John F. Akers is chairman of IBM. His company had a bad year in 1991, suffering a loss of $2.8 billion. But Akers “suffered” along with the stockholders. Because his compensation is partly linked to company performance his annual salary and bonus fell to less than $1.6 million from $2.6 million.
Pay for performance is not reserved just for senior managers. Operative employees also can participate in such programs. Store employees at sixty Great Atlantic & Pacific Tea Co. (A&P) supermarkets in the Philadelphia area have taken a twenty-five percent pay cut in exchange for a cash bonus based on their store’s sales. The program is given credit for having significantly increased labor productivity in these stores, while at the same time boosting employee overall wages.
What is Performance-Based Compensation?
Piece-rate pay plans, wage incentive plans, profit-sharing, and lump-sum bonuses are all forms of performance-based compensation. What differentiates these forms of time on the job, their pay is adjusted to reflect some performance measure. That might be individual productivity, work group or departmental productivity, unit profitability, or the overall organization’s profit performance. Two of the more widely used of the performance-based compensation plans are piece-rate wages for production workers and annual performance bonuses based on corporate profits for senior executives.
In piece-rate pay plans, workers are paid a fixed sum for each unit of production completed. When an employee gets no base salary and is paid only for what he or she produces, this is a pure piece-rate plan. People who work ball parks selling peanuts and soda pop frequently are paid this way. They might get to keep twenty-five cents for every bag of peanuts they sell. If they sell two hundred bags during a game, they make $50. If they sell only forty bags, their take is a mere $10. The harder they work and the more peanuts they sell, the more they earn. Many organizations use a modified piece-rate plan, where employees earn a base hourly wage plus a piece-rate differential. So a legal typist might be paid &6 an hour plus twenty cents per page. Such modified plans provide a floor under an employee’s earnings, while still offering a productivity incentive.
For years, senior corporate executives received regular increases in their pay, regardless of their company’s success or failure. More top executives than ever are now finding their compensation linked directly to corporate performance. When things go well for a firm, it is assumed that management had a large part I that outcome, so they should share in the good times. For example, Charles Lazarus, chairman of Toys “R” Us Inc., earns a base salary of $315,000 a year. Because his contract provides him an annual performance bonus of one percent of all pretax profits over $18 million, and because the company’s 1990 income was a healthy $326 million, Lazarus pocked over $3 million in performance pay that year. Of course, in a bad year, executives many get no bonus at all.
Linking Performance-Based Compensation and Expectancy Theory
Performance-based compensation is probably most compatible with expectancy theory predictions. Specifically, individuals should perceive a strong relationship between their performance and the rewards they receive if motivation is to be maximized. If rewards are allocated completely on nonperformance factors such as seniority or job title then employees are likely to reduce their effort.
The evidence supports the importance of this linkage, especially for operative employees working under piece-rate systems. For example, one study of four hundred manufacturing firms found that those companies with wage incentive plans achieved forty-three to sixty-four percent greater productivity than those without such plans.
Performance-Based Compensation in Practice
“Pay-for-performance” is a concept that is rapidly the annual cost-of-living raise. One reason, as cited above, is its motivational power but don’t ignore the cost implications. Bonuses and other incentive rewards avoid the fixed expense of permanent salary boots.
Corporate America seems to have gotten this message. In 1991, thirty-five percent of the Fortune 500 companies had some form of pay-for-performance program up from only seven percent ten years earlier. Table 8-1, based on a national survey of 435 U.S. Companies, demonstrates which programs are most popular.
Among firms that haven’t introduced performance-based compensation programs, common concerns tend to surface. Managers fret over what should constitute performance and how it should be measured. They have to overcome the historical attachment to cost-of-living adjustments and the belief that they have an obligation to keep all employees’ pay in step with inflation. Other barriers include salary scales keyed to what the competition is paying, traditional compensation systems that rely heavily on specific pay grades and relatively narrow pay ranges, and performance appraisal practices that produce inflated evaluation and expectations of full rewards.
John F. Akers is chairman of IBM. His company had a bad year in 1991, suffering a loss of $2.8 billion. But Akers “suffered” along with the stockholders. Because his compensation is partly linked to company performance his annual salary and bonus fell to less than $1.6 million from $2.6 million.
Pay for performance is not reserved just for senior managers. Operative employees also can participate in such programs. Store employees at sixty Great Atlantic & Pacific Tea Co. (A&P) supermarkets in the Philadelphia area have taken a twenty-five percent pay cut in exchange for a cash bonus based on their store’s sales. The program is given credit for having significantly increased labor productivity in these stores, while at the same time boosting employee overall wages.
What is Performance-Based Compensation?
Piece-rate pay plans, wage incentive plans, profit-sharing, and lump-sum bonuses are all forms of performance-based compensation. What differentiates these forms of time on the job, their pay is adjusted to reflect some performance measure. That might be individual productivity, work group or departmental productivity, unit profitability, or the overall organization’s profit performance. Two of the more widely used of the performance-based compensation plans are piece-rate wages for production workers and annual performance bonuses based on corporate profits for senior executives.
In piece-rate pay plans, workers are paid a fixed sum for each unit of production completed. When an employee gets no base salary and is paid only for what he or she produces, this is a pure piece-rate plan. People who work ball parks selling peanuts and soda pop frequently are paid this way. They might get to keep twenty-five cents for every bag of peanuts they sell. If they sell two hundred bags during a game, they make $50. If they sell only forty bags, their take is a mere $10. The harder they work and the more peanuts they sell, the more they earn. Many organizations use a modified piece-rate plan, where employees earn a base hourly wage plus a piece-rate differential. So a legal typist might be paid &6 an hour plus twenty cents per page. Such modified plans provide a floor under an employee’s earnings, while still offering a productivity incentive.
For years, senior corporate executives received regular increases in their pay, regardless of their company’s success or failure. More top executives than ever are now finding their compensation linked directly to corporate performance. When things go well for a firm, it is assumed that management had a large part I that outcome, so they should share in the good times. For example, Charles Lazarus, chairman of Toys “R” Us Inc., earns a base salary of $315,000 a year. Because his contract provides him an annual performance bonus of one percent of all pretax profits over $18 million, and because the company’s 1990 income was a healthy $326 million, Lazarus pocked over $3 million in performance pay that year. Of course, in a bad year, executives many get no bonus at all.
Linking Performance-Based Compensation and Expectancy Theory
Performance-based compensation is probably most compatible with expectancy theory predictions. Specifically, individuals should perceive a strong relationship between their performance and the rewards they receive if motivation is to be maximized. If rewards are allocated completely on nonperformance factors such as seniority or job title then employees are likely to reduce their effort.
The evidence supports the importance of this linkage, especially for operative employees working under piece-rate systems. For example, one study of four hundred manufacturing firms found that those companies with wage incentive plans achieved forty-three to sixty-four percent greater productivity than those without such plans.
Performance-Based Compensation in Practice
“Pay-for-performance” is a concept that is rapidly the annual cost-of-living raise. One reason, as cited above, is its motivational power but don’t ignore the cost implications. Bonuses and other incentive rewards avoid the fixed expense of permanent salary boots.
Corporate America seems to have gotten this message. In 1991, thirty-five percent of the Fortune 500 companies had some form of pay-for-performance program up from only seven percent ten years earlier. Table 8-1, based on a national survey of 435 U.S. Companies, demonstrates which programs are most popular.
Among firms that haven’t introduced performance-based compensation programs, common concerns tend to surface. Managers fret over what should constitute performance and how it should be measured. They have to overcome the historical attachment to cost-of-living adjustments and the belief that they have an obligation to keep all employees’ pay in step with inflation. Other barriers include salary scales keyed to what the competition is paying, traditional compensation systems that rely heavily on specific pay grades and relatively narrow pay ranges, and performance appraisal practices that produce inflated evaluation and expectations of full rewards.
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