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Related Topics
- Gain Sharing
- Management by Objectives (MBO)
- Performance Appraisals
- Stock Option Plans
Description
Pay-for-Performance systems tie compensation directly to specific business goals and management objectives. These systems try to improve individual accountability, align shareholder, management, and employee interests, and enhance performance throughout the organization. To achieve the latter, they match measurable and controllable performance targets and appraisal mechanisms to corporate objectives.
Methodology
Pay-for-Performance systems consist of two components:
Performance measurement systems
For this tool to be effective, a system must be developed that ties a company?s short- and long-term strategic objectives to its performance measures. These measures are classified into categories that focus employees on the most important activities. They include financial indicators (such as ROS, ROA and ROE) and non-financial indicators (such as customer retention, product quality, development speed and cost reduction). They also establish the importance of individual versus group performance. Group performance is measured at the team, facility, divisional, or corporate level. There are many permutations of performance systems that can be used; the optimum choice depends on the corporate culture, company strategy, and industry characteristics.
Compensation methods
In Pay-for-Performance systems, an employee?s compensation is composed of a fixed base salary and a variable pay component. The most commonly used variable pay methods are:
- Stock options?distribution of rights to purchase a set number of shares of the company?s stock at a given strike price;
- Bonuses?one-time cash awards for extraordinary accomplishments or other profit-related distributions;
- Gain sharing?distribution of a portion of profits to employees based on performance versus plan.
Common Uses
These systems are designed to retain top-performing employees, motivate the desired performance, and control costs. They can be applied to many levels within an organization, from executives to plant operators. Depending on the level of the employee within the company, different approaches are appropriate.
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Selected References
Berlet, Richard, and Douglas Cravens. Performance Pay As a Competitive Weapon. John Wiley & Sons, 1991.
Brown, Duncan, and Michael Armstrong. Paying for Contribution: Real Performance-Related Pay Strategies. Kogan Page Ltd., 2000.
Chingos, Peter T. Paying for Performance: A Guide to Compensation Management. 2nd Edition. John Wiley & Sons, 1997.
Flannery, Thomas P., David A. Hofrichter, and Paul Platten. People, Performance & Pay.The Free Press, 1995.
Grossman, Wayne, and Robert E. Hoskisson. "CEO Pay at the Crossroads of Wall Street and Main: Toward the Strategic Design of Executive Compensation." Academy of Management Executive, February 1998, pp. 43-57.
Hall, Brian. "Incentive Strategy Within Organizations." Harvard Business Review. March 2002, pp. 94-101.
Jensen, Michael. "Corporate Budgeting is Broken." Harvard Business Review. November 2001.
Kerr, Steven. Ultimate Rewards: What Really Motivates People to Achieve. Harvard Business School Press, 1997.
Meyer, Christopher. "How the Right Measures Help Teams Excel." Harvard Business Review, May/June 1994, pp. 95-103.
Oxman, Jeffrey. "The Hidden Leverage of Human Capital." Sloan Management Review. Summer 2002, pp. 79-83. 50
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