18 Classification Of Rewards Or Incentives

Learning Objectives

After completing this session, you will be able to:

  • classify rewards or incentives.
  • discuss types of incentives for managers.

(i) Direct compensation

(ii) Indirect compensation.

  • Direct compensation includes the basic salary or wage that the individual is entitled to for his job, overtime-work and holiday premium, bonuses based on performance, profit sharing and opportunities to purchase stock options, etc.
  • Indirect compensation includes protection programmes (insurance plans, pensions), pay for time not worked, services and perquisites. But these are maintenance factors rather than components. Since they are made available to all employees, irrespective of performance, they will tend to retain people in the organization but not stimulate them to greater effort and higher performance.

Rewards and Incentives – Short-term Plans – Long-term


Incentive Payments Incentives are monetary benefits paid to workmen in recognition of their outstanding performance. The “International labour organization (ILO) refers to incentives as “payment by results.” But it is appropriate to call them “incentive systems of payments” emphasizing the point of, that is, the imparting of incentives to workers for higher production and productivity.

Need for Incentive Payments

The primary advantage of incentives is the inducement and motivation for higher efficiency and greater output. But with fixed remuneration, it is difficult to motivate employees. Increased earnings would enable the employees to improve their standard of living and help the organization to improve their production capacity. They also help in reduced supervision, better utilization of equipment, reduced scrap, reduced lost time, reduced absenteeism and turnover and increased output


Straight piece-rate system A pay system in which wages are determined by multiplying the number of units produced by the piece rate for one unit

Differential piece-rate system Pays employees one piecerate wage for units produced up to a standard output and a higher piecerate wage for units produced over the standard

  1. Piece-Rate Determination To review the wage and hour regulations regarding determining the overtime rates for employees paid on piece rate plans, see this section.
  2. Bonus A one-time payment that does not become part of the employee’s base pay


  1. Salary Plan – offered by some firms. Straight salary makes it simple to switch territories or to reassign salespeople, and it can foster loyalty among the sales staff. A disadvantage is that it can constrict sales and de-motivate potentially high-performing salespeople.
  2. Commission Plan – pays salespeople for results, and only for results; thus, they tend to attract high-performing salespeople who see that effort clearly leads to rewards. But it may cause them to neglect non-selling duties like servicing small accounts, cultivating dedicated customers, and pushing hard-to-sell items.
  3. Combination Plan – Most companies pay salespeople a combination of salary and commissions, usually with a sizable salary component. Combination plans give salespeople a floor to their earnings, and still provide an incentive for superior performance. But they can become complicated, and misunderstandings can result.


A. Sarbanes-Oxley – affects how employers formulate their executive incentive programs to inject a higher level of responsibilities into executives’ and board members’ decisions.

B. Short-Term Incentives:

The Annual Bonus – is aimed at motivating the short-term performance of managers and executives.

      • Eligibility usually includes both top and lower-level managers.
      • Fund Size refers to the total amount of bonus money the firm makes available. A nondeductible formula is where they use a straight percentage (usually of the company’s net income) to create the short-term incentive fund.  A deductible formula assumes that the fund should start to accumulate only after the firm has met a specified level of earnings.

C. Individual Performance – Typically, a target bonus (as well as maximum amount) is set for each eligible position, and the actual award reflects the person’s performance.

Long-Term Incentives – are used to inject a long-term perspective into executives’ decisions.

      1. Stock Options – account for over half of executives’ compensation. A stock option is the right to purchase a specific number of shares of company stock at a specific price during a specific period of time; the executive thus hopes to profit by exercising his/her option to buy the shares in the future but at today’s price.
      2. Broad-Based Stock Options – Many companies have implemented broad-based stock option plans in which the potential appreciation is relatively modest, but in which all or most employees can participate. With companies now having to show options as an expense when awarded, some firms are now awarding stock rather than options.
      3. Other Plans – Stock appreciation rights permit the recipient to exercise the stock option (by buying the stock) or to take any appreciation in the stock price in cash, stock, or some combination of these. A performance achievement plan awards shares of stock for the achievement of predetermined financial targets. In a restricted stock plan, shares are usually awarded without cost to the executive, but selling the stock is restricted for a specified time period.


 Many organizations, especially large ones, administer executive compensation somewhat differently than compensation for lower-level employees.

      1. Executive salaries:
      • Executive bonus plans : because executive performance may be difficult to determine, bonus compensation must reflect some kind of performance measure if it is to be meaningful. As an example, a retail chain with over 250 stores ties annual bonuses for managers to store profitability. The bonuses have amounted to as much as 35% of a store manager’s base salary
      • Performance incentives—long term vs. Short term: performance-based incentives attempt to tie executive compensation to the long-term growth and success of the organization. However, whether the emphasis is really on the long term or merely represents a series of short-term rewards is controversial. Short-term rewards based on quarterly or annual performance may not result in the kind of long-run-oriented decisions necessary for the company to continue to do well.
      • Stock option : a plan that gives an individual the right to buy stock in a company, usually at a fixed price for a period of time.
      • Perquisites (perks) special benefits: —usually non- cash items—for executives.
      • Golden parachute : a severance benefit that provides protection and security to executives in the event that they lose their jobs or that their firms are acquired by other firms.
      • Silver parachute: a severance and benefits plan to protect non executives if their firms are acquired by other firms

D.Team Incentives

Distributing Team Incentives:

 The two primary approaches for distributing team rewards are as follows:

    • Same size reward for each team member: In this approach, all team members receive the same payout, regardless of job levels, current pay, or seniority.
    • Different size rewards for each team member: Using this approach, individual rewards vary based upon such factors as contribution to team results, current pay, years of experience, and skill levels of jobs performed

Team-Based Variable Pay:

    1. Enhances Productivity
    2. Ties Earnings to Team Performance
    3. Improves Quality
    4. Aids Recruiting and Retention of Employees
    5. Improves Employee Morale

Team incentives seem to work best when the following criteria are present:

    • Significant interdependence exists among the work of several individuals, and teamwork and cooperation are essential.
    • Difficulties exist in identifying exactly who is responsible for differing levels of performance.
    • Management wants to create or reinforce teamwork and cooperation among employees.
    • Rewards are seen as being allocated in a fair and equitable manner.
    • Employee input is obtained in the design of the team-incentive plan

E. Organizational Incentives:

A. Gain sharing: The sharing with employees of greater-than expected gains in profits and/or productivity.

      1. The rewards can be distributed in four ways:
      2. A flat amount for all employees
      3. Same percentage of base salary for all employees
      4. Percentage of the gains by category of employees
      5. Amount of percentage based on individual performance against measures

Types of Gain Sharing Plans include:

        1. IMPROSHARE
        • A number of gain sharing-type plans have been devised. One is Improshare, which stands for Improved Productivity through Sharing. Improshare was created by Mitchell Fein, an industrial engineer. It is similar to a piece-rate plan except that it rewards all workers in the organization. Input is measured in hours and output in physical units.
        • A standard is calculated and weekly bonuses are paid based on the extent to which the standard is exceeded. Generally, the Improshare programs have resulted in productivity gains.


      • Since its development in 1927, the Scanlon plan has been implemented in many organizations, especially in smaller unionized industrial firms. The basic concept underlying the Scanlon plan is that efficiency depends on teamwork and plant-wide cooperation. Incentive rewards are paid to employees on the basis of improvements in preestablished ratios.
      • Ratios of labor costs to total sales value or total production or total hours to total production are the most commonly used. Savings due to differences between actual and expected ratios are placed in a bonus fund. A predetermined percentage of this fund is then split between employees and the organization.


      • The Rucker plan, almost as old as the Scanlon plan, was developed in the 1930s by the economist Allan W. Rucker.
      • The Scanlon formula measures performance against a standard of labor costs in relation to the dollar value of production, whereas the Rucker formula introduces a third variable: the dollar value of all materials, supplies, and services that the organization uses.

B. Profit sharing

 A system to distribute a portion of the profits of the organization to employees.

Objectives of profit-sharing plans

The primary objectives of profit-sharing plans are to:

    • Improve productivity
    • Recruit or retain employees
    • Improve product/service quality
    • Improve employee morale

Drawbacks of profit-sharing plans :

When used throughout an organization, including lower-echelon workers, profit-sharing plans can have some drawbacks.

  • The management must be willing to disclose financial and profit information to employees. As many people know, both the definition and level of profit can depend on the accounting system used and decisions made.
  • Therefore, to be credible, management must be willing to disclose sufficient financial and profit information to alleviate the scepticism of employees, particularly if profit-sharing levels are reduced from previous years

Requisite Guidelines for Effective Incentive Plans

All things considered, it may be concluded that in many industries or undertakings and for a large group of operations, well-designed systems of payment by results shall yield advantages to all concerned. Many of these advantages will be realized provided sufficient safeguards are provided.

  1. Co-operation : The co-operation of workers in the implementation of an incentive scheme is essential because the employees somehow devise, if they do not like a scheme, ingenious ways of evading or sabotaging the plan, often with the tacit connivance of the foreman or supervisor. The prime points to be accepted by all are:

(i) The methods followed in measuring the results or output upon which payment is based;
(ii) The methods followed in setting wage rates for different classes of work; and
(iii) Appropriate safeguards concerning earnings, job security and settlement of disputes over piece-work rates and allotted time.

2. The scheme must be based on scientific work measurement. The standards set must be realistic and must motivate workers to put in better performance. Workers must be provided with necessary tools, equipment and materials so as to enable them reach their standards.
3. Indirect Payments:  Indirect workers, such as supervisors, foremen, charge hands, helpers, crane operators, canteen staff, store keepers, and clerical staff should also be covered by incentive schemes.
4. Cost and Time : here should be management commitment to the cost and time necessary to administer incentive schemes properly, and these must be carefully assessed before embarking on an incentive programme. There are many situations in which the potential gains are just not worth the cost and effort involved.
5. : There is greater need for planning. Many incentive schemes, started hurriedly, planned carelessly, and implemented indifferently have failed and have created more problems for the organisation than they have tried to solve.

6. Communication :  The scheme should be well communicated and understood by all the relevant parties included.


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