Chapter-11

Incentives And Rewards

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Why Are Incentive Plans Important?

Some people work harder than others and should be compensated for that.

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How Incentives Work

Lets understand how different incentive plans affect employees attitudes and behavior. Theories of Motivation: 1. Reinforcement theory 2. Goal setting theory 3. Expectancy theory 4. Agency theory
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Reinforcement Theory
To understand behavior one must understand the consequences of that behavior. Behavior that leads to a positive consequence (reward) tends to be repeated, while behavior that leads to a negative consequence (punishment) tends not to be repeated. Behavior can be changed by providing properly scheduled rewards (or punishments).

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Goal Setting Theory

When employees are committed to specific, challenging, but attainable goals, the goals serve as an anchor to focus their effort on as well as for the amount of effort needed.

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Expectancy Theory
Motivation is a function of:
Expectancy: the belief that effort will lead to performance. Instrumentality: the connection between performance and the appropriate reward. Valence: the value the person places on the reward.

Motivation = (E x I x V)
If any factor (E, I, or V) is zero, then there is no motivation to work toward the reward. Employee confidence building and training, accurate appraisals, and knowledge of workers desired rewards can increase employee motivation.
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Agency Theory
Managers can motivate their employees to act in certain ways by aligning their interests with the interests of the firms other stakeholder

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Motivation, Performance, and Pay

Incentives
Financial rewards paid to workers whose production exceeds a predetermined standard.

Frederick Taylor
Popularized scientific management and the use of financial incentives in the late 1800s.
Systematic soldiering Fair days work

Linking Pay and Performance

Understanding the motivational bases of incentive plans
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The Hierarchy of Needs

Maslows Hierarchy of Needs:
Physiological (food, water, warmth) Security (a secure income, knowing one has a job) Social (friendships and camaraderie) Self-esteem (respect) Self-actualization (becoming a whole person)

Maslows prepotency process principle:

People are motivated first to satisfy each lower-order need and then, in sequence, each of the higher-level needs.
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Herzbergs HygieneMotivator Theory

Hygienes (extrinsic job factors)
Satisfy lower-level needs Inadequate working conditions, salary, and incentive pay can cause dissatisfaction and prevent satisfaction.

Motivators (intrinsic job factors)

Satisfy higher-level needs Job enrichment (challenging job, feedback, and recognition) addresses higher-level (achievement, self-actualization) needs.

Premise:
The best way to motivate someone is to organize the job so that doing it provides feedback and challenge that helps satisfy the persons higher-level needs.

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Types of Employee Incentive Plans

Individual Employee Incentive and Recognition Programs

Pay-for-Performance Plans

Team/Group-based Variable Pay Programs

Organizationwide Incentive Programs

Executive Incentive Compensation Programs

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Individual Incentive Plans

Piecework Plans
The worker is paid a sum (piece rate) for each unit he or she produces.
Straight piecework Standard hour plan

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Pros and Cons of Piecework

Easily understandable, equitable, and powerful incentives Employee resistance to changes in standards or work processes affecting output Quality problems caused by an overriding output focus Possibility of violating minimum wage standards Employee dissatisfaction when incentives either cannot be earned or are withdrawn
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Individual Incentive Plans (contd)

Merit Pay
Is a permanent cumulative salary increase the firm awards to an individual employee based on his or her individual performance Can detract from performance if awarded across the board Becomes permanent ongoing reward for past performance

Merit Pay Options

Give annual lump-sum merit raises that do not make the raise part of an employees base salary. Tie merit awards to both individual and organizational performance.
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Individual Incentive Plans (contd)

Standard Hour Plan: focus employees attention on how quickly they can perform their tasks. Spot Award: used to encourage employees to work toward specific outcomes. Commission Plan: pays employees a percentage of the total sales they generate. Salary Plan: employees receive a set compensation, regardless of their level of sales.
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Individual Incentive Plans (contd)

Profit Sharing Plan: A group based incentive plan where company profits are shared with employees. Stock Option Plan: provides employees with the right to purchase shares of their companys stock at some established price for a given period of time.

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Team/Group Incentive Plans

Team (or Group) Incentive Plans
Incentives are based on teams performance.

How to Design Team Incentives

Set individual work standards. Set work standards for each team member and then calculate each members output. Members are paid based on one of three formulas:
All receive the same pay earned by the highest producer. All receive the same pay earned by the lowest producer. All receive the same pay equal to the average pay earned by the group.
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Pros and Cons of Team Incentives

Pros
Reinforces team planning and problem solving Helps ensure collaboration Encourages a sense of cooperation Encourages rapid training of new members

Cons
Pay is not proportionate to an individuals effort Rewards free riders
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Organization wide Incentive Plans

Profit-Sharing Plans
Current profit-sharing (cash) plans
Employees receive cash shares of the firms profits at regular intervals.

Deferred profit-sharing plans

A predetermined portion of profits based on the employees contribution to the firms profits is placed in each employees retirement account under a trustees supervision. Employees income taxes on the distributions are deferred, often until the employee retires.
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Incentives for Managers and Executives

Executive Total Reward Package
Base salary (cash) Short-term incentives (bonuses) Long-term incentives (e.g., stock options)

Sarbanes-Oxley Act of 2002

Makes executives and the board of directors personally liable for violating their fiduciary responsibilities to their shareholders. Requires the CEO and CFO to repay bonuses, incentives, or equity-based compensation received following issuance of a financial statement that the firm must restate.
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Gainsharing Plans
Scanlon Plan Components

Philosophy of cooperation

Identity

Competence

Involvement system

Benefits sharing formula

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Implementing a Gainsharing Plan

1. Establish general plan objectives.

2. Choose specific performance measures.

3. Decide on a funding formula. 4. Decide on a method for dividing and distributing the employees share of the gains. 5. Choose the form of payment. 6. Decide how often to pay bonuses.

7. Develop the involvement system.

8. Implement the plan.
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Short- and Long-Term Incentives

Short-Term Incentives: The Annual Bonus
Plans intended to motivate short-term performance of managers and tied to company profitability. Issues in awarding bonuses
Eligibility basis Fund size basis Individual performance award

Long-term incentives
Stock options Performance shares Indexed options Premium price options Stock appreciation rights

Perks
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At-Risk Variable Pay Plans

Put some portion of the employees weekly pay at risk.
If employees meet or exceed their goals, they earn incentives.

If they fail to meet their goals, they forego some of the pay they would normally have earned.

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What Makes An Incentive Plan Effective?

1. Define the strategic context for the executive compensation program. 2. Shape each component of the package to focus the manager on achieving the firms strategic goals.

3. Check the executive compensation plan for compliance with all legal and regulatory requirements and for tax effectiveness.
4. Install a process for reviewing and evaluating the executive compensation plan whenever a major business change occurs.
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Why Incentive Plans Fail

Performance pay cant replace good management.

You get what you pay for.

Pay is not a motivator. Rewards punish. Rewards rupture relationships. Rewards can have unintended consequences.

Rewards may undermine responsiveness.

Rewards undermine intrinsic motivation.
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