Objectives of Performance-Based Pay

Objectives of Performance-Based Pay

Strategic Importance of Using Performance-Based Pay to Enhance Motivation

•   Supporting Strategic Objectives

ØUse pay to align individual goals with strategic objectives

ØCan change and direct employee behavior during times of change and diversification

•   Managing Labor Costs

ØIt is important to reward good performance.

ØMerit pay raises increase labor costs but do not guarantee ongoing productivity increases.

•  How to pay only for current performance?

Strategic Importance of Using Performance-Based Pay to Enhance Motivation (cont’d)

•   Attracting, Retaining, and Motivating Talent

ØWant best employees to find system attractive

ØWant to interest best applicants for jobs

ØEarly in company life cycle, the potential for wealth is used to attract workers

The Strategic Value of Three Types of Pay

Use of Performance-Based Pay within
an Integrated HRM System

Design Choices for Performance-Based Pay

•   Monetary and Nonmonetary Rewards

Ø Not behavior must be compensated, but it should be recognized and rewarded in some way.

•   Forms of Performance-Based Pay

Ø Merit pay—reflects past performance

Ø Incentive pay—motivates future performance

Ø Earnings-at-risk plans—earning more incentive-based pay by putting more base pay at risk

•   Aggregation

Ø Organizations levels at which performance is measured and rewards are distributed—individual, team, and company as a whole .

Performance-Based Pay under Merit, Incentive,
and Earnings-at-Risk Pay Plans

The HR Triad and Performance-Based Pay

Designing Performance-Based Pay

•   To be effective, performance-based pay must successfully deal with:

–        Specifying and measuring performance

–        Specifying the methods for linking pay to performance

–        Specifying the level of aggregation for reward distribution

–        Specifying the type of reward

–        Specifying eligibility for rewards

–        Gaining employee acceptance

Specifying and Measuring Performance

•   What Gets Measured Gets Rewarded

ØEmployers should both measure and reward what is important, being careful not to ignore aspects of performance that are difficult to measure.

•   Measuring Results versus Measuring Behaviors

ØBoth results and behaviors are important

•  Examples of results: Profits, productivity

•  Example of behavior: “Returns customer calls within 24 hours.”

•  Results must be under workers’ control

Specifying and Measuring Performance (cont’d)

•   Short-Term versus Long-Term Perspectives

ØDifficult “balancing act”

ØFor example:

•  Raise stock price at
long-term expense
for company

•  Neglect of current team
for long-term self-

Metrics for Short-Term Incentives

Levels of Aggregation for
Reward Distribution

•   Objectivity in Reward Measures

ØObjectivity increase as level at which performance is measured rises

•  Individual, work team, department, plant, strategic
business unit, organization

•   Behaviors

ØWhich types of individual behaviors are desirable (e.g. cooperation, competition)?

ØCompeting against objective performance goals overcomes the problem of competition among employees.

Effectiveness of Alternative Forms of Pay

Types of Reward

•   Form of payment

•   Size of rewards

ØProportion of pay “at risk”

•   Eligibility rules for rewards

•   Timing of rewards

•   Combinations of rewards

•   Value of rewards to employees

Prevalence of Incentive Awards

Size of Incentive Awards

Why Employees Oppose
Performance-Based Pay

Steps for Building Employee Acceptance
of Performance-Based Pay

Performance Based Pay: Legal Considerations

•   Discrimination

ØEmployers must apply same decision rules to all employees.

ØEmployees are protected by Title VII of the Civil Rights Act and the Equal Pay Act.

•   Taxes and Accounting Rules

ØTreatment of capital gains and stock option plans affects the value of incentives to employees and the bottom-line profitability of firms.

Merit Pay Plans

•   Merit pay results in a permanent increase in base pay—past performance is rewarded and future productivity is not assured.

•   The Performance-to-Pay Link:

ØLink may be looser than it appears.

ØPlans may be based on subjective, contaminated, or deficient, performance measures.

ØManagerial discretion: annual raises may consider non-performance factors.

ØBudget may not allow meaningful increases.

Merit Increase Based on Current Position
in the Salary Range

Incentive Pay Plans

•   Benefits of Incentives

Ø Employees earn a one-time increase in pay that does not increase base pay.

Ø Rewards are based on objective performance measures.

Ø Rewards are for short-term performance; one year or less.

•   Individual incentives

Ø Piecework

Ø Standard hour plans

Ø On-the-spot awards

Ø Rewards for suggestions

Ø Rewards for innovations and patents

Ø Executive incentives

•   Team incentives

•   Special achievement awards

•   Profit sharing

•   Gainsharing


•   Straight Piecework

ØStandard rate:  base pay divided by normal rate.

ØEmployees are guaranteed standard rate for each unit produced.

•   Differential piece rate

ØMore than one rate of pay
for same job

Standard Hour Plans

•   Standard Hour

ØStandard time set for each unit of production

ØFor mechanics, rate includes amount paid to the worker plus a premium for shop owner

ØCustomer pays fixed rate,
regardless of time the
work actually takes.

Executive Incentives

•   Pay formula relates incentives to attainment of corporate goals

•   May include:

Ø Cash

Ø Restricted stock grants

Ø Performance shares

Ø Stock option grants

•   Controversial issues:

Ø Amount of executive pay

Ø Small role of performance in determining pay

Team Incentives

•   Advantages of Team-based Incentives:

ØPresence of team members reinforces behavior.

ØPeer pressure for counterproductive behavior is reduced.

ØGroup rewards, such as
praise and camaraderie,
increase reward value.

ØHigh group performers
are role models.

Example of Incentives Used by a Manufacturer to Reward Team and Plant Performance

Pay Plans for Different Types of Teams

Issues in Performance-Based Team Pay Design

Profit Sharing

•   Timing

ØCurrent distribution plans: a percentage of profits distributed is quarterly or annually.

ØDeferred distribution plans: funds are distributed at retirement, termination, death, disability

•   Strategic Objectives:

ØA criticism of profit sharing:
it is difficult for employees to
see the connection between
their performance and profitability.


•   Introduced in 1889

•   Overall approach:

ØMeasure work unit’s costs and productivity

ØShare future gains with employees

ØTypically involve all employees in work unit or firm

ØMedian payout is 3%

Gainsharing Plans

•   First Generation: Scanlon and Rucker Plans

ØShare benefits of productivity-generated savings

•  Gather employee suggestions to increase productivity and reduce costs

•  Employee committees evaluate ideas

•   Second Generation: Improshare

ØFocus on labor hours saved

•  Based on time-and-motion studies

•  Non-production workers included

•   Third Generation:

ØBroader range of organizational goals

ØCustom designed for each company

Calculations for Selected Gainsharing Plans

Pay That Puts Earnings at Risk

•   Commission

ØPay that is based on a percentage of the sales price of the product

•   Establishing a sales commission plan

ØWhat are the strategic objectives to be achieved?

ØWhat criteria to be used to measure performance?

ØAre territories equivalent in sales potential?

ØWill commission rates vary by product or vary depending on sales level?

ØWill earnings have a cap?

ØWhat will be the timing of commission payments?


•   Used to direct activities of non-supervised sales personnel

ØStraight salary is more appropriate when non-direct sales activities are more important.

•   Straight Commission

ØHighly motivating if objectives are
clear and program is well-designed

•   Combined Plans

ØSalary (as a draw) and commission
is a common approach.

Stock Ownership

•   Employee Stock Ownership Plans (ESOPs)

ØGrant shares of stock to employees as a means of long-term savings and retirement.

ØNot tied to individual performance

•   Stock Options

ØGive employees right to buy company stock at later date at price established when the purchase option was granted.

ØExecutive stock options:

•  Often exceeds all other compensation

•  Encourages executives to “think like owners”?

Explanation of Selected Stock-Based Pay Awards

Explanation of Selected Stock-Based Pay Awards

International Considerations

•   Relatively little systematic research investigating cultural differences in how employees react to alternative forms of performance-based pay.

•   Research Findings on Incentives:

ØAmericans would prefer unequal, performance-based distribution of rewards and the Chinese would prefer more equal distribution.

ØChinese preferred to see socioemotional awards—such as parties and managerial friendliness—distributed unequally, whereas the Americans felt these socioemotional awards should be distributed to everyone equally.

Acceptance of Pay at Risk in Selected Countries