Many employers have incentives plans in which most employees can participate. These variable pay plans include profit sharing, employee stock owner ship (ESOP), and Scanlon gain sharing plans.
Profit sharing Plans:
Profit sharing plans in which all or most employees receive a share of the firmâ€™s annual profits are popular today. Ford Motor Co. introduced a profit sharing plan for salaried employees, and General Motors increased its profit-sharing payout when profits improved.
Yet research on such plansâ€™ effectiveness is sketchy. One study concludes that there is ample evidence that profit-sharing plans boost productivity, but that their effect on profits is insignificant, once you factor in the cost of the plans payouts.
There are several types of profit making plans. In cash plans, the most popular one is in which the firm simply distributes a percentage of profits (usually 15% to 20%) as profit share to employees at regular intervals. The Lincoln incentive system, first instituted at the Lincoln Electric Company of Ohio, is a more complex plan. In one version, employees work on a guaranteed piecework basis, and the firm distributes total annual profits less taxes, 6% dividends to stockholders and a reserve for investment each year among employees based on their merit rating. The Lincoln plan also includes a suggestion system that pays individual workers rewards for savings resulting from their suggestions. The plan has been quite successful.
There are also deferred profit-sharing plans: The firm places a predetermined portion of profits in each employeeâ€™s account under a trusteeâ€™s supervision. There is a tax advantage here, since income tax on the distributions are deferred, often until the employee retires and the money is taxed at a lower rate.
Employee Stock Ownership Plan (ESOP):
Employee stock ownership are companywide plans in which a corporation contributes shares of its own stock or cash to be used to purchase such stock to a trust established to purchase shares of the firmâ€™s stock for employees. The firm generally makes these contributions annually in, proportional to total employee compensation, with a limit of 15% of compensation. The trust holds the stock in individual employee accounts, and distributes it to employees upon retirement (or other separation from service), assuming the person has worked long enough to earn ownership of the stock. Stock options, as discussed elsewhere, go directly to the employees individually to use as they see fit, rather than into a retirement trust. One study compared performance of 229 â€œnew economyâ€ firms offering broad-based stock options to that of their non-stock-option counterparts. Those offering the stock options had higher shareholders returns that did those not offering the options.
ESOPs have several advantages. The company gets a tax deduction equal to the fair market value of the shares that are transferred to the trustee, and can also claim an income tax deduction for dividends paid on ESOP-owned stock. Employees arenâ€™t taxed until they receive a distribution from the trust usually at retirement when their tax rate is lower. The Employee Retirement Income Security Act (ERISA) allows a firm to borrow against employee stock held in trust and then repay the loan in pretax rather than after-tax dollars, another tax incentive for using such plans.
ESOPs can also help the shareholders of closely held corporations in which for instance, a family owns virtually all the shares to diversify their assets by placing some of their own shares of the companyâ€™s stock into the ESOP trust and purchasing other marketable securities for themselves n their place.
Research suggests that ESOPs do encourage employees to develop a sense of ownership in and commitment to the firm. They do so in part because the ESOPs provide increased financial incentives; create new sense of ownership and help to build team work. The following example illustrates how one company shares the wealth through a combination of companywide cash bonuses an stock ownership plans.
The annual employee bonus at Thermacore Inc., is one way the firm lets employee share in the wealth generated by operations during the year. All employees of Thermacore and its parent corporation, DTX are eligible. The unique aspect of the program is that all employees receive the same amount of bonus regardless of total compensation, seniority, or position in the company.
The bonus pool is based in pretax income minus a minimum, threshold guarantee to the stockholders. The guarantee is typically 15% of the firmâ€™s equity at the beginning of the year. The amount of income to place in the bonus pool is determined by multiplying company income less the 15% of equity guarantee by an employee bonus pool percentage determined by the board of directors and senior management. Regular employees then receive a full share, and part-time employees receive a share based on the percentage of time worked. One typical year, the bonus pool rate was 12%, and full bonus share was more than $1,300 per employee.
Thermacore also has a stock ownership plan for all employees. Each year, the stockholders and the board of directors approve a dollar value of stock to offer to employees. For example, the board may decide to make available $100,000 of company stock. No one employee may subscribe for more than $10,000 worth of stock. Thermacore is a private company, so the stock trades only within the company. The firm sells shares to the employees at a discount. The company has the right of first refusal should the employee wish to leave the company or sell stock. Employees can pay for the stock in cash at the closing of the subscription period or by payroll deduction.