The piece-rate pay plan has long been popular as a means of compensating production workers with a fixed sum for each unit of production completed, but it can be used in any organizational setting where the outputs are similar enough to be evaluated by quantity. A pure piece-rate plan provides no base salary and pays the employee only for what he or she produces. Ballpark workers selling peanuts and soda are frequently paid piece-rate. If they sell 40 bags of peanuts at $1 each for their earnings, their take is $40. The more peanuts they sell, the more they earn. Alternatively, piece-rate plans are sometimes distributed to sales teams, so a ballpark worker makes money on a portion of the total number of bags of peanuts sold by the group during a game.

Piece-rate plans are known to produce higher productivity and wages, so they can be attractive to organizations and motivating for workers.62 In fact, one major Chinese university increased its piece-rate pay for articles by professors and realized 50 percent increased research productivity.63 The chief concern of both individual and team piece-rate workers is financial risk. A recent experiment in Germany found that 68 percent of risk-averse individuals prefer an individual piece-rate system, and that lower performers prefer team piece-rate pay. Why? The authors suggested risk-averse and high-performing individuals would rather take their chances on pay based on what they can control (their own work) because they are concerned others will slack off in a team setting.64 This is a valid concern, as we will discuss in the next chapter.

Organizations should verify that their piece-rate plans are indeed motivating to individuals. European research has suggested that when the pace of work is determined by uncontrollable outside factors such as customer requests, rather than internal factors such as coworkers, targets, and machines, a piece-rate plan is not motivating.65 Either way, managers must be mindful of the motivation for workers to decrease quality in order to increase their speed of output. They should also be aware that by rewarding volume, piece-rate plans increase the probability of workplace injuries.66

A merit-based pay plan pays for individual performance based on performance appraisal ratings. A main advantage is that high performers can get bigger raises. If designed correctly, merit-based plans let individuals perceive a strong relationship between their performance and their rewards.67

Most large organizations have merit-based pay plans, especially for salaried employees. Merit pay is slowly taking hold in the public sector. For example, New York City’s public hospital system pays doctors based on how well they reduce costs, increase patient satisfaction, and improve the quality of care.68A move away from merit pay, on the other hand, is coming from some organizations that don’t feel it separates high and low performers enough. When the annual review and raise are months away, the motivation of this reward for high performers diminishes. Even companies that have retained merit pay are rethinking the allocation.69

Despite their intuitive appeal, merit-based pay plans have several limitations. One is that they are typically based on an annual performance appraisal and thus are only as valid as the performance ratings, which are often subjective. This brings up issues of discrimination, as we discussed in Chapter 2. Research indicates that African American employees receive lower performance ratings than White employees, women’s ratings are higher than men’s, and there are demographic differences in the distribution of salary increases, even with all other factors being equal.70 Another limitation is that the pay-raise pool of available funds fluctuates on economic or other conditions that have little to do with individual performance. For instance, a colleague at a top university who performed very well in teaching and research was given a pay raise of $300. Why? Because the pay-raise pool was very small. Yet that amount is more of a cost-of-living increase than pay-for-performance. Lastly, unions typically resist merit-based pay plans. For example, relatively few U.S. teachers are covered by merit pay for this reason. Instead, seniority-based pay, which gives all employees the same raises, predominates.

An annual bonus is a significant component of total compensation for many jobs. Once reserved for upper management, bonus plans are now routinely offered to employees in all levels of the organization. The incentive effects should be higher than those of merit pay because rather than paying for previous performance now rolled into base pay, bonuses reward recent performance (merit pay is cumulative, but the increases are generally much smaller than bonus amounts). When times are bad, firms can cut bonuses to reduce compensation costs. Workers on Wall Street, for example, saw their average bonus drop by more than a third as their firms faced greater scrutiny.71

Bonus plans have a clear upside: they are motivating for workers. As an example, a recent study in India found that when a higher percentage of overall pay was reserved for the potential bonuses of managers and employees, productivity increased.72 This example also highlights the downside of bonuses: they leave employees’ pay more vulnerable to cuts. This is problematic, especially when employees depend on bonuses or take them for granted. “People have begun to live as if bonuses were not bonuses at all but part of their expected annual income,” said Jay Lorsch, a Harvard Business School professor. KeySpan Corp., a 9,700-employee utility company in New York, combined yearly bonuses with a smaller merit-pay raise. Elaine Weinstein, KeySpan’s senior vice president of HR, credits the plan with changing the culture from “entitlement to meritocracy.”73

A profit-sharing plan distributes compensation based on some established formula designed around a company’s profitability. Compensation can be direct cash outlays or, particularly for top managers, allocations of stock options. When you read about executives like Mark Zuckerberg, who accepts an absurdly modest $1 salary, remember that many executives are granted generous stock options. In fact, Zuckerberg has made as much as $2.3 billion after cashing out some of his stock options.74 Of course, the vast majority of profit-sharing plans are not so grand in scale. Jacob Luke started his own lawn-mowing business at age 13. He employed his brother Isaiah and friend Marcel and paid them each 25 percent of the profits he made on each yard.

Studies generally support the idea that organizations with profit-sharing plans have higher levels of profitability than those without them.75 These plans have also been linked to higher levels of employee commitment, especially in small organizations.76 Profit sharing at the organizational level appears to have positive impacts on employee attitudes; employees report a greater feeling of psychological ownership.77 Recent research in Canada indicates that profit-sharing plans motivate individuals to higher job performance when they are used in combination with other pay-for-performance plans.78 Obviously, profit sharing does not work when there is no reported profit per se, such as in nonprofit organizations, or often in the public sector.

An employee stock ownership plan (ESOP) is a company-established benefit plan in which employees acquire stock, often at below-market prices, as part of their benefits. Research on ESOPs indicates they increase employee satisfaction and innovation;79 however, they have the potential to increase job satisfaction only when employees psychologically experience ownership.80 Even so, ESOPs may not inspire lower absenteeism or greater motivation,81 perhaps because the employee’s actual monetary benefit comes with cashing in the stock at a later date. Thus, employees need to be kept regularly informed of the status of the business and have the opportunity to positively influence it in order to feel motivated toward higher personal performance.82

ESOPs for top management can reduce unethical behavior. For instance, CEOs are less likely to manipulate firm earnings reports to make themselves look good in the short run when they have an ownership share.83 Of course, not all companies want ESOPs, and they won’t work in all situations.