Pay for Performance

Module 4
Dr. Aparna Mendiratta
 Linking to the Links:

• https://yourstory.com/2018/05/pay-performance-paradigm-shift-indian-workplace
• http://aonhewitt.co.in/Home/Resources/TotalRewards-Quarterly/Vol-8-Issue-1/The-Paradigm-of-Pay-and-
Performance
• https://m.economictimes.com/jobs/ceo-compensation-larger-parts-of-salary-components-being-linked-to-
performance/articleshow/62463881.cms
• https://www.forbes.com/sites/louismosca/2018/03/22/case-study-the-motivating-power-of-pay-for-
performance/#3e367ed47583
• https://www.primeum.com/en/blog/google-implemented-innovative-incentive-compensation-system
• https://www.inc.com/bill-murphy-jr/you-dont-just-get-fired-at-amazon-what-happens-instead-is-brilliant-
or-maybe-insane-your-choice.html
• https://www.cnbc.com/2019/05/13/amazon-will-pay-employees-thousands-to-quit-and-become-business-
owners.html
• https://www.forbes.com/sites/robinferracone/2019/04/23/dare-to-be-different-the-case-of-amazon-
com/#32352be9cb99
 Designing a pay-for-performance plan

• The effectiveness of a pay model depends upon three things- efficiency,

equity and compliance.

1. Efficiency: it involves three general areas of concern.

(i) Strategy:
• Does the pay-for-performance plan support corporate objectives?
• The plan should link well with HR strategy and objectives.
• The reward should not be on the basis of status quo.
• Finally, management has to address the most difficult question like- How
much of an increase makes a difference? How does it take to motivate an
employee?
(ii) Structure:
• Structure of the organization should be sufficiently decentralized to allow different
operating units to create flexible variations on a general pay for performance plan.
• Different operating units may have different competences and different
competitive advantages, so the organization should not have a rigid pay-for-
performance system that detracts from these advantages.

(iii) Standards:
• The key to designing a pay-for-performance system rests on standards:
• Objectives
• Measures
• Eligibility
• Funding
2. Equity/Fairness :
• The second design objective is to ensure that the system is fair to
employees. Two types of fairness are concerns of employees:
• Distributive justice: Fairness in the amount that is distributed to the
employees. Managers have little influence over the size of employee’s pay
check. It is influenced more by external market conditions, pay policy
decisions of organization and occupational choices.
• Procedural justice: Fairness of the procedure used to determine the
amount of reward employee receives. Managers have control over this
type and the organizations that use fair procedures and supervisors are
perceived as more trustworthy and command higher levels of
commitments.
• A key element in fairness is communication regarding what is expected
from employees.
3. Compliance:
The pay for performance system should comply with existing laws as a good
reward system enhances the reputation of the firm.
 Specific Pay for Performance (Short Term)

• Merit Pay Increases

A merit pay increase refers to an increase to an employee’s base pay due to
high performance. These raises are typically delivered an annual basis, and are
budgeted for as part of the annual salary increase budgeting process. Merit
pay increases are the most commonly used pay-for-performance model for
recognition of employee performance, as they deferentially reward top
performers for their contributions with a bump to their base salary for the
following year.
 Contd…

• Lump-Sum Bonuses
These are the substitutes for merit pay, based on employee or company’s
performance employees receive an year of end bonus that does not build into
base pay.
• Spot Awards
Usually these payouts are awarded for exceptional performance, often on
special projects or for performance that exceeds expectations.
 Specific Pay for Performance (Long Term)

• Employee Stock Ownership Plans(ESOP’s): In an ESOP, the company contributes

to employee retirement plans with its own stock. This might occur through cash or
securities contributions to the plan, or by allowing the ESOP to obtain a bank loan
to purchase shares from the company.
• Broad Based Option Plans(BBOP’s): The company gives employees shares of
stock over a designated time period. (Southwest Airlines, Pepsico, Procter and
Gamble, Microsoft, Starbucks etc.) Starbucks –it has a stock program called
Beanstock and all employees who work for 500 hours per year are eligible for this.
 Individual Incentive Plans
Incentive plans are part of an employee's compensation or pay. The incentive
plan gives an employee the opportunity to increase his annual pay based upon
either company performance or individual performance. Incentive plans are a
way for companies to keep employees motivated to perform to the best of
their abilities, thus increasing company profit.
 There are four general categories of plan
1. Cell 1
 The most frequently implemented incentive system is a straight
piecework system.
 Rate determination is based on units of production per time period, and
wages vary directly as a function of production level.
 The major advantages of this type of system are that it is easily
understood by workers and, perhaps consequently, is more readily
accepted than some of the other incentive systems.

1. Cell 2
 Two relatively common plans set standards based on time per unit and tie
incentives directly to level of output:
a. Standard hour plan is a generic term for plans setting the incentive
rate based on completion of a task in some expected time period.
b. Bandeaux plan provides a variation on straight piecework and
standard hour plans. It requires division of a task into simple actions
and determination of the time required by an average skilled worker to
complete each action.
Cell 3
The two plans included in cell 3 provide for variable incentives as a function
of units of production per time period:
a)Taylor Plan – establishes two piecework rates:
1)Goes into effect when a worker exceeds the published standard for a given
time period.
2) Established for production below standard, and this rate is lower than the
regular wage.
b) Merrick Plan – operates in the same way, except that three piecework
rates are set:
1)High for production exceeding 100% of standard
2)Medium for production between 83 and 100% of standard
3)Low for production less than 83% of standard
4. Cell 4
The three plans included in cell 4 provide for variable incentives linked to
a standard expressed as a time period per unit of production:
a. Halsey 50-50 method – derives its name from the shared split
between worker and employer of any savings in direct cost.
b. Rowan Plan – similar to the Halsey plan in that an employer and
employee both share in savings resulting from work completed in
less than standard time.
c. Gantt Plan – differs from both the Halsey and the Rowan plans in
that the standard time for a task is purposely set at a level requiring
high effort to complete.
 Individual Incentive Plans
Advantages:
 Substantial impact that raises productivity, lowers production costs,
and increases earnings of workers.
 Less direct supervision is required to maintain reasonable levels of
output than under payment by time.
 In most cases, systems of payments by results, if accompanied by
improved organizational and work measurement, enable labor costs to
be estimated more accurately than under payment by time. This helps
costing and budgetary control.
 Individual Incentive Plans
Disadvantages:
 Greater conflict may emerge between employees seeking to maximize
output and managers concerned about deteriorating quality levels.
 Attempts to introduce new technology may be resisted by employees
concerned about the impact on production standards.
 Reduced willingness of employees to suggest new production methods
for fear of subsequent increases in production standards.
 Increased complaints that equipment is poorly maintained, hindering
employee efforts to earn larger incentives.
 Increased turnover among new employees discouraged by the
unwillingness of experienced workers to cooperate in on-the-job
training.
 Elevated levels of mistrust between workers and management.
 Group Incentives
The incentive schemes can be applied on a group basis also. Group incentive
schemes are appropriate where jobs are interdependent. It is difficult to
meaningfully measure individual performance and group pressures affect the
performance of the members of the group. The chief group incentive schemes
are discussed here.

Profit-Sharing
The concept of profit-sharing emerged towards the end of the nineteenth
century. Profit-sharing, as the name itself suggests, is sharing of profit of
organization among employees. The International Co-operative Congress”
held in Paris in 1889 considered the issue of profit-sharing and defined it as
“an agreement (formal or informal) freely entered into by which an employee
receives a share fixed in advance of the profits”.
• Gain Sharing: As the name suggests, employees share in the gains in these
types of group incentive plans. It looks at cost components of the income
ledger and identifies savings over which employees have more impact
(reduced scrap, lower labor costs, reduced utility costs).
Group Incentives
Some Examples
 Long Term Incentives
Long term incentives focus on performance beyond the one-year time line used as the
cutoff for short term incentive plans. recent explosive growth in long-term plans.
recent explosive growth in long-term plans appears to be surprised in part by a desire
to motivate long term value creation.

Long-Term Incentives & Their Risk-Reward Tradeoff ’s

Level One: Risk/Reward

1)Time-Based Restricted Stock:
2)Performance-accelerated restricted stock:
3)Stock Purchase Plan:

Level Two: Medium Risk/Reward

4)Time-Vested stock option
5)Performance-versed restricted stock
6) Performance-accelerated stock option
Level Three: High Risk/Reward
7)Premium-priced stock option
8)Indexed stock option
9)Performance-vested stock option