Lesson 1, Topic 1
In Progress

Organization-wide variable pay

Organization wide incentive plans reward employees on the basis of the success of the organization over a specified time period. These plans seek to promote a ‘culture of ownership’ by developing a sense of belongingness, cooperation and teamwork among all employees. There are three basic types of organization-wide incentive plans: profit sharing, gain sharing and employee stock ownership plans.

Profit Sharing

Profit sharing is a scheme whereby employers undertake to pay a particular portion of net profits to their employees on compliance with certain service conditions and qualifications. The purpose of introducing profit sharing schemes has been mainly to strengthen the loyalty of employees to the firm by offering them an annual bonus (over and above normal wages) provided they are on the service rolls of the firm for a definite period. The share of profit of the worker may be given in cash or in the form of shares in the company. These shares are called bonus shares. In India, the share of the worker is governed by the Payment of Bonus Act.


  1. The idea of sharing the profits inspires the management and the worker to be sincere, devoted and loyal to the firm.
  2. It helps in supplementing the remuneration of workers and enables them to lead a rich life.
  3. It is likely to induce motivation in the workers and other staff for quicker and better work
    so that profits of the firm are increased which in turn increases the share of worker therein.
  4. Workers do not require close supervision, as they are self-motivated to put in extra labour
    for the prosperity of the firm.
  5. It attracts talented people to join the ranks of a firm with a view to share the profits.


  1. Profits sharing scheme is, in practice, a fair-weather plan. Workers may get nothing if the
    business does not succeed.
  2. Management may dress up profit figures and deprive the workers of their legitimate share it
  3. Workers tend to develop loyalty toward firm discounting their loyalty toward trade unions, thus impairing the solidarity of trade unions.
  4. Fixation of worker’s share in the profits of firm may prove to be a bone of contention in the long run.

Gain Sharing Plan

A gain sharing plan aims at increasing productivity or decreasing labour costs and sharing the resultant gains (usually a lump sum payment) with employees. It is based on a mathematical formula that compares a baseline of performance with actual productivity during a given period. When productivity exceeds the base line an agreed-upon savings is shared with employees. Gainsharing is built around the idea that involved employees will improve productivity through more effective use of organisational resources. Three major types of gainsharing plans are currently in use: Scanlon Plan, Rucker, Plan, and Improshare. Improshare stands for improved productivity through sharing. This plan is similar to a piece rate except that it rewards all employees in an organisation. Input is measured in hours and output in physical units. A standard is calculated and weekly bonuses are paid based on the extent to which the standard is exceeded.

The employees and the organisation each receive payment for 50 per cent of the improvement. Unlike profit sharing plans which have deferred payments, gainsharing plans are current distribution plans. They are directly related to individual behaviour and are distributed on a monthly or quarterly basis. Gainsharing plans tend to increase the level of cooperation across workers and teams by giving them a common goal. Managers are not required to base their calculations on complex mathematical formulae, nor they are required to closely look into the specific contributions of individuals or independent teams. It is easier for both, to formulate bonus calculations and to achieve employee acceptance of those plans. Gainsharing plans, however, protect low performers. Where rewards are spread across a large number of employees, poor performers may get rewards for non-performance at the cost of the bright performers.

Gainsharing Plans may fail due to other reasons as well: poorly designed bonus formulae, lack of management support for employees’ participation, increasing cost factors that undermine the bonus formula, poor communication, lack of trust, and apathy on the part of employees. To develop an organisation-wide incentive plan that has a chance to survive, let alone succeed careful, in depth planning must precede implementation. A climate of trustworthy labour management in also absolutely essential. The financial formula should be simple and should measure and reward performance with a specific set of measurable goals and a clear allocation method.

Employees Stock Ownership Plans

Employee stock ownership plans originated in the USA in early 90s. Such plans have not gained popularity in India till recently, due to the absence of legal provisions in the Companies Act covering stock options. However, in 1988, the Government has allowed stock options to software professionals, recognising the importance of retaining talent within the country. Under employee stock option plan, the eligible employees are allotted company’s shares below the market price. The term stock option implies the right of an eligible employee to purchase a certain amount of stock in future at an agreed price. The eligibility criteria may include length of service, contribution to the department/division where the employee works, etc. The company may even permit employees to pay the price of the stock allotted to them in installments or even advance money to be recovered from their salary every month. The allotted shares are generally held in trust and transferred to the name of the employee whenever he or she decides to exercise the option.

The stock option empowers the employee to participate in the growth of the company as a part owner. It also helps the company to retain talented employees and make them more committed to the job. Employee stock options are welcomed everywhere due to their in-built motivating potential. Some of the powerful benefits offered by Esops may be catalogued thus:
i. Stock options are a tremendous motivator because they directly link performance to the market place. The underlying rationale is to let employees add value to a company and benefit from it on the same terms as any other provider of risk capital.

ii. Employees remain loyal and committed to the company. To become part owners, everyone has to stay for a while, contribute their best and then share the resultant gains according to an agreed criteria. Stock options motivate people to give their best to the company because individual performances will translate into share price increases only if it is part of a larger collective effort.
iii. By transforming your employee into a stockholder, stock options foster a long- term bond between the employee and the company. Employees begin to look at themselves as real owners in place of just paid servants of a company. ESOPs give employees a ‘piece of the action’ so that they can share in the growth and profitability of their company. Everyone also loves the concept of employee ownership as a kind of “People’s capitalism.”

iv. ESOPs underscore the importance of team effort among employees.
v. Better industrial relations, reduced employee turnover, lesser supervision, increased dividend income, etc., are other incidental benefits. ESOPs have their critics as well who attack the method on the following grounds:

 Only profitable companies can use the tool vii Stock prices do not always reflect fundamentals.
 Falling share price could mean losses for employees.
 The inability to cash in quickly can dampen interest.
 Lack of transparency can earn accusations of favouritism.

Employees’ sharing the platform with owners, evidently, can be a disadvantage because they may feel ‘forced’ to join, thus placing their financial future at great risk (e.g., employees who opted for ESOPs during the software boom in the late 90s have suffered huge losses when stock prices crashed subsequently). Another drawback is that ESOps could be used by managements to fend off unfriendly takeover attempts.

Holders of stock options often align with management to turn down bids that would benefit outside shareholders but would replace management and restructure operations. Surely, ESOPs are not meant to entrench inefficient management. Despite these disadvantages, ESOPs have grown in popularity in recent times.