Strategic Mgt. Acc. - Incentive Plans & Organization Performance

Incentive Plans &
Organization Performance
Prepared for :
Dr. Mahfuzul Hoque
Professor
Department of Accounting & Information
Systems
Faculty of Business Studies
University of Dhaka
Bangladesh
mhoque71@gmil.com
Incentive Plans & Organizational 2 03/10/10

Issues Covered
Incentive Plan & Organiztional Performance
1
3
Monetary Compensation Plans

2
Performance Relayed Pay System

3
The Agency View of Incentive Schemes

4

Incentive Plan &
Organiztional Performance
Topics to be discussed by me
Incentive – What is it?
1
3
The most common types of Incentive

2
Key Considerations in Desiging Incentives and
3 Gainsharing Approachs
Bases for Incentive System

4
Executive Incentives
5
3
How to Design an Effective Incentive Program

6
Types of Incentive Programs

7
3
Incentive Rewards & Incentive problems

8
What is incentive?
An incentive is any factor (financial or non-financial) that provides a motive

for a particular course of action, or counts as a reason for preferring one
choice to the alternatives. Since human beings are purposeful creatures,
the study of incentive structures is central to the study of all economic
activity (both in terms of individual decision-making and in terms of co-
operation and competition within a larger institutional structure).
Eventually, incentives' aim is providing value for money and contributing to
organizational success.

Most common types of Incentives?
Incentives can be classified according to the different ways in which they

motivate agents to take a particular course of action. One common and
useful taxonomy divides incentives into three broad classes:
1. Remunerative incentives (or financial incentives)
2. Moral incentives
3. Coercive incentives
- Personal Incentive
- Social Incentive

Incentive Issues
Besides providing greater flexibility in matching labour cots to organizationl
success, incentive raises issues that should be considered before a
particular approach is selected. Managers and HR specialists should
understand the purpose, eligibility and coverage, payout standard, and
administration of pay-for performance plans.
Issues Key Considerations

Purpose of nontraditional Why is it under consideration?
Compensation
Eligibility Coverage Who will be covered under this program? Where will it be
applied? All facilities?
Payout standard What will trigger an incentive bonous? When will it be

paid?
Administration How will the program be administered? By personnel? By
line managers? Both?

Bases for Incentive System
Incentive systems exist for almost every type of job from mannual labour
to professionals, managerials, and executines work. The more common
incentives syetaem are:
1. Piecework
2. Production Bonouses
3. Commissions
4. Maturity Curves
5. Merits Raises
6. Pay-for-Knoledge / Pay-for Skills Copmensation

Executive Incentives
Executve copensation schemes can be in various forms. Incentives –
especially executive incentives – need to achieve a balance between
short-term results and long-term performance. Althrough incentives that
relate to long term improvements were found in one study, most
companies still tie executive bonouses to annual profits, which are
considered short-term. Kaplan and Atkinson categorise executive
compensation schemes, as follows:
1. Short Vs. Long Term

2. Cash Vs. Equity
3. Monetary Vs. Nonmonetary

How to Design an Effective
Incentive Program
In order to create an effective program, organizations must keep the
overall objective in mind when considering program design and
implementation. Objectives should be formed based on the organizations
overall goals and should be straightforward and specific so participants
clearly understand the expectations. Program objectives can vary
depending on the needs of each individual organization. They should be
challenging, yet achievable. If objectives are viewed as unattainable, the
program will be destined for failure. Objectives may include motivating
employees, recognizing performance, persuading customers to make a
purchase, or even reinforcing a marketing message. Once the program
goals have been determined, every aspect of the program must be
measured against this goal in order to ensure the program's success in
goal achievement. If successful, objectives should provide measurable
results allowing the organization to track performance and measure the
overall success of the program.

Types of Incentive Programs
The major types of incentive programs are -
1. Points Program
2. Employee Program
3. Consumer Program
4. Dealer/Channel Program
5. Sales Program

Incentive Rewards
While there are many important factors to consider when creating an
incentive program, selecting the appropriate rewards is vital to any
programs success. The goal in choosing rewards is to select items that will
spark the participant’s interest or feelings, and support the program’s
objectives. Effective rewards will both motivate short-term behavior and
provide motivation over time. While rewards come in a variety of shapes
and sizes, here are some of the more common types:
1. Cash
2. Non-cash Rewards
3. Gift cards/certificates
4. Merchandise
5. Travel
6. Experiential
7. Non-monetary Rewards

Incentive problems
Incentive structures, however, are notoriously more tricky than they might
appear to people who set them up. Human beings are both finite and
creative; that means that the people offering incentives are often unable to
predict all of the ways that people will respond to them.
Thus, imperfect knowledge and unintended consequences can often make

incentives much more complex than the people offering them originally
expected, and can lead either to unexpected windfalls or to disasters
produced by unintentionally perverse incentives.

Monetary Compensation
Plans
3
1 Forms of Monetary Compensation plan
2 Gain sharing-a bonus plan
3 When does gain sharing work best ?
4 Best way to implement Gain sharing
3
5 Improving Plant Performance Through Gain sharing

Forms of Monetary Compensation Plan
Kaplan Atkinson (1989) discuss several forms of

compensation plans.
• Cash bonus or profit sharing and the stock bonus:

Cash or stock bonuses are awarded at the end of an
accounting period.
• Deferred bonus and compensation award: Cash or

stock is deferred until a future period
• Stock options: Employees have the right to purchase

company stock at a future date, at a price established when
the options were granted.

Forms of Monetary Compensation Plan
• Performance shares or units: These are awarded in the form of company

stock for achieving a specified, usually long-term, performance target.
• Stock appreciation rights: Stock appreciation rights are deferred cash

payments based on the increase of the stock price from the time award to
the time of payment.
• Phantom stock plans: These are awards in units of number of hares of

stocks.
• Participating units: These awards are similar to stock appreciation rights

except that payment is keyed to operating results rather than stock price.

Gain Sharing – A Bonus Plan
The literature has discussed another form of bonus plan, which is

commonly known as gain sharing. Imberman(1995) illustrates gain
sharing as follows:
“Gain sharing is not an incentive or bonus plan for individuals

exceeding a standard or quota. That’s the old piecework system. Gain
sharing is group bonus plan. The entire factory workforce is involved is
an effort to exceed past performance and achieve target gains. If
successful, the gain is translated into cash shared. Usually the
workforce receives 50% of the gain in bonuses, and the company
receives an equal share in savings. That’s gain sharing in its simplest
form.”

Imberman (1995) has discussed the following three sample gain sharing
formulas:
The Scanlon plan:

This plan involves the ratio of payroll costs to sales, as expressed below:
Cost of work and non-work time paid + Pension + Insurance
Sales dollars- returned goods + Inventory changes

The Rucker Plan:

This plan involves the value added by manufacturing. It provides an
incentive to save material and labor costs and it can be expressed as
follows:
Costs of wages, benefits
Sales dollar value of product- goods returned- supplies, services materials

Improshare plan:
This measures only labour costs and uses time standards and past production records
to set a production criterion. Its bonus formula is given below:
Total actual hours worked

Standard value hours earned (Base period)
X
(current period)
Total standard value hours
earned (Base period)
Total hours worked (Current period)

Gain Sharing – When works best?
Works best when company performance

levels can be easily quantified. Employee
involvement significantly enhances the
effectiveness of incentive pay. When used
simultaneously, productivity gains from
combining these techniques can exceed
gains achieved separately.

Gain Sharing – What is the best way
to implement ?
Meet with executives to develop a clear understanding of Gain

sharing. Develop various formulas and models to be used in
predicting future gains and the costs associated with sharing
those gains. Prepare rules, presentation materials, and
dissemination of policy. Retrain supervisors and administrators.
Teams of employees are selected by peers to develop cost-
saving measures. Through their personal knowledge about
their jobs, employees are able to reduce waste and increase
efficiency.

Improving Plant Performance Through
Gain sharing (Woodruff Imberman )
Gain sharing offers industry the opportunity to

improve plant performance and boost productivity
while reducing costs attributed to poor quality (e.g.,
waste, spoilage, rejects, and customer returns).
Today, there are approximately 2,500 companies
are using gain sharing, according to a study done
by the American Management Association. Among
the companies using the plan in their plant
operations are such firms as Dresser Rand,
Consolidated Diesel, Carter-Day, Dover Rotary Lift,
Gradall Company, Ingersoll-Rand, Mixer Systems,
Proen Products, Rexnord, Webster Electric,
Cincinnati Milacron, and a host of smaller
companies.

Improving Plant Performance Through
Gain sharing (Woodruff Imberman )
As an example of how gain sharing works, consider a company producing rigid and
steering differential axles for tractors. From its records, the company determined that
every $1,000,000 of good product output required 10,000 worker hours. Under gain
sharing, the next $1,000,000 of axle output and shipment was produced with only 9,000
hours. If the average wage rate is $10 an hour, the 1,000 hours saved are worth
$10,000. That is a gain to be shared equally between the workforce and company.
In addition to helping reduce manufacturing costs, gain sharing can also enable a
company to cut costs due to poor quality. For example, a company producing rolling
bearings with solid lubricant cages had small labor costs (about 10 percent), but high
poor-quality costs. An analysis of the company's records revealed that for every
$1,000,000 in shipments, $200,000 was directly traceable to the cost of spoilage,
rejects, and customer returns. By establishing a gain sharing program, the workforce
was able to provide proper thermal hardening of the antifriction compound and provide
equipment maintenance more promptly. The cost of poor quality was cut to $150,000 in
the next $1,000,000 of shipments and the gain of $50,000 was shared between the
workforce and the company.

Performance Related Pay
(PRP) System
Performance Related Pay (PRP) – What is it?

3
1
The most common types of PRP

2
Steps in preparing PRP

3
Why do employers introduce PRP?

4
Factors need to considered in preparing PRP

5
3
Safeguards against good PRP

4

What is Performance Related Pay?
Performance Related Pay System links pay to a measure

of individual, group or organizational performance. There
is a wide variety of methods used, but all schemes
assume that –
“the promise of increased pay will provide an incentive to

greater performance”

Types of Performance Related Pay?
There are many different forms of performance related

pay, which may be used on their own or side by side.
Employers may move from one to another. Most common
are:
1. Piecework
2. Payment by results
3. Plant or organization wide incentives
4. Merit pay
5. Performance related pay
6. Competence based pay
7. Profit related pay
1. Piecework:
A price is paid for each unit of output; this is the oldest form of
performance pay.
2. Payment by results:
Bonus earnings depend on measured quantities or values of output
for individuals or groups, usually based on work studied time units;
this covers a wide range of bonus schemes.
3. Plant or organization wide incentives:

Bonus earnings or pay levels are based on measured quantities or
values for the whole establishment.
4. Merit pay:
Bonus earnings or pay levels are usually based on a general
assessment of an employee’s contributions to performance; this is
an earlier, less structured form of the next system.
5. Performance related pay:
Bonus earnings or pay levels are based on an assessment or
appraisal of an employee’s (or team’s) performance against
previously set objectives, usually part of a performance
management system; this is a fairly recent development, particularly
in the public sector, which has grown sharply in use since the 1980s.
6. Competence based pay:

Reward and training are linked to competency frameworks, based
on the worker demonstrating certain skills (eg. Problem solving,
decision making, leadership, customer service, dealing with differing
views) or achieving certain qualifications.
7. Profit related pay:

Bonus or share options are based on the organization's profit
performance; this is widespread in the private sector, where share
options are often important for senior managers. Profit related pay
has become less common since the government phased out tax
relief
Incentive Plans on PRP schemes.
& Organizational 32 03/10/10
Steps in preparing PRP
The key to all performance pay systems is the

measurement required to determine the output on which
to base payments. The main steps are:
1. Setting objectives
2. Appraisal results
3. Linking achievements to pay (and deciding
where the money comes from).

Why do employers introduce PRP?
1. To clarify objectives and engage employees with the organization's

goals.
2. To motivate employees by linking pay to achievement of targets not

length of service
3. To reward achievement and identify under performance; foster

teamwork and fairness.
4. To contribute to overall improvements in productivity;
5. To introduce more flexible pay systems or deal with recruitment and

retention problems.
6. In the case of some employers, to give greater power to managers

and weaken trade union influence in bargaining and representation of
staff.
Factors need to be considered in preparing a
good PRP?
The effectiveness of any pay system depends many factors. However,
there are some problems inherent in all performance related pay schemes:
1. Staff motivation and moral –

A wide range of research has found schemes less effective than expected. In the
public sector this is frequently due to cash limits making rewards for high
performance ratings too small to motivate staff. Problems of poor training for
managers and inadequate communication with staff have had a negative impact on
staff morale.
2. Fairness
Because performance related pay systems are based on appraisal of
the individual worker, often by their line manager, bias and personal favoritism can
influence the result of pay reviews. Instead of motivating workers, performance pay
can “undermine performance of both the individual and the organization by
undermining team work, encouraging a short term focus and leading people to
believe that pay is not related to performance, but to having the ‘right’ relationships
and an ingratiating personality”. (Jeffrey P feffer, Harvard Business Review,
May/June 1998)
Factors need to be considered in
preparing a good PRP?
3. Discrimination
Recent research found that performance based pay systems often discriminate
against women because: the appraisal process is subject to gender bias and
stereotypes; women’s skills are often undervalued by their managers (and by
women themselves); women—especially those working part time -- have fewer
opportunities for training, and managers are less likely to correctly assess women’s
training needs. (M.T. Strebler, M. Thompson, P. Heron, Skills, Competencies and
Gender; Issues for pay and training, IES Study 333, 1997). Performance pay may
run counter to the development of objective, gender neutral job evaluation schemes
which are being introduced to achieve equal pay for work of equal value. A study
by the Institute of Personnel and Development, found that almost two-thirds of
employers had no provision for monitoring sex and racial discrimination in their
performance related pay systems.

Safeguards considered in preparing a
good PRP?
1. Negotiability on objective and design –

There should be trade union involvement from the start, with input on who
should be included/excluded from the scheme; the relationship between
employment and pay; how the scheme will operate, including joint
monitoring and the appeals procedure.
2. Transparency –
The basis for appraisal and how rewards are arrived at should be
transparent at both the individual and collective level.
3. Fairness in operation –
There should be a fair and equitable approach to the way the scheme is
carried out for all staff. In competence pay schemes, all staff should have
equal access to training.

Safeguards considered in preparing a
good PRP?
4. Piloting –
The scheme should be piloted to ensure that it achieves its objectives and
does not operate unfairly.
5. Adequate appraisal –
Sufficient time should be available to managers to carry out any appraisals.
The workload implications can be considerable, especially for a complex
scheme.
6. Training –
Training should be available for all managers and staff.

The Agency View
of Incentive Schemes
1
3 What is Agency Relationship
2 Background
3 Conflicts & Costs
4 Techniques 2 Resolve The conflicts
5
3 Different Incentive plans

Agency
Agency Relationship
 Since majority of the world's work is done by person

acting as representative of another person, the ruling of
agency is among the most fundamental.
 The agency describes an agreement between two

people where one will be a representative of another -
the principal and the agent. In other words, the
principal is a person who wants to achieve something
and he/she hires an agent to help him/her to achieve it.
The agency relationship means, that both parties agree,
that agent will represent the principal in doing
business.

Agency Relationship (cont)
 An agency relationship arises whenever one or two

individuals, called principal hire another individual
or organization, called agent, to perform some
services and delegate decision- making authority to
that agent.
 The rights and responsibilities of the parties are

specified in a mutually agreed- upon contract. Both
the agent and the principal are assumed to be
rational economic persons motivated solely by self-
interest.

Agency Relationship (cont)
In the context of a public corporation there are contractual relationships like:
Principal Contractual Contractual relation

relation Agent
Agent
Shareholders Board of directors
Board of directors Executives
Executives Subordinates

BACKGROUND
 So far known agency theory came from Kenneth Arrow’s
theory of choice. According to the theory, there is a set of
conceivable actions, which an individual could take each
of which leads to certain consequences (Arrow 1974: 1).
 Agency theory in a formal sense originated in the early
1970s, but the concepts behind it have a long and varied
history. Among the influences are-
 Organization economics
 Contract law
 Political philosophy
 The work of Locke and Hobbes.
 In financial management, the primary agency relationships
are those between,
 Stockholders and managers
 Managers and debt holders
Types of Agency Relation
According to Kaplan and Atkinson (1989).
There are two types of principal-agent relationships.
Agency
Theory
First Second
The firm’s owner or The firm’s top
shareholders acting as the management groups
principal hire the chief acts as the principal and
executive officer to be their hires divisional
agent in managing the firm managers as agents to
in their best interests. manage the units or
divisions.
STOCKHOLDERS VS MANAGERS
A potential agency conflict arises whenever the manager of a firm owns less than
100 percent of the firm's common stock. If a firm is a sole proprietorship managed by
the owner, the owner-manager will undertake actions to maximize his or her own
welfare. The owner-manager will probably measure utility by personal wealth, but
may trade off other considerations, such as leisure and perquisites, against personal
wealth. If the owner-manager forgoes a portion of his or her ownership by selling
some of the firm's stock to outside investors, a potential conflict of interest, called an
agency conflict, arises.
Figure: Basic idea of Agency Theory (P: Principal, A: Agent)

Source: http://en.wikipedia.org/wiki/Principal-agent_problem
STOCKHOLDERS (through managers) VS CREDITORS
A SECOND AGENCY CONFLICT

Creditors have the primary claim on part of the firm's earnings in the form of interest
and principal payments on the debt as well as a claim on the firm's assets in the
event of bankruptcy. The stockholders, however, maintain control of the operating
decisions (through the firm's managers) that affect the firm's cash flows and their
corresponding risks.
Creditors lend capital to the firm at rates that are based on the risk ness of the firm's
existing assets and on the firm's existing capital structure of debt and equity
financing, as well as on expectations concerning changes in the risk ness of these
two variables.
The shareholders, acting through management, have an incentive to induce the firm to
take on new projects that have a greater risk than was anticipated by the firm's
creditors.
On the other hand, shareholders may be reluctant to finance beneficial investment

projects.

Problems In Agency Relation
The agent is generally assumed to be a risk- averter

and the principal to be a risk- seeker or risk averter.
The agent might have a shorter duration with

the organization than the principal
The problem in the
agency relationship is The agent’s earnings are fixed (in the absence
that the agent and of incentive payments) while the principal is the
the principal may be residual claimant.
at variance with each
other. The principal does not directly take part in
management decision making and control
(i.e., ownership is separated from management).
There is information asymmetry between the agent and the

principal, in fact the principal is ignorant of many details
of the agent’s activity.
Agency Costs
 Agency costs are defined as those costs borne

by shareholders to encourage managers to
maximize shareholder wealth rather than
behave in their own self-interests.

Agency Costs (Cont)
 Kaplan and Atkinson suggested that all individuals- principal
and agents care not only about financial compensation and
wealth but also about perquisites of the job, such as attractive
working conditions and flexibility in hours worked. If only a
straight salary compensates the top executives of the firm,
they may not be motivated to take actions that maximize the
value of the firm to the shareholders.
 Agency costs in the owner-manager relationship are the sum
of:
 The costs of the incentive compensation plans (bonus, reward, etc.)
 The costs of monitoring managers actions (audited financial
statements)
 The remaining costs of actions taken by managers that diverge from
the preferences of the owners.

Dealing with Conflicts
Conflicts may produce four distinct outcomes depending on the approaches taken
by the people involved.
Win Win- Lose Win- Win

Individ
outco
Lose-Lose Lose-Win
A’s
me
ual
Lose
Lose Win
Individual B’s outcome
Figure: Four possible outcomes of conflict

Source: “organizational behavior
Human behavior at work”; Page: 258
Written by: Keith Davis, John W. Newstrom

Dealing with Conflicts (cont)
Mutual interest:
Ethics
Employee Employee
Goals
Super Ordinate Mutual Organization

Goal of Mutual Accomplishment
Interest of Goals
Society
Organization
Goals
Figure: Mutual interest provides a super ordinate goal for

employees, the organizations, and society.

Dealing with Conflicts (cont)
 In addition to monitoring, the following

mechanisms encourage(!) managers to act in
shareholders' interests:
 Performance-based incentive plans,
 Performance related pay (PRP )
 Employment contract
 Long Term Incentive Plans
 Direct intervention by shareholders,
 The threat of firing, and
 The threat of takeover.

Performance-based incentive plans
 Most publicly traded firms now employ performance shares, which
are shares of stock given to executives on the basis of
performances as defined by financial measures such as earnings
per share, return on assets, return on equity, and stock price
changes.
 If corporate performance is above the performance targets, the

firm's managers earn more shares. If performance is below the
target, however, they receive less than 100 percent of the shares.
 Incentive-based compensation plans, such as performance shares,

are designed to satisfy two objectives.
 First, they offer executives incentives to take actions that will

enhance shareholder wealth.
 Second, these plans help companies attract and retain managers

who have the confidence to risk their financial future on their own
abilities—which should lead to better performance.
Performance related pay (PRP )
 To reduce the agency cost and to improve the

executive performance and for the best interest
of the company or organization, we can show
the following equation:
 Salary Y= mx + c [international level follows it.]
 Here y = total salary, mx = performance related
compensation, c = constant base salary.
 But In Bangladesh, it follows the following

equation-
 Y = c, that is only constant base salary.
Employment contract
 Milgrom and Roberts (1992) identify four basic

principles of contract design:
 the Informativeness Principle,

 the Incentive-Intensity Principle,
 the Monitoring Intensity Principle, and
 the Equal Compensation Principle.

A linear model
 The four principles can be summarised in terms
of the simplest (linear) model of incentive
compensation:
 w = a + b(e + x + g×y) [Source: Internet]
 where w stands for the wage, e for (unobserved)
effort, x for unobserved exogenous effects on
outcomes, and y for observed exogenous
effects; while g and a represent the weight given
to y, and the base salary, respectively. The
interpretation of b is as the intensity of
incentives provided to the employee.
 Exogenous Greek words "exo" and "gen",
meaning "outside" and "production
Long Term Incentive Plans and
Managerial Decision- making
 One way to mitigate managerial risk aversion is
to provide the manager with long term incentive
contracts that have a payoff structure that is a
convex function of the firms’ stock price.

Direct intervention by shareholders
 An increasing percentage of common stock in corporate America is
owned by institutional investors such as insurance companies,
pension funds, and mutual funds. The institutional money managers
have the clout, if they choose, to exert considerable influence over a
firm's operations. Institutional investors can influence a firm's
managers in two primary ways.
 First, they can meet with a firm's management and offer

suggestions regarding the firm's operations.
 Second, institutional shareholders can sponsor a proposal to be

voted on at the annual stockholders' meeting, even if the proposal
is opposed by management. Although such shareholder-sponsored
proposals are nonbinding and involve issues outside day-to-day
operations, the results of these votes clearly influence management
opinion.

The threat of firing
 In the past, the likelihood of a large company's
management being ousted by its stockholders was so
remote that it posed little threat. This was true because
the ownership of most firms was so widely distributed,
and management's control over the voting mechanism
so strong, that it was almost impossible for dissident
stockholders to obtain the necessary votes required to
remove the managers.
 In recent years, however, the chief executive officers at

American Express Co., General Motors Corp., IBM, and
Kmart have all resigned in the midst of institutional
opposition and speculation that their departures were
associated with their companies' poor operating
performance.
The threat of takeover:
 Hostile takeovers, which occur when

management does not wish to sell the firm, are
most likely to develop when a firm's stock is
undervalued relative to its potential because of
inadequate management. In a hostile takeover,
the senior managers of the acquired firm are
typically dismissed, and those who are retained
lose the independence they had prior to the
acquisition. The threat of a hostile takeover
disciplines managerial behavior and induces
managers to attempt to maximize shareholder
value.
AGENCY AND ETHICS
 Since agency relationships are usually more complex
and ambiguous (in terms of what specifically the agent
is required to do for the principal) than contractual
relationships, agency carries with it special ethical
issues and problems, concerning both agents and
principals.
 Ethicists point out that the classical version of agency
theory assumes that agents (i.e., managers) should
always act in principals' (owners') interests.
 However, if taken literally, this entails a further
assumption that either
 (a) the principals' interests are always morally acceptable ones or
 (b) managers should act unethically in order to fulfill their "contract" in
the agency relationship.
 Clearly, these stances do not conform to any practicable
model of business ethics.

AGENCY THEORY OVERVIEW
Key Idea Principal-agent relationships should reflect efficient organization of
information and risk-bearing costs
Unit Of Analysis Contract between principal and agent
Human 1. Self interest
Assumptions 2. Bounded rationality
3. Risk aversion
Organizational 1. Partial goal conflict among participants
Assumptions 2. Efficiency as the effectiveness criterion
3. Information asymmetry between principal and agent
Information Information as a purchasable commodity
Assumption
Contracting 1. Agency (moral hazard and adverse selection)
Problem 2. Risk sharing
Problem Relationships in which the principal and agent have partly differing
Domain goals and risk preferences (e.g. compensation, regulation,
leadership, impression management, whistle blowing, vertical
integration, transfer pricing)
“It Is Not Important That How
Good You Are…
It’s Important… How Easily You
Can Make Relation With
Others….”

Summary
 To improve organizational performance and effectiveness, business
over the past few years have embarked upon various incentive
schemes.
 We have shown that incentive plans provide motivation for
organizational managers and executives.
 The principal-agent relationship theory suggests that organizational
managers and top executives must compensated through financial
compensation (salary, bonuses, etc) as well as non-financial
compensation such as attractive working conditions, flexible hours,
free holidays , and a car parking permit.
 Organization’s incentive plan depend on its particular
circumstances within which it operates such as business size,
strategic focus, economic conditions and external environment.
 Contemporary incentive schemes should be based on both financial
and non financial performances. An effective incentive scheme
provides strong motivation for the organizational managers and
executives to achieve organizational goals.

Sample Question
 What is incentive plan?
 What are the most common types of incentive plan?
 What are the key Considerations in Desiging Incentives and Gainsharing
Approachs?
 What are the bases for Incentive System?
 What is executive Incentives ?
 How can one design a incentive plan?
 What are the major types of incentive program?
 What is incentive rewards & what are the major problems in incentive
plan?
 What are the forms of Compensation plans?
 What is Gain sharing?
 How does Gain sharing work?
 What is the best way to implement Gain sharing?
 How Plant performance be improved through?
Sample Question
 What is performance related pay system?
 What are the most common types of performance related pay systems?
 What are the steps in preparing performance related pay system?
 Why do employer introduce performance related pay system?
 What are the factors that needs to consider in preparing performance
related pay system?
 What are the that safeguards should be keep in mind in preparing
performance related pay system?
 What are the sample Gain sharing Formulas?
 What is agency or agency theory?
 What are different types of agency relations?
 What are the costs and conflicts of agency?
 How corporations can resolve or minimize the conflicts?
 Is it possible to run the corporate world without agents? Why or why not?
Write the positive and negative sides of agency relation.

Strategic Mgt. Acc. - Incentive Plans &amp; Organization Performance

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Strategic Mgt. Acc. - Incentive Plans &amp; Organization Performance

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Incentive Plans &

Incentive Plans & Organizational 2 03/10/10

Monetary Compensation Plans

Performance Relayed Pay System

The Agency View of Incentive Schemes

Incentive Plans & Organizational 3 03/10/10

The most common types of Incentive

Bases for Incentive System

How to Design an Effective Incentive Program

Types of Incentive Programs

Incentive Rewards & Incentive problems

An incentive is any factor (financial or non-financial) that provides a motive

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Incentives can be classified according to the different ways in which they

1. Remunerative incentives (or financial incentives)

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Issues Key Considerations

Payout standard What will trigger an incentive bonous? When will it be

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1. Short Vs. Long Term

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Thus, imperfect knowledge and unintended consequences can often make

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2 Gain sharing-a bonus plan

3 When does gain sharing work best ?

4 Best way to implement Gain sharing

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Kaplan Atkinson (1989) discuss several forms of

• Cash bonus or profit sharing and the stock bonus:

• Deferred bonus and compensation award: Cash or

• Stock options: Employees have the right to purchase

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• Performance shares or units: These are awarded in the form of company

• Stock appreciation rights: Stock appreciation rights are deferred cash

• Phantom stock plans: These are awards in units of number of hares of

• Participating units: These awards are similar to stock appreciation rights

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The literature has discussed another form of bonus plan, which is

“Gain sharing is not an incentive or bonus plan for individuals

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The Scanlon plan:

Cost of work and non-work time paid + Pension + Insurance

Sales dollars- returned goods + Inventory changes

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The Rucker Plan:

Costs of wages, benefits

Sales dollar value of product- goods returned- supplies, services materials

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Total actual hours worked

Total hours worked (Current period)

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Works best when company performance

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Meet with executives to develop a clear understanding of Gain

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Gain sharing offers industry the opportunity to

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Performance Related Pay (PRP) – What is it?

The most common types of PRP

Strategic Mgt. Acc. - Incentive Plans & Organization Performance

Strategic Mgt. Acc. - Incentive Plans & Organization Performance