Thursday, August 9, 2012

Reward Schemes & Good Reward or Remuneration Packages

Reward Schemes

1) Basic Pay

Basic pay is fixed amount payable usually in arrears on monthly basis. Basic pay should not be excessive in comparison to industry average. In addition, basic pay should consider:

  • Individual knowledge, skill and experience;
  • Past performance, awards, special achievements.
  • Availability of particular skills in the market;
  • Organizations need to retain such skilled employees.

 

2) Bonus

Bonus is the cash payment made for motivating employees to perform efficiently in future rather than rewarding current performance. Bonus should not be excessive in comparison with basic pay of individual employee. Normally, it is calculated as a percentage of basic pay. However, bonus can be performance related or fixed monetary amount.

 

3) Share Based Payment

Share based payment is the reward given in form of shares rather than cash. It should be given on condition to keep shares issued until specified future date. It can be performance related or number of shares given up to fixed monetary amount.

Share based payment also encourages the long-term view of company’s performance.

 

4) Pension

Pension is the amount payable to directors and employees after retirement. Pension does not focus on growth but it is useful to encourage decisions that lead to organizations stability in long term.

Only the basic pay should be used for calculating pension and impact of increasing basic pay on pension payment should be considered.

 

5) Benefits

Benefits are the reward given in kind to motivate employees and enable them to perform efficiently in their duties.

These should be not given excessive to any director in comparison with other employees.

 

Performance Related Reward Schemes

 

1) Profit Related Pay

Profit related pay is usually based on performance measures such as ROCE and RI. It focuses on short-term performance.

Profit related pay encourages directors to take excessive risk.

Risk and profits have direct relationship. High risk, high reward.

 

2) Share Options

It is a right to buy shares in the company.

It is exercisable at future date.

It is given to directors and employees.

Value of share option depends on value of market share price of the company.

It is issued above market price to encourage directors to increase share price of the company and shareholders wealth.

It encourages directors to take long-term view regarding performance of the company. However, share options are marketable security, which can be sold by directors at any time in the stock market. In that case, directors have no incentive to focus on long-term performance of the company.

 

Good Remuneration Package

Rewards based on one reward system, such as basic pay gives no incentive for directors to improve their efficiency and align their objectives (interest) with the objectives of the organization.

The alignment of interest is also called goal-congruence.

Basic pay alone will not motivate directors to maintain and improve organizational performance because it has to be paid regardless of profits or losses incurred by the organization.

Good remuneration package consists of majority of performance-based rewards so that managers/directors can be encouraged to set their goals in line with goal of the organization.

Good remuneration package makes use of multiple reward schemes.

Focus on profit related pay would encourage directors to focus on short-term performance and trying to increase profitability by taking excessive risk, which is beyond the risk appetite of the organization and can be detrimental to long-term stability of the organizational.

Combination of reward schemes such as basic pay, pension, share options, bonus etc would lead to better alignment of interest (Goal congruence).