PowerPoint Presentation by Charlie Cook The University of West Alabama 10 © 2010 South-Western, a...

© 2010 South-Western, a part of Cengage LearningAll rights reserved.© 2010 South-Western, a part of Cengage LearningAll rights reserved.

PowerPoint Presentation by Charlie CookThe University of West Alabama

PowerPoint Presentation by Charlie CookThe University of West Alabama

10

© 2010 South-Western, a part of Cengage Learning. All rights reserved. 10–2

Discuss the basic requirements for successful implementation of incentive programs.

Identify the types of and reasons for implementing individual incentive plans.

Explain why merit raises may fail to motivate employees adequately and discuss ways to increase their motivational value.

Indicate the advantage of each of the principal methods used to compensate salespeople.

Differentiate how gains may be shared with employees under the Scanlon and Improshare gainsharing systems.

Chapter ObjectivesAfter studying this chapter, you should be able to


Differentiate between profit sharing plans and explain advantages and disadvantages of these programs.

Describe the main types of ESOP plans and discuss the advantages of ESOP to employers and employees.

Chapter Objectives (cont’d)After studying this chapter, you should be able to


Strategic Reasons for Incentive PlansStrategic Reasons for Incentive Plans

•Variable PayVariable Pay Tying pay to some measure of individual, Tying pay to some measure of individual,

group, or organizational performance.group, or organizational performance.

•Incentive Pay ProgramsIncentive Pay Programs Establish a performance “threshold” to qualify Establish a performance “threshold” to qualify

for incentive payments.for incentive payments. Emphasize a shared focus on organizational Emphasize a shared focus on organizational

objectives.objectives. Create shared commitment in that every Create shared commitment in that every

individual contributes to organizational individual contributes to organizational performance and success.performance and success.


FIGURE

10.1Types of Incentive Plans


Incentive Plans as Links toIncentive Plans as Links toOrganizational ObjectivesOrganizational Objectives

• Incentive Plan Purposes Incentive Plan Purposes Encourage employees to assume “ownership” of their Encourage employees to assume “ownership” of their

jobs, thereby improving effort and job performance.jobs, thereby improving effort and job performance.

Motivate employees to expend more effort than under Motivate employees to expend more effort than under hourly and/or seniority-based compensation systems.hourly and/or seniority-based compensation systems.

Support a compensation strategy to attract and retain Support a compensation strategy to attract and retain top-performing employees.top-performing employees.

• Incentive Plan EffectivenessIncentive Plan Effectiveness There is evidence of a relationship between incentive There is evidence of a relationship between incentive

plans and improved organizational performance.plans and improved organizational performance.


FIGURE

10.2Advantages of Incentive Pay Programs

• Incentives focus employee efforts on specific performance targets. They provide real motivation that produces important employee and organizational gains.

• Incentive payouts are variable costs linked to the achievement of results. Base salaries are fixed costs largely unrelated to output.

• Incentive compensation is directly related to operating performance. If performance objectives (quantity and/or quality) are met, incentives are paid. If objectives are not achieved, incentives are withheld.

• Incentives foster teamwork and unit cohesiveness when payments to individuals are based on team results.

• Incentives are a way to distribute success among those responsible for producing that success.

• Incentives are a means to reward or attract top performers when salary budgets are low.


Do Incentive Plans Work?Do Incentive Plans Work?

•Successful Plans Successful Plans Use important organizational metrics by which Use important organizational metrics by which

to measure employee performanceto measure employee performance Find the right incentive payout. Payout Find the right incentive payout. Payout

formulas should be simple and understandable.formulas should be simple and understandable. Are continuously communicated to employees Are continuously communicated to employees

to establish a clear link between performance to establish a clear link between performance and payout.and payout.

Effectively measure employee output and Effectively measure employee output and reward exceptional employee performancereward exceptional employee performance


Do Incentive Plans Work?Do Incentive Plans Work?

•Why Incentive Plans Fail:Why Incentive Plans Fail: They fail to meet employee expectations for They fail to meet employee expectations for

pay gains.pay gains. There is confusion about incentive payment There is confusion about incentive payment

calculations due to poor design and calculations due to poor design and implementation of the plan.implementation of the plan.

Employees do not have the capability to Employees do not have the capability to change their performance levels.change their performance levels.

The organization environment does not support The organization environment does not support plan.plan.


1Setting Performance Measures—The Keys

Both large and small organizations have established performance measures to improve operational success while rewarding employees for their performance outcomes. Establishing meaningful performance measures is one of the important and difficult challenges facing management today. Before managers or supervisors develop and implement organizational measures, they should consider the following guidelines.

• Performance measures—at all organizational levels—must be consistent with the strategic goals of the organization.

• Define the intent of performance measures and champion the cause relentlessly.

• Involve employees.

• Consider the organization’s culture and workforce demographics when designing performance measures.

• Widely communicate the importance of performance measures.


Administering Incentive PlansAdministering Incentive Plans

•Incentive systems are effective:Incentive systems are effective: When incentives are based on actual When incentives are based on actual

differences in individual, team, or differences in individual, team, or organizational performance and not seen as organizational performance and not seen as entitlements.entitlements.

When annual incentive budgets are large When annual incentive budgets are large enough to reward and reinforce exceptional enough to reward and reinforce exceptional performance.performance.

When overhead costs associated with plan When overhead costs associated with plan implementation and administration are implementation and administration are properly considered beforehand and are properly considered beforehand and are controllable.controllable.


Employee Opposition to Incentive PlansEmployee Opposition to Incentive Plans

• Production standards are set unfairly.Production standards are set unfairly.• Incentive plans are really “work Incentive plans are really “work

speedup.”speedup.”• Incentive plans create competition among Incentive plans create competition among

workers.workers.• Increased earnings result in tougher Increased earnings result in tougher

standards.standards.• Payout formulas are complex and difficult Payout formulas are complex and difficult

to understand.to understand.• Incentive plans cause friction between Incentive plans cause friction between

employees and management.employees and management.


Successful Incentive PlansSuccessful Incentive Plans

• Employees have a desire for an incentive plan.Employees have a desire for an incentive plan.

• Employees are encouraged to participate.Employees are encouraged to participate.

• Employees see a clear connection between the Employees see a clear connection between the incentive payments they receive and their job incentive payments they receive and their job performance.performance.

• Employees are committed to meeting the Employees are committed to meeting the standards. standards.

• Standards are challenging but achievable.Standards are challenging but achievable.

• Payout formulas are simple and understandable.Payout formulas are simple and understandable.

• Payouts are a separate, distinct part of Payouts are a separate, distinct part of compensation.compensation.


Effective Incentive Plan AdministrationEffective Incentive Plan Administration

•Grant incentives based on individual Grant incentives based on individual performance differences.performance differences.

•Have the financial resources to reward Have the financial resources to reward performance.performance.

•Set clearly defined, accepted, and Set clearly defined, accepted, and challenging yet achievable performance challenging yet achievable performance standards.standards.

•Use an easily understood payout formulaUse an easily understood payout formula•Keep administrative costs reasonable.Keep administrative costs reasonable.•Do not “ratchet up” performance Do not “ratchet up” performance

standards.standards.


Individual Incentive PlansIndividual Incentive Plans

•Straight PieceworkStraight Piecework An incentive plan under which employees An incentive plan under which employees

receive a certain rate for each unit produced.receive a certain rate for each unit produced.

•Differential Piece RateDifferential Piece Rate A compensation rate under which employees A compensation rate under which employees

whose production exceeds the standard whose production exceeds the standard amount of output receive a higher rate for all amount of output receive a higher rate for all of their work than the rate paid to those who of their work than the rate paid to those who do not exceed the standard amount.do not exceed the standard amount.


Computing the Piece RateComputing the Piece Rate

hourper units 5 unit)per time(standard minutes 12

hour)(per minutes 60=

unitper $2.55 hour)(per units 5

rate)(hourly $12.75=


Piecework: The DrawbacksPiecework: The Drawbacks

•Problems with piecework systems:Problems with piecework systems: Is not always an effective motivatorIs not always an effective motivator Piecework standards can be difficult to develop.Piecework standards can be difficult to develop. Individual contributions can be difficult measure.Individual contributions can be difficult measure. Not easily applied to work that is highly mechanized Not easily applied to work that is highly mechanized

with little employee control over output.with little employee control over output. Piecework may conflict with organizational culture Piecework may conflict with organizational culture

(teamwork) and/or group norms (“rate busting”).(teamwork) and/or group norms (“rate busting”). When quality is more important than quantity.When quality is more important than quantity. When technology changes are frequent.When technology changes are frequent.


Individual Incentive Plans (cont’d)Individual Incentive Plans (cont’d)

•Standard Hour PlanStandard Hour Plan An incentive plan that sets pay rates An incentive plan that sets pay rates

based on the completion of a job in a based on the completion of a job in a predetermined “standard time.”predetermined “standard time.”

If employees finish the work in less than If employees finish the work in less than the expected time, their pay is still based the expected time, their pay is still based on the standard time for the job multiplied on the standard time for the job multiplied by their hourly rate.by their hourly rate.


Individual Incentive Plans (cont’d)Individual Incentive Plans (cont’d)

•BonusBonus Incentive payment that is supplemental to Incentive payment that is supplemental to

the base wage for cost reduction, quality the base wage for cost reduction, quality improvement, or other performance improvement, or other performance criteria.criteria.

•Spot bonusSpot bonus Unplanned bonus given for employee effort Unplanned bonus given for employee effort

unrelated to an established performance unrelated to an established performance measure.measure.


Merit PayMerit Pay

•Merit Pay Program (Merit Raise)Merit Pay Program (Merit Raise) Links an increase in base pay to how Links an increase in base pay to how

successfully an employee achieved some successfully an employee achieved some objective performance standard.objective performance standard.

•Merit GuidelinesMerit Guidelines Guidelines for awarding merit raises that are Guidelines for awarding merit raises that are

tied to performance objectives.tied to performance objectives.


Problems with Merit RaisesProblems with Merit Raises

1.1. Money for merit increases may be inadequate to Money for merit increases may be inadequate to satisfactorily raise all employees’ base pay.satisfactorily raise all employees’ base pay.

2.2. Managers may have no guidance in how to define Managers may have no guidance in how to define and measure performance; there may be and measure performance; there may be vagueness regarding merit award criteria.vagueness regarding merit award criteria.

3.3. Employees may not believe that their Employees may not believe that their compensation is tied to effort and performance; compensation is tied to effort and performance; they may be unable to differentiate between they may be unable to differentiate between merit pay and other types of pay increases.merit pay and other types of pay increases.

4.4. Employees and their managers may hold different Employees and their managers may hold different views of the factors that contribute to job success.views of the factors that contribute to job success.

5.5. Merit pay plans may create feelings of pay Merit pay plans may create feelings of pay inequity.inequity.


Motivation Through Merit RaisesMotivation Through Merit Raises

• Develop employee confidence and trust in Develop employee confidence and trust in performance appraisal.performance appraisal.

• Establish job-related performance criteria.Establish job-related performance criteria.

• Separate merit pay from regular pay.Separate merit pay from regular pay.

• Distinguish merit raises from cost-of-living Distinguish merit raises from cost-of-living raises.raises.

• Withhold merit payments when Withhold merit payments when performance declines.performance declines.


Lump-Sum Merit PayLump-Sum Merit Pay

•Lump-Sum Merit ProgramLump-Sum Merit Program Program under which employees receive a Program under which employees receive a

year-end merit payment, which is not added to year-end merit payment, which is not added to base pay.base pay.

Advantages:Advantages: Provides financial control by maintaining annual salary Provides financial control by maintaining annual salary

expenses and not escalating base salary levels.expenses and not escalating base salary levels.

Contains employee benefit costs for levels of benefits Contains employee benefit costs for levels of benefits normally calculated from current salary levels.normally calculated from current salary levels.

Provides a clear link between pay and performance.Provides a clear link between pay and performance.


Incentive Awards and RecognitionIncentive Awards and Recognition

•AwardsAwards Often used to recognize productivity gains, Often used to recognize productivity gains,

special contributions or achievements, and special contributions or achievements, and service to the organization.service to the organization.

Employees feel appreciated when employers Employees feel appreciated when employers tie awards to performance and deliver awards tie awards to performance and deliver awards in a timely, sincere and specific way.in a timely, sincere and specific way.

•Noncash Incentive AwardsNoncash Incentive Awards Are most effective as motivators when the Are most effective as motivators when the

award is combined with a meaningful award is combined with a meaningful employee recognition program.employee recognition program.


2Customize Your Noncash Incentive Awards

Compensation specialists recognize that a successful noncash incentive program will offer employees a wide selection of awards—awards that appeal to a diverse workforce and the uniqueness of individual employees. “One-size-fits-all” is not the approach to take. What appeals to younger employees may not be attractive to older employees. For example, one marketing firm characterizes recognition and rewards based on generations as follows:

Traditionalists (61+). These individuals are less likely to spend money on themselves. Attractive awards include entertainment venues, vacations, and technology items. They also appreciate health and wellness opportunities.

Boomers (41–60). Personal recognition is important. These individuals want to feel appreciated for their work contributions and are likely to change jobs if they feel under valued or go unrecognized. Boomers favor incentive rewards in the areas of travel, luxury gifts, health and wellness options, and personalized plaques and awards.

Generation X (25–41). This group values a balanced lifestyle of work and play. Generation X employees value gadgets and high-tech items along with flexible schedules and discretionary time off. A flexible “day-off-work” would appeal to this group.

Generation Y (14–25). These employees desire immediate performance feedback. Employee-of-the-Month programs appeal to these employees as do “spot” recognition plans. Gift cards, gift certificates to “trendy” stores, and movie tickets are appropriate as rewards for the immediate recognition of performance.


Sales IncentivesSales Incentives

Straight Commission

Sales Incentive PlansSales Incentive Plans

Straight Salary

Salary and CommissionCombinations


Incentive Plans for SalespersonsIncentive Plans for Salespersons

•Straight Salary PlanStraight Salary Plan Compensation plan that permits salespeople to Compensation plan that permits salespeople to

be paid for performing various duties that are be paid for performing various duties that are not reflected immediately in their sales not reflected immediately in their sales volume.volume.

Advantages:Advantages: Encourages building customer relationships.Encourages building customer relationships.

Provides compensation during periods of poor sales.Provides compensation during periods of poor sales.

Disadvantage:Disadvantage: May not provide sufficient motivation for maximizing sales May not provide sufficient motivation for maximizing sales

volume.volume.



•Straight Commission PlanStraight Commission Plan Compensation plan based upon a percentage Compensation plan based upon a percentage

of sales. of sales. DrawDraw is a cash advance that must be paid back as is a cash advance that must be paid back as

commissions are earned.commissions are earned.

Disadvantages:Disadvantages: Emphasis is on sales volume rather than on profits.Emphasis is on sales volume rather than on profits.

Customer service after the sale is neglected.Customer service after the sale is neglected.

Earnings tend to fluctuate widely between good and poor Earnings tend to fluctuate widely between good and poor periods of business.periods of business.

Temptation to grant price concessions to get sales.Temptation to grant price concessions to get sales.



•Combined Salary and Commission PlanCombined Salary and Commission Plan A compensation plan that includes a straight A compensation plan that includes a straight

salary and a commission component salary and a commission component (“leverage”).(“leverage”).

Advantages:Advantages: Combines the advantages of straight salary and straight Combines the advantages of straight salary and straight

commission forms of compensation.commission forms of compensation.

Offers greater design flexibilityOffers greater design flexibility

Can be used to develop the most favorable ratio of selling Can be used to develop the most favorable ratio of selling expense to sales.expense to sales.

Motivates sales force to achieve specific company marketing Motivates sales force to achieve specific company marketing objectives in addition to sales volume.objectives in addition to sales volume.


Incentives for Professional EmployeesIncentives for Professional Employees

Profit sharing and stock ownershipProfit sharing and stock ownership

Double-track wage systemsDouble-track wage systems

Managerial and Executive IncentivesManagerial and Executive Incentives

Bonuses and merit increasesBonuses and merit increases

Performance incentive bonusesPerformance incentive bonuses

Executive perquisites (perks)Executive perquisites (perks)


Executive CompensationExecutive Compensation

•The Executive Pay PackageThe Executive Pay Package Base salaryBase salary Short-term incentives or bonusesShort-term incentives or bonuses Long-term incentives or stock plansLong-term incentives or stock plans BenefitsBenefits Perquisites (perks)Perquisites (perks)


Executive CompensationExecutive Compensation

•JustificationsJustifications Large financial incentives Large financial incentives

reward superior reward superior performance.performance.

Business competition is Business competition is pressure-filled and pressure-filled and demanding.demanding.

Good executive talent is in Good executive talent is in great demand.great demand.

Effective executives create Effective executives create shareholder value.shareholder value.


FIGURE

10.3Types of Long-Term Incentive Plans

Stock options Rights granted to executives to purchase shares of their organization’s stock at an established price for a fixed period of time. Stock price is usually set at market value at the time the option is granted.

Stock appreciation rights (SARs)

Cash or stock award determined by increase in stock price during any time chosen by the executive in the option period; does not require executive financing.

Stock purchase Opportunities for executives to purchase shares of their organization’s stock valued at full market or a discount price, often with the organization providing financial assistance.

Phantom stock Grant of units equal in value to the fair market value or book value of a share of stock; on a specified date the executive will be paid the appreciation in the value of the units up to that time.

Restricted stock Grant of stock or stock units at a reduced price with the condition that the stock not be transferred or sold (by risk of forfeiture) before a specified employment date.

Performance units Grants analogous to annual bonuses except that the measurement period exceeds one year. The value of the grant can be expressed as a flat dollar amount or converted to a number of “units” of equivalent aggregate value.

Performance shares

Grants of actual stock or phantom stock units. Value is contingent on both predetermined performance objectives over a specified period of time and the stock market.


Executive Compensation: Executive Compensation: Ethics and AccountabilityEthics and Accountability

• Incentive payments are excessive compared with Incentive payments are excessive compared with return to stockholders.return to stockholders.

• Time periods for judging and rewarding Time periods for judging and rewarding performance are too short.performance are too short.

• Quarterly earnings growth is emphasized at the Quarterly earnings growth is emphasized at the expense of research and development.expense of research and development.

• Emphasis is placed upon equaling or exceeding Emphasis is placed upon equaling or exceeding executive salary survey averages.executive salary survey averages.

• Benefits do not relate closely to individual Benefits do not relate closely to individual performance.performance.


3The “Sweetness” of Executive Perks


Executive Compensation ReformExecutive Compensation Reform

•Current Reform MeasuresCurrent Reform Measures The Internal Revenue Service (IRS) is looking for The Internal Revenue Service (IRS) is looking for

tax-code violations in executive pay packages tax-code violations in executive pay packages and will make executive pay a part of corporate and will make executive pay a part of corporate audits.audits.

The Securities and Exchange Commission issued The Securities and Exchange Commission issued pay disclosure rules which require companies pay disclosure rules which require companies listed on the New York Stock Exchange and listed on the New York Stock Exchange and NASDAQ to disclose the true size of their top NASDAQ to disclose the true size of their top executive pay packages.executive pay packages.

The Financial Accounting Standards Board (FASB) The Financial Accounting Standards Board (FASB) now requires that stock options be recognized as now requires that stock options be recognized as an expense on income statements.an expense on income statements.


Executive Compensation Reform (cont’d)Executive Compensation Reform (cont’d)

•Other Reform Measures:Other Reform Measures: The adoption of performance formulas that peg The adoption of performance formulas that peg

executive compensation to organizational executive compensation to organizational benchmarks other than stock pricebenchmarks other than stock price

Shareholder resolutions that allow Shareholder resolutions that allow shareholders the right to vote on executive pay shareholders the right to vote on executive pay packagespackages

Greater accountability by compensation Greater accountability by compensation committees to justify large executive pay committees to justify large executive pay awards or severance or retirement packagesawards or severance or retirement packages


Group Incentive PlansGroup Incentive Plans

•Team Incentive PlansTeam Incentive Plans Compensation plans where all team members Compensation plans where all team members

receive an incentive bonus payment when receive an incentive bonus payment when production or service standards are met or production or service standards are met or exceeded.exceeded.

•Establishing Team Incentive PaymentsEstablishing Team Incentive Payments Set performance measures upon which Set performance measures upon which

incentive payments are basedincentive payments are based Determine the size of the incentive bonus.Determine the size of the incentive bonus. Create a payout formula and fully explain to Create a payout formula and fully explain to

employees how payouts will be distributed. employees how payouts will be distributed.


4Lessons Learned: Designing Effective Team Incentives

Will your team incentive program be successful? While there are no exact keys to success, team compensation specialists cite the following as important components of a meaningful team incentive plan.

• Are organizational members—employees and managers—predisposed to a team incentive reward system? Is there a “cultural readiness” for team compensation? If change is indicated, what information needs to be given to all organizational employees?

• Enlist total employee and managerial support for the incentive effort. While top management support is critical, without the encouragement of employees and middle- and lower-level managers (those directly involved in the program implementation), team incentive programs invariably fail.

• When developing new programs, include representatives from all groups affected by the incentive effort—labor, management, employees. Inclusion, not exclusion, serves to build trust and understanding of the program’s intent and its overall importance to organizational success.

• Establish effective, fair, and precise measurement standards. Selected performance measures should be key indicators of organizational success. Do not attempt to measure everything. Employees should be able to directly influence the performance measures selected. Furthermore, performance measures should be challenging but realistic and obtainable. Standards must encourage increased effort without becoming entitlements.

• Incentive payout formulas must be seen as fair, be easy for employees to calculate, offer payouts on a frequent basis, and be large enough to encourage future employee effort. The goal is to create a pay-for-performance environment. When standards are not met, explain why the reward was not earned.

• Determine how incentive rewards will be distributed. Will team members receive equal dollar awards, or will team members receive differential payments based on such factors as seniority, skill levels, rates of pay, member contributions, and so forth?

• Communicate, communicate, communicate. Constantly champion the benefits of the incentive awards to employees and their contribution to organizational success.


Team Incentive Plans (cont’d)Team Incentive Plans (cont’d)

• AdvantagesAdvantages Team incentives support group planning and problem Team incentives support group planning and problem

solving, thereby building a team culture.solving, thereby building a team culture. The contributions of individual employees depend on The contributions of individual employees depend on

group cooperation.group cooperation. Team incentives can broaden the scope of the Team incentives can broaden the scope of the

contribution that employees are motivated to make.contribution that employees are motivated to make. Team bonuses tend to reduce employee jealousies and Team bonuses tend to reduce employee jealousies and

complaints over “tight” or “loose” individual standards.complaints over “tight” or “loose” individual standards. Team incentives encourage cross-training and the Team incentives encourage cross-training and the

acquiring of new interpersonal competencies.acquiring of new interpersonal competencies.


Team Incentive Plans (cont’d)Team Incentive Plans (cont’d)

•DisadvantagesDisadvantages Individual team members may perceive that Individual team members may perceive that

“their” efforts contribute little to team success “their” efforts contribute little to team success or to the attainment of the incentive bonus.or to the attainment of the incentive bonus.

Intergroup social problems—pressure to limit Intergroup social problems—pressure to limit performance and the “free-ride” effect may performance and the “free-ride” effect may arise.arise.

Complex payout formulas can be difficult for Complex payout formulas can be difficult for team members to understand.team members to understand.


Group Incentive Plans (cont’d)Group Incentive Plans (cont’d)

•Gainsharing PlansGainsharing Plans Programs under which both employees and the Programs under which both employees and the

organization share the financial gains organization share the financial gains according to a predetermined formula that according to a predetermined formula that reflects improved productivity and profitability.reflects improved productivity and profitability.


Scanlon PlanScanlon Plan Rewards come from employee participation in improving productivity and reducing costs.

Rewards come from employee participation in improving productivity and reducing costs.

Rucker Plan (SOP)

Rucker Plan (SOP)

Shared rewards come from the difference between labor costs and sales value of production.

Shared rewards come from the difference between labor costs and sales value of production.

ImproshareImproshare Gainsharing based on increases in productivity of the standard hour output of work teams.

Gainsharing based on increases in productivity of the standard hour output of work teams.

Gainsharing Incentive PlansGainsharing Incentive Plans

Earnings-at-riskEarnings-at-riskEncourages employees to achieve higher output and quality standards by placing a portion of their base salary at risk of loss.

Encourages employees to achieve higher output and quality standards by placing a portion of their base salary at risk of loss.


FIGURE

10.4Scanlon Plan Suggestion Process


Enterprise Incentive PlansEnterprise Incentive Plans

•Profit SharingProfit Sharing Any procedure by which an employer pays, or Any procedure by which an employer pays, or

makes available to all regular employees, in makes available to all regular employees, in addition to their base pay, current or deferred addition to their base pay, current or deferred sums based upon the profits of the enterprise.sums based upon the profits of the enterprise.

Challenges:Challenges: Agreement over the percentages of shared of profits and Agreement over the percentages of shared of profits and

the forms of distribution (cash or deferred) of profits the forms of distribution (cash or deferred) of profits between company and employeesbetween company and employees

Annual variations and possibility of no payout due to Annual variations and possibility of no payout due to financial condition of companyfinancial condition of company

Maintaining motivational connection of profit-sharing to Maintaining motivational connection of profit-sharing to performance of employeesperformance of employees


Enterprise Incentive Plans (cont’d)Enterprise Incentive Plans (cont’d)

•Stock OptionsStock Options Granting employees the right to purchase a Granting employees the right to purchase a

specific number of shares of the company’s specific number of shares of the company’s stock at a guaranteed price (the option price) stock at a guaranteed price (the option price) during a designated time period.during a designated time period.

The value of an option is subject to stock The value of an option is subject to stock market conditions at the time that option is market conditions at the time that option is exercised.exercised.


5Employee Stock Option Plans

What Is a Stock Option?

A stock option gives an employee the right to buy a certain number of shares in the company at a fixed price for a certain number of years. The price at which the option is provided is called the “grant” price and is usually the market price at the time the options are granted. Employees who have been granted stock options hope that the share price will go up and that they will be able to “cash in” by exercising (purchasing) the stock at the lower grant price and then selling the stock at the current market price.

How Stock Option Plans Work

Here is an example of a typical employee stock option plan. An employee is granted the option to purchase 1,000 shares of the company’s stock at the current market price of $5 per share (the “grant” price). The employee can exercise the option at $5 per share—typically the exercise price will be equal to the price when the options are granted. Plans allow employees to exercise their options after a certain number of years or when the company’s stock reaches a certain price. If the price of the stock increases to $20 per share, for example, the employee may exercise his or her options to buy 1,000 shares at $5 per share and then sell the stock at the current market price of $20 per share.

Companies sometimes revalue the price at which the options can be exercised. This may happen, for example, when a company’s stock price has fallen below the original exercise price. Companies revalue the exercise price as a way to retain their employees.


Enterprise Incentive Plans (cont’d)Enterprise Incentive Plans (cont’d)

•Employee Stock Ownership Plans (ESOPs)Employee Stock Ownership Plans (ESOPs) Stock plans in which an organization Stock plans in which an organization

contributes shares of its stock to an contributes shares of its stock to an established trust for the purpose of stock established trust for the purpose of stock purchases by its employees.purchases by its employees. The employer establishes an ESOP trust that qualifies as a The employer establishes an ESOP trust that qualifies as a

tax-exempt employee trust under Section 401(a) of the tax-exempt employee trust under Section 401(a) of the Internal Revenue CodeInternal Revenue Code

Stock bonus plans are funded by direct employer Stock bonus plans are funded by direct employer contributions of its stock or cash to purchase its stock.contributions of its stock or cash to purchase its stock.

Leveraged plans are funded by employer borrowing to Leveraged plans are funded by employer borrowing to purchase its stock for the ESOP.purchase its stock for the ESOP.


Employee Stock Ownership PlansEmployee Stock Ownership Plans

Rewards and Risks of ESOPSRewards and Risks of ESOPS

AdvantagesAdvantages DisadvantagesDisadvantages

Liquidity and valueLiquidity and value

Pride of ownershipPride of ownership

Deferred taxesDeferred taxes

Single funding basisSingle funding basis

Not insuredNot insured

Retirement benefitsRetirement benefits


bonus

combined salary and commission plan

differential piece rate

employee stock ownership plans (ESOPs)

gainsharing plans

Improshare

lump sum merit program

merit guidelines

perquisites

profit sharing

salary plus bonus plan

Scanlon Plan

spot bonus

standard hour plan

straight commission plan

straight piecework

straight salary plan

team incentive plan

variable pay

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