10.7 Discuss the importance of using incentives to motivate managers
Rina Dhillon
The choice of the specific incentive structure is very important for goal congruence – where employees and managers in multiple levels of a business share the same goal – between the individual manager and the company and its owners. It also makes good tax sense, since compensation based on performance-related measures provides an unlimited amount that can be deducted.
There are three main types of compensation:
- Cash Compensation
- Stock-based Compensation
- Non-cash benefits
Let’s examine each of these compensation types closely.
1. Cash Compensation
Cash compensation can be paid in the form of salary or end-of-period bonuses. Many companies use a combination of the two in which a base salary is paid without regard to meeting individual or company performance criteria and bonuses are paid if managers meet or exceed established goals. For example, in 2021, the CEO of Qantas Group, Alan Joyce, received a base pay of $1.78 million with other benefits totalling an extra $201,000. These benefits can be in the form of bonuses if Alan as part of the senior management team meets certain pre-established goals set by the company. These goals can include meeting or exceeding profit targets, success in attracting and retaining key employees and customers and even increasing the overall value of the company including share price. However, bonuses tied to a single performance measure, say for example increasing net profit by a certain dollar amount or percentage, are problematic and can lead to manager manipulation (a manager can increase profit by reducing costs through unethical means such as reducing quality).
2. Stock-based Compensation
To encourage managers to take a longer-term view, many companies provide compensation to top managers and executives in the form of stock-based compensation, such as stock options or restricted stock compensation plans. Stock-based compensation is a way of paying employees, executives, and directors of a company with equity in the business. It is typically used to motivate employees beyond their regular cash-based compensation (salary and bonus) and to align their interests with those of the company’s shareholders – i.e. both want to see the company prosper and the share price rise. Shares issued to employees are usually subject to a vesting period before they are earned and can be sold. Thus another advantage of this type of compensation is that it creates an incentive for employees to stay with the company (as they have to wait for shares to vest). However, stock options may have disadvantages if managers focus on increasing the share price in the short term rather than focus on the longer-term success of the business.
3. Non-cash benefits
Non-cash benefits include club memberships, company cars, a corner office, health insurance and so on, depending on the desires of the particular manager. Benefits and perks such as these can be used to motivate managers to strive to attain the goals of the organisation. A recent workforce survey held in 2020 (depicted in the diagram below) showed that a competitive cash compensation is the most important benefit for employees. However, cash isn’t the only benefit that’s important to employees. The other 60% of benefits related to factors such as career development, training opportunities, and a good work environment which played a part in their loyalty to the company:
