
• They are based primarily on performance appraisal systems, which may be subject to error.
• They may be prone to focusing on too broad a period of performance.
• They are subject to considerable disagreement among employees.
• Increases given to individuals become a permanent part of base pay.
Skill- and Knowledge-Based
Pay Systems and Merit
• Skill- and knowledge-based pay systems reward employees for the acquisition of more skills or knowledge.
Incentive Compensation Systems
• Piece-rate incentive plan
– Paying an employee a certain amount of money for every unit she or he produces
• Individual incentive plans
– Reward individual performance on a real-time basis
• Sales commission
– An incentive paid to salespeople
• Other forms
– Time off, special perks
Limitations of Incentive
Compensation Systems
• They are practical only when performance can be measured easily and objectively.
• They are often an administrative burden.
• They are likely to focus attention on only a narrow range of behaviors, perhaps at the expense of other behaviors.
Team and Group
Incentive Reward Systems
• Gainsharing
– A team- and group-based incentive system designed to share the cost savings from productivity improvements with employees
• Scanlon plan
– A type of gainsharing plan in which the distribution of gains is tilted much more heavily toward employees and across the entire organization.
Other Types of
Team and Group Rewards
• Profit sharing
– An incentive system in which, at the end of the year, some portion of the company’s profits is paid into a profit-sharing pool, which is then distributed to all employees
• Employee stock ownership plans (ESOPs)
– Group-level reward systems in which employees are gradually given a major stake in the ownership of a corporation
Limitations of Team and Group
Reward Systems
• Not every member of a group may contribute equally to the group’s performance.
• Employees may not see how their efforts lead to increased profits.
• Employees may come to view the group-level incentive as a normal part of their compensation.
Standard Forms of
Executive Compensation
• Base salary
– A guaranteed amount of money that the individual will be paid
• Stock-option plan
– An incentive plan established to give senior managers the option to buy the company stock in the future at a predetermined fixed price
Criticisms of Executive Compensation
• The levels of executive compensation attained by some managers seem too high for the average shareholder to understand.
• Executive compensation in the U.S. seems far out of line with that paid to senior executives in other countries.
• Little or no relationship seems to exist between the performance of the organization and the compensation paid to its senior executives.
• The gap between the earnings of the CEO and the earnings of a typical employee is enormous.
New Approaches to
Performance-Based Rewards
• A company could grant a salary-increase budget to work groups and then allow the members of those groups themselves to determine how the rewards will be allocated.
• Some companies now offer stock options to all their employees rather than just top executives.
A Strategic Perspective on Incentives and Performance-Based Rewards
• The organization must decide what it needs in order to compete more effectively.
• Reward systems should provide incentives to employees so that they work for the desired outcomes.
• Organization must be careful that the incentive plan does not encourage undesirable behaviors and outcomes.