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Incentive Pay Systems Chapter 14 Mc. Graw-Hill/Irwin Copyright © 2008 by The Mc. Graw-Hill Incentive Pay Systems Chapter 14 Mc. Graw-Hill/Irwin Copyright © 2008 by The Mc. Graw-Hill Companies, Inc. All Rights Reserved.

Incentive Pay Plans • Pay plans designed to relate pay directly to performance or Incentive Pay Plans • Pay plans designed to relate pay directly to performance or productivity • Used in conjunction with a base wage and salary system • Incentive pay plans attempt to strengthen the performance –reward relationship • Motivate employees • Incentive systems can be categorized on the basis of individual, group, or organizational level • Advantage • Not permanent and must be earned each year 14 -2

Individual Incentives • All types of individual incentives tied in some measure to performance Individual Incentives • All types of individual incentives tied in some measure to performance of individual • Advantage • Employees can readily see relationship between what they do and what they get • With group- and organization-based plans, relationship is often not so clear • Drawback • Competition among employees may produce negative results 14 -3

Piece Rate Plans • Simplest and most common type of incentive plan • Employer Piece Rate Plans • Simplest and most common type of incentive plan • Employer pays employee a certain amount for every unit he or she produces • Differential piece rate plan – Devised by Frederick W. Taylor • Pays one rate for all acceptable units produced up to some standard and a higher rate for all pieces produced if output exceeds standard 14 -4

Plans Based on Time Saved • Standard hour plans • Similar to piece rate Plans Based on Time Saved • Standard hour plans • Similar to piece rate plans; a standard time is set in terms of time it should take to complete a particular job • Incentive plans based on time saved give an employee a bonus for reaching a given level of production or output in less than standard time 14 -5

Plans Based on Commissions • Incentive plan that rewards employees, at least in part, Plans Based on Commissions • Incentive plan that rewards employees, at least in part, based on their sales volume • Many salespeople work under this type of plan • Straight commission basis – Pay is entirely determined by their volume of sales • Combination of salary plus commission – A guaranteed base salary plus a commission on sales 14 -6

Individual Bonuses • Bonus – Reward that is offered on a one-time basis for Individual Bonuses • Bonus – Reward that is offered on a one-time basis for high performance • May be in cash or in some other form (trips etc. ) • Advantage – Must be earned each year and organization is not obligated over long run • Drawback – Can become an extension of salary and occurs • When awarding bonus becomes practically guaranteed since it is not tied to profits or some other measure of performance • Merit pay increase – Reward based on performance but also perpetuated year after year 14 -7

Suggestion Systems • Systems that usually offer cash incentives for employee suggestions that result Suggestion Systems • Systems that usually offer cash incentives for employee suggestions that result in either increased profits or reduced costs • Can provide means for • Making employees feel more a part of the organization • Improving communications between management and employees • The systems involve specific procedures for submitting ideas and utilize committees to review and evaluate suggestions 14 -8

Incentives for Managerial Personnel • Generally take the form of • Annual bonuses • Incentives for Managerial Personnel • Generally take the form of • Annual bonuses • Some type of stock option 14 -9

Annual Bonus • Most plans provide a year-end bonus based on that year’s performance, Annual Bonus • Most plans provide a year-end bonus based on that year’s performance, usually measured • In terms of profits • Sometimes measured by other means • Annual cash bonus – Most common type of incentive • Typically, bonus is paid in cash as a lump sum soon after end of performance year 14 -10

Stock Options for Managerial Personnel • • • Designed to give managers an option Stock Options for Managerial Personnel • • • Designed to give managers an option to buy company stock at a predetermined, fixed price • If price of stock goes up – Individual exercises option to buy stock at the fixed price and realizes a profit • If price of stock goes down – Stock option is said to be “underwater, ” and the manager does not purchase the stock Intent is to provide incentive for managers to work hard and increase company profits, thus increasing price of the stock Drawbacks • Some executives become concerned with pumping up short-term value of the stock to increase their personal wealth • It dilutes the holdings of current shareholders 14 -11

Group Incentives • Incentives based on group rather than individual performance – Recommended where Group Incentives • Incentives based on group rather than individual performance – Recommended where jobs are interdependent • Based on such factors as profits or reduction in costs of operations • Encourages employees to exert peer pressure on group members to perform • Drawback • Members may not perceive direct relationship between individual performances and that of the group • Different groups can become overly competitive with one another to the detriment of the entire organization

Organizationwide Incentives • Incentives that reward all members of the organization based on the Organizationwide Incentives • Incentives that reward all members of the organization based on the performance of the entire organization • Common organizationwide incentive plans include • Gain-sharing plans • Scanlon-type plans • Employee stock ownership plans (ESOPs)