Pay for performance (PFP) systems link employee compensation to work performance. Effective PFP systems tie rewards to strategic objectives and critical organizational outcomes. They also involve workers, ensure performance is measurable, and use rewards valued by employees. However, PFP systems can be difficult to implement due to issues like lack of objective performance measures, perceived inequities, and union resistance. The type of PFP system used depends on factors like the job, whether individual or group work is more appropriate for incentives, and how performance will be evaluated.

1. McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All
rights reserved.
Rewarding Performance
HUMAN RESOURCE MANAGEMENT
AN EXPERIENTIAL APPROACH
SIXTH EDITION
Chapter 11
Understand determinants of effective reward systems
Identify critical variables related to selection of most
appropriate reward systems
Describe evidence on effectiveness of different types of reward
systems
Know relative advantages & disadvantages of various
approaches to reward effective performance
Objectives
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2. PFP can be a key to success
Link to obtain ROI on employee compensation
Strong trend to implement PFP systems
PFP systems HPWP
PFP puts some portion of pay at risk
Need to understand difficulties of PFP
Cheating an economic act
600% rise in CEO pay largely due to PFP component
Pay For Performance
Why?
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Does PFP Work?Certain types of PFP systems correlate with
superior corporate performanceDepends on what is being
rewardedShort term measures must correlate with long term
successIndividual & situational contingencies need to be
consideredSuccessful when
Tailored to particular work situation
Linked to long term strategic objectives
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Effective PFP Systems
Determinants of effective PFP Systems
Worker value outcomes (money, prizes)
Outcome is valued relative to other rewards
Desired performance is measurable
Worker must be able to control rate of output or quality
Worker must be capable of increasing output or quality
Worker must believe that capability to increase exists
Worker must believe that increased output will result in
receiving a reward

3. Size of reward must be sufficient to stimulate increased effort
Performance measures must be compatible with strategic goals
for short & long term
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Expectancy/Instrumentality Theory
Expectancy
(probability that
efforts will lead
to desired
performance)
Valence
(value of outcome
to individual)
Instrumentality
(probability that
performance will
produce desired
outcomes)
Effort
Performance
Outcomes
(pay, recognition,
other rewards)
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Effective PFP Systems
Considerations
Unions becoming more receptive
Consider impact on team culture

4. Tie rewards to critical organizational outcomes
Compatible with strategic goals
Worker involvement in design
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PFP Systems
Difficulties
Poor perceived connection between performance & pay
Expensive to develop & maintain
Lack of objective, countable results
Perception that performance is not accurately measured
Union resistance to such systems & to change in general
Poor or negative relationship between rewarded outcomes &
corporate performance measures
Supervisors do not take it seriously
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PFP Systems
Legal Implications
Subject to same redress as non-PFP compensation
Title VII
Equal Pay Act
Situational constraints can foster sense of inequity
Disparate Impact theory can be used
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PFP System Selection

5. Considerations
Who should be included in the PFP system?
In general, all groups should be included in a PFP system
How will performance be measured?
Individual, group/unit, or organization level
Which are the rewards in the incentive system?
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PFP System Selection
Who to IncludeSystems should be developed with specific
groups & conditions in mind
Companies have different systems for different job or
departments
PFP System should involve as many employees as possible
Americans prefer individual PFP systems
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PFP System Selection
How Will Performance be Measured?
Compatible with short & long term strategic objectives
Maximize reliability and validity of measurement
What are the Rewards?
Cash
Percentage increase to base pay
Non-cash prizes
Stock ownership
Stock options
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6. PFP System Selection
Research supports not having a permanent tie to base paySeeing
a trend to use bonus based PFPLong-term costs are controlled
Behavioral Encouragement Plan
Employees earn rewards for specific accomplishments such as
safety compliance or attendance
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PFP System Selection
Individual, group, or company level PFP?
Extent outcome controlled at group or individual level
Whether individual contributions can be measured
Cooperation & teamwork encouraged by group plans
Preference for individual level systems
When team-based PFP is used
It is part of a comprehensive team-based model of HRM &
compensation
The pool of rewards should not be fixed
High achievers may go elsewhere
Free- riders increase as group size increases
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Individual PFP Plans
Merit pay plans
Incentive Plans
Piece Rate

7. Sales Incentives
Bonus
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Individual PFP Plans
Merit Pay
Distribution of pay based on appraisal of worker’s performance
Most common plan
Employees want a link between performance & pay
Fundamental problem is accuracy in performance measurement
Raters can be trained to increase accuracy
Can lead to turnover of best performers
Avoid forced distribution
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Individual PFP Plans
Piece Rate System
Based on units produced, provides the closest connection
between individual performance & individual pay
Standards set for level of work done in specific amount of time
Fair rate of pay set using internal or external measures
Pay only for quality pieces
Can be combined with bonus pay
Effective when work is repetitive, controllable & no need for
cooperation
Need to involve workers in design
Differential piece rate system addresses issues of production
variability
Standard hourly rate sets production standard based in time

8. units
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Individual PFP Plans
Sales Incentive & Bonus
Sales Incentives
Proven to increase sales over time
Important to consider all performance dimensions
Pay based on sales data
Commission can be paid in rewards other than cash
Variable Formats
Draw - plus commission
Commission plus salary
Sales bonus
Bonus
One time payments not tied permanently to base pay
Tend to be more effective than base pay adjustments
May include individual or group performance
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Group Incentive Plans
Profit Sharing
Gain Sharing
Stock Plans
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Group Incentive Plans
Profit Sharing

9. Distributes a portion of corporate profits among designated
employeesPayments linked to a ratio related to base payMeans
to align management and employee goalsGroup size impacts
perception of fairnessWorkers’ perception of connection
between effort & profitability is key to success
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Group Incentive Plans
Stock Plans
Employee stock ownership plans (ESOPs)
Retirement plan in which company contributes its stock to the
plan
Employees never buy or hold the stock directly Employee stock
option plans
Employee has the right to purchase specific number of shares at
a fixed price within a period of time
Works best with employee involvement & problem solving
May be perceived as more equitable than profit sharing & gain
sharing
If value drops to lower than perception then can result in feeling
of inequity
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Group Incentive Plans
Gain Sharing
Sharing financial benefits of cost reductions or productivity
increases with workers
Worker involvement cooperation & trust are critical

10. Usually paid out monthly
Four Approaches
Scanlon Plan
Rucker Plan
IMPROSHARE Plan
Winsharing
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Group Incentive Plans
Gain Sharing
SCANLON
Most common plan
Reward for suggestions
Suggestions reviewed by screening committees
Measures relationship between sales value of production &
labor costs
RUCKER Similar to the Scanlon plan but includes value of all
supplies, materials, & services Incentive created to save on all
inputsMore difficult to explain & understand
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Group Incentive Plans
Gain Sharing
IMPROSHARE (Improved Productivity Through Sharing)
Similar to Scanlon plan
Ratio uses standard hours rather than labor costs

11. Savings in hours result in reward allocation to workers
Rewards all employees equally
Gains can be seen over 3 years before plateau
Easy to administer and understand
WINSHARING
Combines gain-sharing with profit sharing
Takes market demand into consideration
Rewards are split evenly between workers & company
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Gain Sharing
Bottom LineImproved productivity & quality Trend is to use
gain sharing with other approaches to improving productivity &
quality (e.g., TQM)Success depends on
Significant involvement & support by management
Realistic employee & if applicable, union expectations
Company size- Smaller number of employees (200 vs. 400)
results in larger productivity gains
IMPROSHARE is easier to understand & allows control over
production
Scanlon & Rucker plans workers share financial risks, &
integrates problem solving process
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Managerial and Executive PayExecutive incentive reportedly
linked to financial performanceTotal compensation rose 28% in
2010Increase mainly due to incentive vs. base payTying
executive comp to earnings has coincided with dramatic
increase in earnings restatements Plans continue to favor short
vs. long term results“Pay for No Performance”- The Wall Street

12. Journal article documents loss in linkage between executive
pay & performance CEOs of seven troubled or collapsed
financial institutions $464 million in performance pay from
2005 to 2008 (half in cash)Clawbacks – recouping
compensation, is a hot political & shareholder issue
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Negative Consequences to
Widening Pay Dispersion
One study found pay dispersion in high-tech firms is predictive
of subsequent team/unit performance decrements
Pay dispersion tends to diminish communication, increase status
gaps, & foster aggressive competition
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Short or Long-Term
Measures of PerformanceLower level managers typically have
short term incentivesExecutives typically have short & long-
term incentives Rewards usually in the form of lump sum bonus
Stock options for long-term rewards
A good but abused idea
Considerable abuse in awards and re-pricing of stocks
Backdating stocks (option award to a date when the stock price
was low)
Over 200 companies have been the subject of government
investigations into whether they “backdated” their executives’
stock options - Managers are in jail for backdating
Not proven to effectively incent outstanding performance
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13. Pay for Performance
The Board RoomRarely linked to corporate performance
Boards provide little corporate governance & oversight
Research indicates higher corporate performance results if
Board of Directors is paid strictly with stock
Is increased shareholder power the answer?
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PFP Systems
Managerial Implications
Results of a well-designed PFP system
lower costs
higher profits
higher degree of individual or group motivation
Strategies for Effective PFP
Pay the person-Pay according to individual market value
Translate business strategy into measures that can be used for a
reward system
Individualize the reward system
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Key Points
The PFP system must be compatible with long term success
Plans must support the company’s values & culture
Openness & trust are critical

14. Money can be a motivator
Rewards should be based on individual, group & organizational
performance
Sound measurement is key
All important work dimensions should be included
Close monitoring is required
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