Paper XXVIII: Compensation Management
4 CHAPTER-3 ORGAISATIONAL-WIDE INCENTIVE PLANS
An organizational incentive system compensates all employee in the organization based on how well the organization as a whole performs during the year. The purpose of these plans is to produce better results by rewarding co-operation throughout the organization. The conflicts between different departments, levels, and individuals can be reduced by rewarding organization wide productivity. To be effective, an organizational incentive programme should include every one in the organization.
At times, no distinction is made between group incentive plans and organizational incentive plans as an organization is a bigger group.
Some of the organizational incentive plans are (they can be used as group incentive plans):
· Scanlon Plan
· Profit Sharing
· Employee Stock Option Plans
· Employee Stock Ownership Plans
It is a plant-wide scheme designed to involve workers in making suggestions for reducing the cost of operations and improving work methods by showing the gains of increased productivity. It has two basic features:
(1) Financial incentives are used to increase productivity and to reduce costs.
(2) Department/Plant screening committees are set up to evaluate employee suggestions.
Generally all the employees (workers, supervisors and managers) participate by making suggestions for improving productivity and cutting costs. These suggestions are screened by various screening committees. If a suggestion is implemented successfully, all employees share the gains in productivity.
· Involves workers in making suggestions for reducing cost of operation, improving working methods and sharing in the gains of increased productivity.
· Assumes efficiency requires company wise cooperation.
· Employees participate in cost cutting suggestions and a committee evaluates these suggestions.
· Employees share 75% of the savings if a suggestion is implemented successfully.
· Encourages a sense of partnership.
The conditions needed for the success of the plan are:
· The number of workers should be small preferably less than 1000.
· Product lines and costs are stable,
· Healthy industrial relations and good supervision,
· Strong commitment to the plan on the part of management.
It is a system to distribute a portion of the profits of the organization to employees. The primary objectives of any profit sharing plan include the following:
· Improve productivity.
· Recruit or retain employees.
· Improve product/service quality.
· Improve employee morale.
Following are the features of the profit sharing:
- An incentive based compensation program to award employees a percentage of the company's profits.
- The company contributes a portion of its pre-tax profits to a pool that will be distributed among eligible employees.
- The amount distributed to each employee may be weighted by the employee's base salary so that employees with higher base salaries receive a slightly higher amount of the shared pool of profits.
- This is done on an annual basis.
Typically, the percentage of the profits distributed to employees is agreed on by the end of the year before distribution. In some profit-sharing plans, employees receive portion of the profits at the end of the year, in others, the profit are deferred, placed in a fund and made available to employees on retirement.
- Brings groups of employees to work together toward a common goal.
- Helps employees focus on profitability.
- The costs of implementing the plan rise and fall with the company's revenues.
- Enhances commitment to organizational goals.
- The pay for each employee moves up or down together (no individual differences for merit or performance).
- Focuses only on the goal of profitability (which may be at the expense of quality).
- For smaller companies, these plans may result in drastic swings in earnings for employees, which the employees may find difficult to manage their personal finances.
Following Exhibit shows how profit sharing plans can be set up.
Profit Sharing Plan Framework
1. Fixed percentage of profits.
1. Equally to all employees.
2. Flexible percentage based on sales or return on assets.
2. Based on employee earnings.
3. Units profits
3. Based on years of service.
4. Some other formula.
4. Based on contribution and performance.
Profit sharing plans link employee’s pay with organizational performance. Because of this feature, in recent years unions have started supporting these plans. However when used throughout an organization, including lower echelon workers, these plans can have some drawbacks. Often the level of profits is determined by accounting decisions, marketing efforts, competition, and elements of executive compensation. Therefore, to be credible, management must be willing to disclose sufficient financial and profit information to alleviate the skepticism of employees, particularly if profit levels are reduced from previous years. Second, profits may vary a great deal from year to year, resulting in windfalls and losses beyond the employee’s control. Third, payoffs far removed from employees’ efforts may fail to strongly link higher rewards with better performance.
Profit Sharing in India
The Government of India appointed in 1948 a committee to study the problem of profit sharing in industry. The committee suggested the introduction of profit-sharing as an incentive to productivity- as a method of ensuring industrial peace and as a step towards labor participation in management. The committee suggested that 50% of the profits be shared among workers. Both employers and trade unions rejected the scheme. Trade unions prefer the minimum bonus to profit sharing. The Payment of Bonus Act, 1965 provides for payment of minimum bonus despite loss in an undertaking. This system of compulsory bonus is unscientific. For achieving higher productivity, productivity linked bonus has been introduced by many industrial enterprises both in the public and private sectors.
Employee Stock Option Plan / Scheme (Esop / Esos)
It provides a mechanism through which certain eligible employees may purchase the stock of the company at a reduced rate (Edwin B. Flippo, 1989). Eligibility is usually determined by wage level or length of service or both. There are various ways in which ESOP is implemented.
The stock is offered at the market rate.
The stock is offered at a price which is 10 to 20 percent less than the market price.
The employee is given the option to purchase a certain amount of stock at stated price in future within a specified period of time.
Stock options, once the exclusive domain of executive compensation, are now being used for operatives also in some organizations, though its use for the operative employees is still limited. Another feature of ESOP is that employees are authorized to pay for stock in installments. The employee authorizes a payroll deduction every month.
Under ESOP, employees stand to gain if the stock’s market price exceeds the exercise price. On the other hand, if market price falls below the market price, the option becomes worth less.
The salient features of ESOP are:
(i) It offers an option to the employee to purchase a certain amount of shares or stock of company.
(ii) It is intended to procure and hold talented professional employees in the company.
(iii) It creates mutuality of interests between the employees and the employer.
(iv) Participation is voluntary in nature.
Benefits of ESOP
ESOP has many benefits:
(i) One of them being creation of feeling among all employees that they own their organization.
(ii) It also reduces labor turnover.
(iii) It boosts the morale of the employee.
(iv) As employees are allowed to pay in installments. It reduces their financial burden.
(v) The employees get an opportunity to attend the meetings of the shareholders and have detailed information about the progress and future plan of the company.
(vi) It constitutes a source of extra income to the employees.
(vii) Tax treatment of earnings earmarked for use in ESOP is more favourable as compared to others terms of earnings and their distribution.
Limitations of ESOP
Though voluntary in nature, some employees may feel they are being forced to join.
(i) Their earnings at present and in future become subject to a greater risk (that of performance of their employee)
(ii) It is being used as a management tool to fend off unfriendly takeover attempts. Holders of employee owned stock often align with management to turn down bids that would benefit outside stock holders but would also replace existing inefficient management and restructure operations.
(iii) There is no direct relationship between efforts and reward.
Therefore, ESOPs suffer from many disadvantages and are effective only during periods of prosperity. Still, they are continuously growing in popularity. A more extensive approach of employee stock option plans result in employees actually owning all or significant parts of their employers. That is also known as Employee stock ownership plans(ESOPs)
Mechanism of Establishing an ESOP
An organization establishes an ESOP by using its stock as collateral to borrow capital from a financial institution. Once the loan repayment begins through the use of company profits ,the lender releases a certain amount of stock, which the company allocates to an Employee Stock Ownership Trust(ESOT). The company then assigns shares or stock kept in the trust to individual employees based on length of service and pay level. On retirement, death, or separation from the organization, employees or their beneficiaries can sell the stock back to the trust or on the open market, if the stock is publicly traded.
Appraisal of Employee Stock Option Plan
One of the commonly cited objectives of ESOP is to promote a mutuality of interests. The employee is encouraged to consider the viewpoint of the company as shareholder. He is also led to read company reports received as shareholder which would probably be ignored as an employee. Other possible values are the promotion of thrift and security, the creation of an added incentive to work efficiently.
Employee stock option plan may not be preferred due to the following reasons:
(i) The employee is asked to invest savings as well as earnings in the company.
Most of the workers have hardly any surplus to invest in shares.
(i) There is no guarantee about increase in the market value of shares in future.
(iii) As long as the share prices go up, the morale of employees is higher. When share prices go down, the employees are likely to blame the company. This is what happened in the 1930s in the U.S.A, when the share prices crashed due to economic depression. Thus, such plans are effective during the periods of prosperity only.
(iv) Employee participation in company meetings, management and control, sometimes, may prove more an interference rather than an aid to cooperation.
(iv) It is a very poor incentive because of indirect relationship between effort and reward of employees and remoteness and uncertainty of reward.
Employees Stock Option Scheme in India
The Securities and Exchange Board of India (SEBI) guidelines for Disclosure and Investor Protection explain that ESOS is a voluntary scheme on the part of the company to encourage employee’s participation in the company. A suitable percentage of reservation can be made by the issue, for the employees of his company. However, under the existing guidelines, 5% of the new issue may be reserved for the ESOS subject in a maximum limit of 200 shares per employee who agree to participate to the ESOS. Further, the membership of the ESOS should be restricted only to the permanent employees of the company.
Profit-Sharing and Co-Partnership
Profit-sharing implies payment of specified share in the annual profits of the firm to its workers. Thus, profit sharing is an attractive supplement of a wage system. Under profit-sharing, the employer undertakes to pay his employees a share in the annual net profits of the enterprise. This share is in addition to regular wages and is based neither on time nor on output. Profit-sharing is an agreement entered into between the employee rand the employees under which the employer agrees to pay to the employees the share in the profit fixed in advance.
Profit-sharing is different from wage incentives which are directly connected with the output of workers. But profit-sharing is related to the profit of the enterprise which depends on productivity and several other factors. It is amajor departure from the traditional concept of profit where it is treated as the exclusive monopoly of the employer. The workers are treated as co-partners in the productive process and profit is treated as the outcome of the joint efforts of employer and workers. Naturally, the whole profit should not be pocketed by the employer alone, but should be shared between the employer and the employees.
The Concept Of Profit-Sharing
According to I.L.O., "Profit-sharing is a method of industrial remuneration under which an employer undertakes to pay to his employees, a share in the net profits of the enterprise in addition to their regular wages" Profit-sharing arrangement enhances social justice, strengthens the common interest of capital and labor and increases the productive efficiency of the workers. It would be highly successful if both the parties, viz., labor and employers, take each other into mutual confidence.
The concept of profit-sharing is now accepted in the industrial world and also at the government level. In Western countries, profit-sharing is very popular among the industrial workers. However, this concept is not popular in India. We have a system of bonus payment which is compulsory even when there is no profit to a company. In India, workers and trade unions are interested in bonus payment and they are not interested in profit-sharing agreement. This is because bonus payment is compulsory even when the workers are not co-operative and there is no profit to the industrial unit. However, profit-sharing is possible only when workers give full co-operation to raise the profits over and above a particular limit. The system of bonus payment existing inIndia is defective and unscientific as compared to profit-sharing which is fair to workers and employers.
The objectives of profit-sharing may be summarized as under:
(i) To supplement the earnings of the workers.
(ii) To enable the workers to participate in the prosperity of their firm because the higher profits are among other things caused by sincere co-operation of the workers.
(iii) To create a sense of partnership among the workers and the management so that the interests of both the classes are reconciled.
Features of Profit-Sharing
The salient features of profit-sharing are as under:
(i) Profit-sharing denotes the extra payment given to workers in addition to usual Wages and allowances,
(ii) It is paid out of the net profits and as per the agreement between the two parties, i.e., employers and employees.
(iii) The sharing of profits in a particular proportion is decided by an agreement between the employers and the employees.
(iv) The profit-sharing agreement is possible at the unit level or even at the industry level. It is also possible to have such agreement on regional basis or industry-cum-region basis.
(v) The payment to workers under profit-sharing is generally made on cash basis, but it is also possible to make such payment in shares or transfer of money to provident
fund account of the employees.
(vi) Workers share the profits only. They do not contribute to the losses incurred by the firm.
Rationale Of Profit Sharing
Profit-sharing is a controversial issue in wages and incentives administration. It is contended that labor being the life factor in production is entitled to a legitimate share in the surplus earned by the employer. Because it is labor’s skill, effort, steadfastness and loyalty that bring profits to the firm, employees assert their right to have a share in the surplus profits. On the ground of equity, they argue that profit-sharing is nothing but deferred wage; share in the profit would bridge the gap between the living or fair wage and the actual wage.Wages as a rule are to be based on the firm's ability to pay. But employers often use the profit sharing device to extort their loyalty and reduce the influence of trade unions. It is in general looked upon as a scheme of providing a sort of group incentive to the workers for higher productivity and greater profitability.
Emphasis on profit-sharing and worker's co-ownership in business was laid during the periods of expanding corporate profits notably in the U.K, U.S , France and other industrially advanced countries. In the U K., as early as in 1891, a profit-sharing scheme was initiated by South Metropolitan Gas Company. Since then several companies have been operating profit-sharing arrangements. In the U.S.A., various plans have been adopted to improve employee-morale and increase productivity.
Deferred participation in profits by employees has been widely practiced in France ever since 1820's, in many countries including the U.S A employee ownership in share capital of companies where they are employed has come into vogue whereby stipulated share of each worker in profits is converted into his share-holding. In some countries, profits shared are accumulated and paid on employee’s pension or provident funds.
There are two discernible view-points about the feasibility of profit-sharing.
(1) Participation in surplus profits, and (2) Bonus as a deferred wage.
These are discussed below:
1. Participation in Surplus Profits
It is contended that profits remaining after meeting certain claims and making provisions should be shared between the workers and the Management. Employees skill, efforts, loyalty and sincerity should be regarded as the contributing factors in increasing the profits of the firm. Hence they are entitled to a reasonable share in the aggregate net surplus. Such surplus or profits available for workers would be determined after providing fordepreciation, tax liability etc., and ensuring a reasonable return on share capital and built up reserves.
The implication of this approach is that just as divident on shares is declared every year, wage dividend should also be offered to the workers every year provided adequate surplus profits are available. If no surplus becomes available, obviously workers will have to be content with only their usual wages. Just as dividend is paid only out of profits, bonus too is to be paid out of the apportionable profits,
2. Bonus as a Deferred Wage
A more vocal section of workers contends that if bonus is linked with availability of surplus profits, management will always try to manipulate the finances and show losses or minimum profits so as to avoid payment of bonus to the employees. Hence it is argued that all the workers should be paid a minimum bonus every year irrespective of the profits earned by the firm.
They regard bonus as the deferred wage and hence a charge on the earnings of the firm. Giving an annual bonus is nothing short of giving additional wages at the end of the year. Bonus is meant to bridge the gap to the possibleextent between the actual wages and the living wages standard. Therefore, a minimum bonus is to be paid by every employer to his employees and it will be sliding upwards as the profits increase. A statutory obligation should be cast on the employers to pay a specified sum of minimum bonus to the employees on the roll of regular cadres.
It is, however, argued by the employers that the concept of minimum bonus will not act as a stimulant for higher productivity. Firms running into losses due to unforeseen uncontrollable factors would find statutory minimum bonus a burdensome liability.
Benefits Of Profit-Sharing
The benefits of profit-sharing are listed below:
(i) There is industrial peace in the enterprise. The workers are satisfied as they get an additional amount over and above their wages. A healthy atmosphere prevails in the enterprise. There is cooperation between labor and management as the objectives of both are common, i.e., to increase productivity,
(ii) Profit-sharing acts as a driving force for higher production and productivity. The workers take more interest and initiative leading to higher production.
(iii) The share of workers in the profits depends upon the efforts, initiatives and hard work of the employer and employees. This brings about a team spirit among the workers and the employers. The chances of conflict are reduced.
(iv) The workers are motivated and have a sense of belongingness to the firm. They cooperate voluntarily because their prosperity depends upon the prosperity of the firm. If the firm earns higher profit, the workers will get higher amount of bonus.
(v) Profit-sharing brings about stability in the working of the enterprise. The rate of Labor turnover is reduced because the workers are contented with the management.
(vi) Profit-sharing results in equitable distribution of profits among the employer and the employees of the enterprise.
(vii) Profit-sharing is a step towards industrial democracy as employees are treated not only as wage earners but also as partners in the progress of the company.
Limitations Of Profit-Sharing
The limitations of profit-sharing are as follows:
(i) There is high degree of uncertainty in profit-sharing. The share of profit will be paid only when the profit exceeds a particular limit. The profit may not cross a particular limit due to market forces and theworkers will suffer. Thus, profit-sharing does not give full guarantee of extra-payment to the workers.
(ii) Profit-sharing gives equal benefit to all workers. Distinction is not made between good and bad workers. As a result, sincere and efficient workers get less than what they deserve while bad or inefficient workers get more than what they deserve.
(iii) As the amount of profit is to be distributed after a specified period; there is not real incentive to produce more. The incentive effect of the scheme is completely lost due to remoteness of the reward,
(iv) The scheme of profit-sharing does not eliminate the need for negotiations Between the management and the labour regarding distribution of profits to the labour. Sometimes, relations between labour and management are adversely affected on profit- sharing agreement. This defeats the very purpose of profit-sharing.
(v) Profit-sharing as a method of extra remuneration to workers is used during the period of prosperity when profits are high. Profit-sharing is not possible during the lean years of depression.
(vi) Unscrupulous management may manipulate the accounts to the detriment of the workers.The workers may, therefore, get nothing due to dishonesty of the management. This will dampen the enthusiasm of the workers.
Profit-Sharing In India
In India the issue of bonus has been a source of acute controversy, employers have hardly volunteered to pay their workers legitimate portion of their surplus profits; the workers have been complaining that the employersparticularly during boom periods earned enormous profits without giving them either substantial increase in their wages or allowing them to participate in the extra or abnormal profits. Worker have asserted that annual bonus is their statutory right enforceable against the employers. In 1924, however, the Bonus Dispute Committee headed by the then Chief Justice of Bombay held that it was not an enforceable right. During the Second World War and the years after the end of the war, the courts and tribunals conceded to the workers the claim of annual bonus as their statutory privilege.
The wartime (Second World War) boom and post war rise in prices brought about unprecedented rise in industrial profits without a proportionate rise in wages. This led to industrial unrest in the country resulting in frequent strikes and lockouts in 1947 and thereafter. Industrial Truce Resolution passed in 1947 urged the formulation of satisfactory plan for payment of bonus on the basis of profit-sharing to the workers. The Industrial Policy Resolution. 1948 also contained affirmation of labour right to share in the profits of the industry on the principles of social justice. Workers pleaded for a minimum annual bonus and a satisfactory formula for determining surplus profits and their share therein.
In 1948, the Central Government appointed a committee to study the problem of profit-sharing in industry. The committee suggested the introduction of profit-sharing as an incentive to production as a method of securing industrial peace and as a step of labour participation in management. It, however, did not give any exact formula of profit-sharing, but suggested that the share of labour should be 50% of the surplus profits (i.e., profits available after providing for depreciation reserves and tax liability). This scheme was not favored by the employers and workers, and so the progress of this scheme was limited. The trade unions preferred minimum bonus to profit-sharing,
The Bonus Commission
The number of disputes relating to bonus increased throughout the country during 1950s. For instance, in 1957, 13.6% of total strikes and lockouts pertained to bonus: it was 10.5% in 1960. In 1961, the Government set up a Bonus Commission under the chairmanship of Shri M.R. Meher to define the concept of bonus and determine the basis of its disbursement. The Commission submitted its report in 1964.
The Payment of Bonus Act, 1965
The Government promulgated an ordinance in 1965 which was replaced by Payment of Bonus Act, 1965. The salient features of the Act were:
(i) The Act would be applicable to industrial units employing not less than twenty workers,
(ii) Employees who have worked for not less than 30 days in a year and whose earning do not
exceed Rs, 1600 per month would be eligible for bonus.
(iii) Minimum bonus at four per cent of the salary or wages earned by the employee in a year or Rs. 40 whichever is higher would be paid whether profits or no profits.
(iv) Maximum bonus would be limited to 20% of salary or wages.
(v) Surplus profits would mean Gross profits-(depreciation + taxes + 8.5% on equity shares
actual divident paid on preference shares + 4% on reserves). Sixty per cent of allocable
surplus would be available for bonus disbursement (in case of foreign companies 67%).
In 1971 due to inflation, rising cost of living, surging profits, etc., there was again a pressing demand for increasing the quantum of bonus. The then Union Labour Minister, Shri Khadilkar, mooted a formula to raise the minimum bonus from 4% to 8.33%. The Bonus Review Committee appointed in 1971 also endorsed the Khadilkar formula. The Government enforced this formula through an ordinance. This ordinance was replaced by the Payment of Bonus(Amendment) Act, 1972. Under the Act, the quantum of minimum bonus was raised to 8.33%.
The progress of profit-sharing in India has been insignificant. This is partly due to statutory provision of payment of minimum 8.33%. bonus to workers under the Payment of Bonus Act, However, in many industries, the concept of productivity linked bonus has been introduced under which higher bonus is payable to workers where their productivity is higher. The Government has also given encouragement to this scheme in the recent years.
The reasons of failure of profit-sharing in India have been summed up by V.V. Giri (1972) as follows, "Some employers in India introduced profit-sharing schemes with a view to stimulating interest among their workers in increasing production. There was, however, no change in the outlook of these employers. They did not treat the workers with justice and fairness and refused either to consult or to inform them on matters of common interest in the working of the industry. Requests for facilities for looking into the balance sheets of the companies were resented as unwarranted interference in the sphere of management. Such an attitude defeated the very object and the purpose of the profit-sharing scheme."
The status of employees needs to be raised. They should be treated as equal partners in business and industrial ventures. The concept of copartnership is much wider in scope as compared to the concept of profit-sharing. Co-partnership relates to industrial democracy and labour participation in management. In copartnership employees are made part-owners of the enterprise and are allowed to participate in the decision-making process.Here, the employees are converted into co-partners or co-owners of the company. Thus, employees get higher status and naturally they take more interest in the management of their company. The employees are made more active and responsible due to co-partnership,
Co-partnership can be introduced in the following forms ;
(a) Profit-sharing in kind. In this method, employees are given their share in the profits not in cash but in the form of shares of the company. As a result, they become the regular shareholders of the company with powers to attend company's meetings and participate in the management of their company.
(b) Payment of bonus in kind. In this method, the bonus payment is made in shares and not in cash. As a result, employees are made shareholders of their company with full powers to participate in themanagement of their company by attending company's meetings of shareholders.
(c) Offering new shares to employees. In this method, the new shares of the company are offered to the existing employees of the company. Those who purchase the shares become the shareholders of the company with usual rights and powers of shareholders.
Merits Of Co-Partnership
Under co-partnership, the workers not only get a share in the profits of the company, but also get a control over the management of the organization. Their status is changed and their interests are linked with those of capital. This system is gaining popularity these days. The merits of co-partnership are as follows :
(i) The status of employees is increased as they become the co-owners or shareholders of their company.
(ii) The employees get an opportunity to participate in the management of the company.
(iii) The employees behave in a more responsible manner as their future is linked with the future of the company where they are working,
(iv) The labour-management relations improve considerably. The employees can influence company's labour policies to their advantage.
Difficulties In Co-Partnership
Co-partnership in India has not been very popular because of the following reasons :
(i) Workers show limited interest in co-partnership. They demand bonus in cash and do not purchase shares of their company as and when offered.
(ii) Employees and their leaders have limited capacity to participate in the actual management of the company. As a result, the co-partnership remains on paper only.
(iii) Employees usually prefer to be wage-earners rather than becoming the co-partners or co- owners of the company.