Performance based compensation system:

Employee contributions
 Pay for performance (PFP)

The process in which pay will vary with some measure of individual, team, or
organizational performance is known as pay for performance.

• People stay in a firm (or leave) because of Pay

• Employees more readily agree to develop job skills because of Pay
• People join a firm because of Pay
• Employees perform better on their jobs because of Pay
 Designing PFP plans

• The effectiveness of a pay for performance plan 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.
• 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?
 Designing PFP plans

(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
• Eligibility
• Funding
 Designing PFP plans

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.
• Procedural justice: Fairness of the procedure used to determine the amount of reward
employee receives.
• A key element in fairness is communication regarding what is expected from employees.
 Designing PFP plans

3. Compliance:
The pay for performance system should comply with existing laws as a good
reward system that enhances the reputation of the firm.
 Types of Pay-for-performance

1) Shop-floor incentive: Shop-floor incentive schemes are based on the principle of payment-
by-performance(PBR).
• F. W. Taylor(1911), stated that the object of shop-floor incentive scheme was to reward the
input of labor within closely-defined tasks and by doing so, to stimulate people to work at a
faster pace and increase their output.
• This is in accordance with the instrumentalist view of motivation which is closely associated
with ‘Taylorism’.
• The view that employees will only work harder if they get more money still dominates
thinking about shop-floor incentive schemes.
 Types of Pay-for-performance
2) Sales force incentive:
• Any company with a consumer-facing or a business-to-business aspect will constantly be
looking to increase their sales.
• Targets are set for sales people, but there is frequently little incentive to push beyond these
targets once an employee is drawing a salary.
• Developing effective incentive schemes to encourage your sales people to perform to the
best of their abilities is an important aspect of running a successful consumer facing business.
• The major benefits here are two-fold; in the first instance your turnover obviously increases
as your sales go up. Secondly, a good sales incentive scheme that goes beyond the regular
bonus structure will be a vital tool for keeping hold of your most talented, in demand sales
staff.
 Types of Pay-for-performance

3) Executive pay
•Executive pay is financial compensation received by an officer of a firm, often as a mixture
of salary, bonuses, share call options on the company stock, etc.
• Over the past three decades, executive pay has risen dramatically beyond the rising levels of
an average worker's wage. Executive pay is an important part of corporate governance, and is
often determined by a company's board of directors.
 Types of Pay-for-performance

4) Team based Pay

• It is one of the incentive plans which has lot of attributes and can be a failure reports many
companies if unmanaged.
• First, team comes in many varieties such as, full-time teams(work group organized as a
team), part-time teams(that cut across functional departments. With so many varieties. It is
hard to have a consistent type of compensation plan.
• A second problem with rewarding teams is called the “level problem”.
• Third problem is the complexity of a plan which varies from organization to organization.
Types of team based Pay

• Profit-sharing
• Gain-sharing
• Employees Stock Ownership Plan(ESOP)
 Types of team based Pay
(a) Profit-sharing plan
• Profit sharing, when used as a special term, refers to various incentive plans
introduced by businesses that provide direct or indirect payments to employees
that depend on company's profitability in addition to employees' regular salary
and bonuses.
• The profit sharing plans are based on predetermined economic sharing rules
that define the split of gains between the company as a principal and
the employee as an agent.
 Types of team based Pay
b) Gain-sharing plan:
• Gain-sharing is best described as a system of management in which an
organization seeks higher levels of performance through the involvement and
participation of its people.
• As performance improves, employees share financially in the gain. It is a team
approach; generally all the employees at a site or operation are included.
• Gain-sharing measures are typically based on operational measures i.e.,
productivity, spending, quality, customer service.
• Gain-sharing applies to all types of business that require employee collaboration
and is found in manufacturing, health care, distribution, and service, as well as the
public sector and non-profit organizations.
 Types of team based Pay

(c) Employee Stock Ownership Plan(ESOP):

• Some companies believe that employees can be linked to the success or failure of
the company through ESOP.
• Companies like PepsiCo, Lincoln Electric, Coca-Cola and others aim to increase
employee involvement in the organization which may increase the performance.
• ESOPs don’t make sense as an incentive since the effects are generally long-term.
 Merit Pay

•It is also called as pay for performance or performance related pay.

•Remuneration is linked to an individual’s performance.
• It offers financial rewards in the form of an increase in base pay, cash bonuses.
•It is extensively practiced by firms because it communicates a message that employee’s
performance is valued and realizes by the company.
•Hikes in salaries are made based on the eligibility of an employee such as seniority,
experience, skills possessed. Etc.
 Variable Pay
•It is the cash portion of an employee’s compensation that is added to the fixed pay
portion.
•It varies w.r.t achievement of certain goals or results.
•It is also known as pay at risk.
•There is a direct link with the level of performance.
•The main purpose is to tie employee performance with business strategy.
•If a remarkable job is done then the employee is given as higher compensation.
•Example: Incentives, commission etc
•An employee may be dissatisfied if his salary includes more of variable components.
•Fixed components and variable components collectively leads to the formation of CTC.
•Variable pay may vary in terms of seniority, experience, levels of management etc as per
the scales set by the company.
 Incentives

•Incentives also known as payment by results (PBR)

•It is a monetary benefit paid by an employer to an employee in recognition of their
outstanding performance.
•Incentives vary from individual to individual from time to time.

“An incentive scheme is a plan or programmes to motivate individual for good

performance. An incentive is most frequently built on monetary rewards, but may
also include a variety of non-monetary rewards or prizes”.
By: Smith.
Types of incentives

•Basis of period of payment

• Regular incentives
• Periodical incentives
• Occasional incentives
•Basis of medium of payment
• Cash incentives
• Non cash incentives
•Basis of levels
• Individual incentives
• Group incentives
• Enterprise incentives
 Types of incentives
Regular Incentives:
• Permanent part of compensation.
• Recurring regularly
• May be monetary or non-monetary
• Employees will strive to achieve it.

Periodical incentives:
• Employees are rewarded periodically.
• It is an extra reward to employees in recognition to their performance
• The amount depends on the profitability of the business.
• Payment is based on time periods to employees.

Occasional incentives:
• It is given occasionally.
• Used to create a sense of uniqueness
• It may be monetary or non monetary in nature.
• To meet a specific objective.
• Ex: completion of project before the deadline.
 Types of incentives
Cash incentives:
• Most commonly used.
• Outstanding performance is recognized by a sum of money.
• Cash incentives are not taxed.
• Cash incentives are more preferred by employees.
• Very much valued by the employees.
• Increases organizational image.

Non-cash incentives:
• Outstanding performance by an employee is recognized by awarding of prizes or gifts, travel vouchers.
• They are of no actual financial value to employees.
• Less preferred by employees.
• Reduces the employer’s image.
• The worth is not actually realized by employees.
• Can be used only to reward
 Types of incentives
Individual incentives:
• It is widely accepted today.
• Encourages corporate objectives.
• Employees are paid incentives based on individual performance criteria.
• Employees are differentiated from each other.
• Every employees performance is reviewed in detail to fix the incentive amount.
• Incentives may be fixed or varying based on the organizational operating policy.

Group incentives:
• Motivates a group and values their performance.
• Used where the output is difficult to measure.
• One employee’s performance is affected by the other.
• All the group members are paid a fixed amount as incentives for achieving an objective.
• The entire teams performance is taken into consideration.
• One group is compared with different other groups for recognizing their performance and paying the
incentives.
 Short term incentives
•It is also known as annual incentives.
•It compensates executives for achieving the company’s short term business strategy
based on achievement of goals by the board compensation committee.
Example: Annual incentive plan, discretionary bonus plan
 Long term incentives

Long term incentives:

•Long term incentives reward executives for achieving superior long run performance that provides
above average returns to share holders.
•Long term incentives encourage executives to take risks with firm assets leading to shareholder gains
that they might otherwise avoid.
•Example: Investment in a risky project

ESOP: Employee Stock option plans:

It is used by companies to compensate, retain and attract employees. These plans are the contracts
between a company and its employees that give employees the right to buy a specific number of
company’s shares at a fixed price within a certain period of time.
Compensation of special groups

• Workers compensation
• Managerial compensation
• Executive compensation
 Who Are Special Groups?
• Supervisors

• Corporate directors

• Top management executives

• Professional employees

• Sales staff

• Contingent workers
 Compensation of special groups
Workers compensation:
• People who operate at the lower level.
• It provides a degree of financial protection especially incases of accidents and
illness resulting from the workplace.
• Payment of medical expenses, payments for lost income associated with total or
partial disability, compensating workers family on death of the worker are the
various forms.
• Workers are also included on the permanent payroll of the firm for being eligible for
additional compensatory schemes that leads to job security.
• They are also subjected to various compensation components apart from the base
salary such PF, ESIC etc.
• Companies have tie-ups with hospitals, insurance agencies for providing an
attractive compensation plan to the shop floor employees.
 Compensation of special groups

Managerial compensation:
• They are the personnel’s who report directly to the top level management.
• Generally they are placed at the middle level.
• Managers compensation is usually fixed by the board of directors.
• Managers enjoy higher compensation and benefits when compared to the workmen’s
compensation such as HRA, DA, stock option plan’s, special allowances, telephone
allowances, transport facilities etc.
• It includes 3 major components:
• Salary
• Benefits
• Incentives
 Compensation of special groups
Executive compensation:
• They are the personnel’s at the top level management like CEO’s, MD etc.
• These enjoy the top cream of a company’s compensation plan.
• The basic salary is a definite component.
• Other components may vary depending upon the company policies.
• Executive compensation is always higher when compared to workmen’s and
managerial compensation.
• It includes components like:
• Base Salary
• Benefits
• Bonuses
• Shares
• Long term & short term Incentives
EXHIBIT 14.8: POPULAR PERKS
OFFERED TO EXECUTIVES
 Personal liability insurance
 Company car  Spouse travel

 Financial  Reserved parking

counseling
 Company  Executive dining room
plane
 Home security system
 Income tax preparation
 Car, phone
 First-class air travel
 Financial seminars
 Country club membership
 Loans at low or no interest
 Estate planning
 Legal counseling
Compensation strategies for special groups
STRATEGIES: SUPERVISORY PAY

• Pay strategies
– Key base salaries of supervisors to an amount exceeding highest paid employee

– Pay supervisors for scheduled overtime

• Trend in supervisory compensation

– Increased use of variable pay

– More than half of all companies have a variable pay component for supervisors
CORPORATE DIRECTORS

• Stockholders blame corporate directors for excessively high executive compensation

– Directors are much more active in decision making and somewhat less prone to grant huge salaries to
the CEO
– Approximately two-thirds of boards now include more outside directors than inside directors
EXECUTIVES

• Pay is linked to company performance

– Company performance exceeds industry standards, big bonuses and stock payouts follow
– Poor financial performance means much smaller pay packages
SALES COMPENSATION PACKAGES

• Guaranteed base salary

• Guaranteed base salary + commission
• Guaranteed base salary + bonus
• Guaranteed base salary + commission + bonus
• Commission only
• Combination plan