Pay for performance

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1 March 2016

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Motivation, Performance, and Pay

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

Law of individual differences
The fact that people differ in personality, abilities, values, and needs. Different people react to different incentives in different ways. Managers should be aware of employee needs and fine-tune the incentives offered to meets their needs. Money is not the only motivator.

Employee Preferences for Noncash Incentives

Needs and Motivation

Abraham Maslow’s Hierarchy of Needs
Five increasingly higher-level needs:
physiological (food, water, sex)
security (a safe environment)
social (relationships with others)
self-esteem (a sense of personal worth)
self-actualization (becoming the desired self)
Lower level needs must be satisfied before higher level needs can be addressed or become of interest to the individual.

Herzberg’s Hygiene–Motivator theory
Hygienes (extrinsic job factors)
Inadequate working conditions, salary, and incentive pay can cause
dissatisfaction and prevent satisfaction. Motivators (intrinsic job factors)
Job enrichment (challenging job, feedback and recognition) addresses higher-level (achievement, self-actualization) needs. The best way to motivate someone is to organize the job so that doing it helps satisfy the person’s higher-level needs.

Edward Deci
Intrinsically motivated behaviors are motivated by the underlying need for competence and self-determination. Offering an extrinsic reward for an intrinsically-motivated act can conflict with the acting individual’s internal sense of responsibility. Some behaviors are best motivated by job challenge and recognition, others by financial rewards.

Instrumentality and Rewards

Vroom’s Expectancy Theory
A person’s motivation to exert some level of effort is a function of three things: Expectancy: that effort will lead to performance.
Have to have the skills to do the job
Instrumentality: the connection between performance and the appropriate reward. Goal must be attainable
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.

Types of Incentive Plans

Pay-for-performance plans
Variable pay (organizational focus)
A team or group incentive plan that ties pay to some measure of the firm’s overall profitability. Variable pay (individual focus)
Any plan that ties pay to individual productivity or profitability, usually
as one-time lump payments.

Pay-for-performance plans
Individual incentive/recognition programs
Sales compensation programs
Team/group-based variable pay programs
Organizationwide incentive programs
Executive incentive compensation programs

Individual Incentive Plans

Piecework Plans
The worker is paid a sum (called a piece rate) for each unit he or she produces. Straight piecework: A fixed sum is paid for each unit the worker produces under an established piece rate standard. An incentive may be paid for exceeding the piece rate standard. Standard hour plan: The worker gets a premium equal to the percent by which his or her work performance exceeds the established standard.

Pro 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.
Employee dissatisfaction when incentives either cannot be earned due to external factors or are withdrawn due to a lack of need for output

Merit pay
A permanent cumulative salary increase the firm awards to an individual employee based on his or her individual performance. Merit pay options
Annual lump-sum merit raises that do not make the raise part of an employee’s base salary. Merit awards tied to both individual and organizational performance.

Incentives for professional employees
Professional employees are those whose work involves the application of
learned knowledge to the solution of the employer’s problems. Lawyers, doctors, economists, and engineers.
Decisions can be challenging
These individuals are already well paid and are driven to succeed Possible incentives
Bonuses, stock options and grants, profit sharing
Better vacations, more flexible work hours
Improved pension plans
Equipment for home offices

Recognition-based awards
Recognition has a positive impact on performance, either alone or in conjunction with financial rewards. Combining financial rewards with nonfinancial ones produced performance improvement in service firms almost twice the effect of using each reward alone. Day-to-day recognition from supervisors, peers, and team members is important.

Online award programs
Programs offered by online incentives firms that improve and expedite the awards process. Broader range of awards
More immediate rewards
Information technology and incentives
Enterprise incentive management (EIM)
Software that automates the planning, calculation, modeling and management of incentive compensation plans, enabling companies to align their employees with corporate strategy and goals.

Incentives for Salespeople

Salary plan
Straight salaries
Best for: prospecting (finding new clients), account servicing, training customer’s salesforce, or participating in national and local trade shows. Commission plan
Pay is only a percentage of sales

Specialized Combination Plans

Commission-plus-drawing-account plan
Commissions are paid but a draw on future earnings helps the salesperson to get through low sales periods. Commission-plus-bonus plan
Pay is mostly based on commissions.
Small bonuses are paid for directed activities like selling slow-moving items.

Organizationwide Variable Pay Plans

Profit-sharing plans
Cash plans
Employees receive cash shares of the firm’s profits at regular intervals. The Lincoln incentive system
Profits are distributed to employees based on their individual merit rating. Deferred profit-sharing plans
A predetermined portion of company profits is placed in each employee’s account under a trustee’s supervision.

Organizationwide Variable Pay Plans (cont’d)

Employee stock ownership plan (ESOP)
A corporation annually contributes its own stock—or cash (with a limit of 15%) to be used to purchase the stock—to a trust established for the employees. The trust holds the stock in individual employee accounts and distributes it to employees upon separation from the firm if the employee has worked long enough to earn ownership of the stock. Advantages of ESOPs

ESOPs help employees develop a sense of ownership in and commitment to the firm, and help to build teamwork. No taxes on ESOPs are due until employees receive a distribution from the trust, usually at retirement when their tax rate is lower.

At-Risk Variable Pay Plans

At-risk variable pay plans that put some portion of the employee’s weekly pay at risk. If employees meet or exceed their goals, they earn incentives. If they fail to meet their goals, they forgo some of the pay they would normally have earned.

Short-Term Incentives for Managers And Executives

Annual bonus
Plans that are designed to motivate short-term performance of managers and are tied to company profitability. Eligibility basis: job level, base salary, and impact on profitability Fund size basis : nondeductible formula (net income) or deductible formula (profitability) Individual awards: personal performance/contribution

Long-Term Incentives for Managers And Executives

Stock option
The right to purchase a specific number of shares of company stock at a specific price during a specific period of time.

Other Executive Incentives

Golden handshake
Payments companies make to departing executives in connection with a change in ownership or control of a company. Guaranteed loans to directors
Loans provided to buy company stock.
A highly risky and now frowned upon practice.

Creating an Executive Compensation Plan

Define the strategic context for the executive compensation program. Shape each component of the package to focus the manager on achieve the firm’s strategic goals. Create a stock option plan to meet the needs of the
executives and the company and its strategy. Check the executive compensation plan for compliance with all legal and regulatory requirements and for tax effectiveness. Install a process for reviewing and evaluating the executive compensation plan whenever a major business change occurs.

Why Incentive Plans Fail

You get what you pay for.
“Pay is not a motivator.”
Rewards rupture relationships.
Rewards undermine intrinsic motivation.

Implementing Effective Incentive Plans

Ask: Is effort clearly instrumental in obtaining the reward? Link the incentive with your strategy.
Make sure effort and rewards are directly related.
Make the plan easy for employees to understand.
Set effective standards.
View the standard as a contract with your employees.
Get employees’ support for the plan.
Use good measurement systems.
Emphasize long-term as well as short-term success.

Cite this page

Pay for performance. (1 March 2016). Retrieved from

"Pay for performance" StudyScroll, 1 March 2016,

StudyScroll. (2016). Pay for performance [Online]. Available at: [Accessed: 5 December, 2023]

"Pay for performance" StudyScroll, Mar 1, 2016. Accessed Dec 5, 2023.

"Pay for performance" StudyScroll, Mar 1, 2016.

"Pay for performance" StudyScroll, 1-Mar-2016. [Online]. Available: [Accessed: 5-Dec-2023]

StudyScroll. (2016). Pay for performance. [Online]. Available at: [Accessed: 5-Dec-2023]

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