Variable Pay and Executive Compensation
Module 4
CEO PayMade in America—My StorySam Walton and John Huey (1993)“A lot of what goes on these days with high-
flying companies and these overpaid CEO’s who’re really looting from the top and aren’t watching out for anyone but themselves, really upsets me.”
CEO Pay
Write it down
If you were creating an executive compensation plan, what criteria would
you include?
Variable Pay: Incentives for PerformanceVariable Pay
Compensation linked to individual, group/team, and/or organizational performance.
Basic assumptions:Some jobs contribute more to organizational success
than others.Some people perform better and are more productive
than others.Employees who perform better should receive more
compensation.Some of employees’ total compensation should be
tied directly to performance.
Effective Incentive Plans
Boeing, Nordstrom, Wal-Mart, Safeway
Successes and Failures of Variable Pay Plans
Successful incentive plans require:The development of clear, understandable
plans that are continually communicated.The use of realistic performance measures.Strong links among performance results and
payouts that truly recognize performance differences.
Clear identification of variable pay incentives separately from base pay.
Types of Variable Pay Plans
Piece-Rate SystemsStraight Piece-Rate Systems
Wages are determined by multiplying the number of pieces produced by the piece rate for one unit.
Differential Piece-Rate SystemsEmployees are paid one piece-rate for units
produced up to a standard output and a higher piece-rate wage for units produced over the standard.
Individual Incentives: BonusesBonus
A one-time payment that does not become part of the employee’s base pay.
Spot BonusA special type of bonus used is a “spot”
bonus, so called because it can be awarded at any time.
Special Incentive ProgramsPerformance Awards
Cash or merchandise used as an incentive reward.Recognition Awards
Recognition of individuals for their performance or service to customers in areas targeted by the firm.
Service AwardsRewards to employees for
lengthy service with an organization.
Types of Sales Compensation PlansSalary-Only
All compensation is paid as a base wage with no incentives.
CommissionStraight Commission
Compensation is computed as a percentage of sales in units or dollars.
The draw system make advance payments against future commissions to salesperson.
Salary-Plus-Commission or Bonuses Compensation is part salary for income stability and
part commission for incentive.
Determining Sales Effectiveness
Group/Team Incentives (cont’d)Distributing Rewards
Same-size reward for each memberDifferent-size reward for each member
Problems with Group/Team IncentivesRewards in equal amounts may be perceived as
“unfair” by employees who work harder, have more capabilities, or perform more difficult jobs.
Group/team members may be unwilling to handle incentive decisions for co-workers.
Many employees still expect to be paid according to individual performance.
Social LoafingThe folly of rewarding A and hoping for B
Conditions for Successful Group/Team Incentives
Organizational IncentivesProfit Sharing
A system to distribute a portion of the profits of the organization to employees.
Primary objectives: Increase productivity and organizational performance Attract or retain employees Improve product/service quality Enhance employee morale
Drawbacks Disclosure of financial information Variability of profits from year to year Profit results not strongly tied to employee efforts
Framework Choices for a Profit-Sharing Plan
Employee Stock PlansStock Option Plan
A plan that gives employees the right to purchase a fixed number of shares of company stock at a specified price for a limited period of time. If market price of the stock is above the specified
option price, employees can purchase the stock and sell it for a profit.
If the market price of the stock is below the specified option price, the stock option is “underwater” and is worthless to employees.
Employee Stock PlansEmployee Stock Ownership Plan (ESOP)
A plan whereby employees gain significant stock ownership in the organization for which they work.
Advantages Favorable tax treatment for ESOP earnings Employees motivated by their ownership stake in
the firmDisadvantages
Retirement benefit is tied to the firm’s future performance
Management tool to fend off hostile takeover attempts.
Components of Executive Compensation Packages
Executive Compensation
“Reasonableness” of Executive CompensationWould another company hire this person as an
executive?How does the executive’s compensation compare
with that for executives in similar companies in the industry
Is the executive’s pay consistent with pay for other employees within the company?
What would an investor pay for the level of performance of the executive? Investors are owners We as managers are stewards (agency theory)
Common Executive Compensation Issues
Discussion- did it change?
If you were creating an executive compensation plan, what criteria would
you include?
Exercise On Variable Pay
Microsoft Office Word Document