Pay for Performance and Financial Incentives

One of Lisa Cruz’s biggest pay-related concerns is that the Hotel Paris compensation plan does not link pay to performance in any effective way. Because salaries were historically barely competitive, supervisors tended to award merit raises across the board. So, employees who performed well got only about the same raises as did those who performed poorly. Similarly there was no bonus or incentive plan of any kind aimed at linking employee performance to strategically relevant employee capabilities and behaviors such as greetings in a friendly manner or providing expeditious check-ins and check-outs. The bottom line for Lisa and the CFO was that the company’s financial rewards system potentially, the single biggest tool they had for channeling employee performance toward accomplishing the Hotel Paris’s goals was totally inadequate. She and her team thus turned to the job of deciding what sort of incentive based reward system to install.

We’ll discuss in this article incentives for individual employees, incentives for managers and executives, incentives for managers and executives, incentives for salespeople, incentives for professionals, and organization wide variable pay plans. We’ll turn to financial and non-financial benefits and services such as pay for time not worked and insurance benefits, which are the final part of the compensation package.

Money and Motivation:

There is nothing new about using incentives to motivate workers. Frederick Taylor popularized the use of financial incentives – financial benefits paid to workers whose production exceeds some predetermined standard in the late 1800s as a supervisory employee of the Midvale Steel Company, Taylor had become concerned with what he called “systematic soldiering” tendency of employees to work at the slowest pace possible and to produce at the minimum acceptable level. What especially intrigued him was the fact that some of these workers had the energy to run home and work on their homes, even after a 12-hour day. Taylor knew that if he could find some way to harness this energy during the workday, his firm could make huge productivity gains. His answer in part was to institute employee incentive programs.

Performance and Pay:

Maximizing shareholder value under conditions of enormous competition and turbulence is a necessity today, and this has produced a resurgence of interest in financial incentive/pay-for-performance plans. Studies show why: because incentives can work. One study involved 34 stores of a large retailer, 15 of which installed a new sales incentive plan. The researchers found that installing the plan enables a store to capture more customers from its competitors [especially] when there is more intense competition. The new plan was most effective in the stores facing the greatest competition. Another study focused on 20 Fortune 500 companies. The researchers concluded, data showed that organizations in which turbulence was greater shifted the financial risk to their managers by paying proportionally higher levels of variable pay. Turbulence included reductions in force, sale of assets, acquisition by another company, mergers, joint ventures, and attempted takeovers.

The problem is that other surveys suggest that most incentive plans are less than effective. For example, Mercer Human Resource Consulting found that just 28% of the 2,600 US workers it surveyed said they were personally motivated by their companies’ incentive plans. Only 29% said their firms rewarded their performance when they did a good job. Employees don’t see a strong connection between pay and performance and their performance is not particularly influenced by the company’s incentive plan.

What accounts for the fact that about 70% of these employees felt that their firms’ pay-for-performance plans were ineffective? In many cases, those devising the pay for performance plan simply don’t understand the motivational underpinnings and effects of the plan. Not everyone reacts to a reward in the same way and all rewards are suited to all situations. Compensation experts therefore argue that managers should understand the motivational bases of pay-for-performance plans.