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Strategic Compensation, 8e, Global Edition (Martocchio)

Chapter 4 Incentive Pay

41) How do traditional pay methods differ from incentive pay methods?
Answer: In traditional pay plans, employees receive compensation based on a fixed hourly pay
rate or annual salary. Annual raises are linked to such factors as seniority and past performance.
Some companies use incentive pay programs that replace all or a portion of base pay in order to
control payroll expenditures and to link pay to performance. Companies use incentive pay
programs in varying degrees for different kinds of positions. Some compensation programs
consist of both traditional base pay and incentive pay, whereas other programs, usually for sales
jobs, offer only incentive pay, in which case all pay is at risk.

Traditional core compensation generally includes an annual salary or hourly wage that is
increased periodically on a seniority or merit basis. Companies usually base pay rates on the
importance they place on each job within their corporate structure and on the "going rate" that
each job commands in similar companies. For example, Lincoln Electric determines the
importance of the jobs within its job structure based on job evaluation techniques. The five
criteria on which Lincoln evaluates jobs are skill, responsibility, mental aptitude, physical
application, and working conditions. Lincoln Electric next surveys the pay rates of competitors,
and it uses these data to set base pay rates.

Employees under traditional pay structures earn raises according to their length of service in the
organization and to supervisors' subjective appraisals of their job performance. Again, both merit
pay raises and seniority pay raises are permanent increases to base pay. Annual merit pay
increase amounts usually total no more than a small percentage of base pay (i.e., 2-6 percent is
presently not uncommon), but the dollar impact represents a significant cost to employers over
time.

Companies use incentive pay to reward individual employees, teams of employees, or whole
companies based on their performance. Incentive pay plans are not limited solely to production
or nonsupervisory workers. Many incentive plans apply to such categories of employees as sales
professionals, managers, and executives. Management typically relies on business objectives to
determine incentive pay levels.

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42) Briefly describe the three categories of incentive pay plans and give an example of each.
Answer: Incentive pay plans can be broadly classified into three categories:
Individual incentive plans. These plans reward employees whose work is performed
independently. Some companies have piecework plans, typically for their production employees.
Under piecework plans, an employee's compensation depends on the number of units she or he
produces over a given period. Examples include piecework plans, behavioral encouragement
plans, and referral plans. Group incentive plans. These plans promote supportive, collaborative
behavior among employees. Group incentives work well in manufacturing and service delivery
environments that rely on interdependent teams. In gain sharing programs, group improvements
in productivity, cost savings, or product quality are shared by employees within the group.
Examples include gain sharing plans and team incentives. Companywide incentive plans. These
plans tie employee compensation to a company's performance over a short time frame, usually
from a 3-month period to a 5-year period. Examples include profit sharing plans and stock option
plans.

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43) In an effort to increase the productivity of its employees, a manufacturing company is
considering adopting an incentive pay program. List and discuss the five factors the HR
professionals should consider in the adoption of such a program.
Answer: The first factor to consider is whether the plan should be based on group or individual
employee performance. Clearly, this is dependent on the structure of the company. If the nature
of work performed is interdependent, for example, then group incentives would be appropriate.

A second factor is the level of risk employees would be willing to accept in their overall
compensation package. The level of risk increases as incentive pay becomes a greater part of
total core compensation. The level of risk is also dependent on the amount of control employees
may have toward the attainment of the desired performance goal.

A third factor is whether incentive pay should replace or complement traditional pay. Some
companies may choose to award incentive pay in addition to an employee's base pay and fringe
compensation. Other companies may opt to reduce base pay by placing the reduced portion at
risk in an incentive plan.

A fourth factor is the criteria by which performance should be judged. Criteria should be
quantifiable, be accessible, and reflect a company's competitive strategy. Further, the company
may want to consider using more than one performance measure, particularly if it is relevant. A
weighting scheme could be used to reflect the relative importance of each performance criterion.
As with the level of risk, the criteria chosen should be under the control of the employee.

A fifth factor is the time horizon of goals. Typically, incentives for lower-level employees tend to
be based on short-term goals that are within the control of such employees. Longer-term
incentives are used for professionals because of the length of time it takes for performance to be
adequately measured.

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