INTRODUCTION in the future. For STI, its salaries are

INTRODUCTION

Incentive systems, which aim to motivate
employees to work in line with organisational goals, have become a widely
spread phenomenon within the last decade. Performance dependent rewards provide
the incentive for aligning employees’ natural self-interests with the
objectives of an organisation (Merchant and Van der Stede, 2016). This essay
seeks to evaluate the benefits and costs of the current incentive system
implemented by Superconductor Technologies Incorporated (STI).The limitations
of this incentive system will then be highlighted after which the necessary
solutions to overcome these problems will be discussed.

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THE
COMPANY

Superconductor Technologies, Inc. (STI) is a
technology company based in California, hiring nearly 300 people as at 2003. It
views its employees as its “most important asset” holding the view that its
employees will be vital in helping the company recover from persistent annual
losses being realized as well as a massive decline in its share price. In order
to make this recovery, employee motivation is crucial to STI. The best way
perceived to keep their motivation high is through the company’s compensation
and incentive systems.

 

CURRENT
INCENTIVE SYSTEMS

 

SALARY
INCREASES

This is a short term incentive system that involves a set amount paid in
exchange for an employee’s service. Payments are usually made monthly/annually
and the amount is determined by the position an employee occupies within the
company. They are seen as an incentive as it is earned through performance and
acquisition of skills that lead to improved performance in the future.

For STI, its salaries are set at competitive
levels with increases for most of its employees including top level executives in
the range of 0-5%. Performance based salary increases come with benefits.
Firstly, it could act as an impetus to increase productivity. Employees are motivated
when their efforts are recognised by their employers and so the prospect of
increased salary provides an incentive to work harder. Also, salaries are fixed
and so enable the organisation to plan/forecast. The implementation of this
system is not without its cost to both the employee and the organisation. There
is little/no incentive for employees as payment is made regardless of
performance. There is also limited incremental impact on motivation and
performance. Also, a huge time lag between salary increments could lead to a
gradual decline in motivation and productivity. Salary payments are also not
flexible for firms as they have to be paid when due.

CASH
BONUSES

Cash bonuses are typically short term
incentives, providing lump sum cash payments based on performance measured over
periods of one year or less (Merchant and Van der Stede 2016). Wright Hassall
(2018) explains that a cash bonus is an incentive involving an amount of money
added to the salary, given to an employee as a reward for a strong work
performance. The awards can be based on the performance of an individual, a
group of which an individual is a member of, or even the firm as a whole.

At STI, all top executives are included in a cash bonus plan that provides cash
awards based on the achievement of a weighted combination of corporate and
individual objectives. The targeted bonus awards varied by organization level
from 25% to 40% of base salary. These short term incentive schemes enable
managers to differentiate pay across employees based on variations in their
performance.  This system has a higher impact in terms of motivation on
employees than the aforementioned incentive of salary increases. There is also
the element of risk as employees would want to increase performance to receive
such rewards. Benefits include improvement of employee performance as
individual productivity is taken into consideration. At STI, a compensation
committee decided that individual performance should be taken into account, so
bonuses were changed to include 75% based on corporate performance and 25% on
individual performance. Cash bonuses send signals of appreciation to the
employee creating the impetus to work even harder and be more efficient.

Implementation of cash bonuses comes with its
challenges. STI only uses sales growth as a main benchmark for cash bonus
remuneration and does not consider other qualitative and non-qualitative
factors such as profit, customer satisfaction rates and so on. Also, these
bonus plans only apply to the top level executives and ignores the lower and
middle level managers. This could serve as a demotivating factor as these lower
level managers are involved in one way or the other with the business as a
whole.

 

 

STOCK
OPTIONS

 

Stock options give employees the right to
purchase a set number of shares of company stock at a set price during a
specified period of time. Annually, almost all STI employees were given stock
options, granted for 10 years, and vested over either 4 or 5 years. The advantage
of providing stock options is that employees benefit when the stock price goes
up, therefore this improves incentive alignment with the company’s goals for
better performance and profitability. This is because of the tie between some
of the employee’s wealth and the company’s future. Also, stock options can
create a positive cash flow due to tax savings. However, accounting rules
regarding this are likely to change and this may be infeasible in the long run
as the value of stock would have to be recorded as an expense, reducing
profitability which is already a significant problem for STI.

 

Costs relating to this system relate to how
appropriate the short/long term balance of the package is as well as who is
receiving more options, as lower level employees are given a few options
compared to thousands received by top management. These options might not be
enough to motivate employees to think ‘long term’. Along with the poor
performance of the firm so far, a small number of options may not make a
significant difference to employees at the lower level, as they have less
contribution towards the overall performance of the company, compared to top
management. Furthermore, around 10% of the workforce didn’t receive stock
options. This could sometimes be as a result of not meeting performance
expectations, which could be perceived as unfair, as these employees would not
have a huge influence on overall company performance. Therefore being excluded
from the stock options can be de-motivating and have unintended consequences
for lower level employees, as managers still received stock options despite
corporate performance. This is also shown in the 2003 revised Equity Incentive
Plan, which would reserve 6 million shares for key employees, directors and
consultant of the company, whilst 2 million would be reserved for the top 20
executives.

Furthermore, a promise of accelerated vesting if
the company achieved sustainable profits in the fourth quarter of 2003 could
motivate managers to undertake riskier business strategies, as they are
rewarded well in the short term. This illustrates a conflict between the aim of
providing stock options; to create long term incentives. However, if a profit
is achieved, these stock options can be received earlier, which also has
implications for the accounts as deferred compensation methods have tax
benefits and allow the company to save cash during key periods of growth.
Accelerated vesting would require STI to record the expense, and this could
have an impact on profit, which is opposite to their goal of profit objectives
in the next year. Most importantly, this can encourage short termism and taking
decisions which lead to profit in the short run, whilst not focusing on the
long run performance of the business.

SHORTCOMINGS AND SOLUTIONS

 

A potential shortcoming of the incentive system
could be STI’s policy on the way in which bonuses are proportioned based on
performance. The case study explains that 75% of bonuses are based on corporate
performance while 25% on individual performance. This suggests that overall
performance is prioritised over individual performance thus enabling
individuals to relax on meeting personal targets, so long as overall targets
are met. This has the overall effect of STI’s employees falling short of their
potential optimal performance levels and this could be reflected in low
profitability figures observed in their income statement.

A solution would be to adopt an incentive system
wherein individual performance is prioritised over overall performance. This
could be done by increasing the proportion of bonuses allocated to individual
performance to 60% and reducing that allocated to corporate performance to 40%.
This would likely have the effect of increasing overall corporate performance
as a whole leading to an improvement on individual performances.

 

Looking specifically at the bonus system for
individual performance, a potential shortcoming in STI’s system could be the
stated 12.5% bonus earned when employees partially missed their objectives.
This figure is deemed too high and suggests employees receive over a tenth of
their salary in bonuses despite falling short of their targets. This could
result in complacency from employees in reaching their objectives as they are
rewarded for not meeting their objectives. Stricter individual performance
bonus schemes should be put in place of 12.5% target bonus earned for
“Partially Missed Objectives”. This would help reduce any individual slack as
employees must meet their objectives in order to be appropriately compensated.

The case also reveals that 10% of their workforce does not receive stock
options due to various reasons. This is perceived as a shortcoming due to the
resulting misalignment between the interests of such employees and that of the
company. An employee, being a shareholder means objectives are in congruence
with that of the company as they are part owners leading to the company
achieving targets. For this reason, it’ll be beneficial if all employees had
stock options or another form of company stakes in STI.

 

The new Equity Incentive Plan approved in 2003
promises accelerated vesting, over the next 2 years This could be an issue as
the requirements for this would be to make profit in the last quarter of 2003. This
can create a short term view among employees. This
plan is particularly questionable because STI has never made profit before. In
the event that they do make a profit, it may not be judged as being
‘sustainable’ profit. A better version of this plan would promise accelerated
vesting after at least 2 years. That would only be if the firm can sustain
profitability for at least 2 years, in order to prove that the profits being
made are sustainable, and not just a one off due to short-term decisions made
by top management with economic interests in options. Also, there should be
more stock options for lower-level employees, to align their interests, as this
doesn’t affect cash flow in the short run. If not, this can create conflict
between lower-level employees and management, who receive more stock options
and higher bonuses.

OTHER
SOLUTIONS

Another solution could be the use of bonus
pools. This is based on corporate performance and conditional on meeting
minimum corporate performance thresholds. The pool is then assigned to
individuals, usually through a rating system that provides higher awards to
better performers. This would allow normal employees to be rewarded for their
individual performance, incentivising employees to contribute more to corporate
performance and aligning objectives. This reduces inequality between top
executives and the rest of the employees.

 

Other solutions include the use of non-monetary
fringe benefits to supplement monetary compensation. For example, health care
benefits can be provided for employees rather than extra cash remuneration.
This will be beneficial to STI as it’ll reduce the number of employees going on
sick leave. There would also be clear improvements in employees’ health and
this would improve overall performance levels. However, there are huge monetary
outlays in providing such benefits and this could have adverse effects on
company funds.

 

 

EVALUATION

Bearing in mind the case study reviewed, there
is some difficulty making a judgement on overall company compensation package
because information on incentives provided only applies to positions of those
at director level and above. More information is needed on the middle to lower
level employees’ compensation package in order to make a full evaluation.

Financial performance would improve if
incentives are linked with profitability as opposed to revenue alone. This enables
efficiency in the procurement of raw materials and other costs of production,
hence, likely to improve profit figures on the income statement.

 

CONCLUSION

 

In summary, the benefits and costs of the
current incentive system that applies to STI have been considered after which
the shortcomings and viable solutions to overcome these challenges have been
looked at.

The most important factor when deciding which
combination of incentive systems to use for STI is that rewards should be cost
efficient, in order for profitability to be achieved. To achieve this, it is
important to ensure employees are acting in the best interests of the firm.
This is why it is a better idea to adapt bonus payments to reflect individual
performance, so that each employee feels responsible towards overall
performance.

It is also important to think about the
unintended consequences of incentive systems which can destroy value, e.g. the
current short term view of bonus payments and accelerated stock options. This
encourages actions in the short term that can jeopardize firm viability in the
long run. This is where deferring long term stock options are useful, but only
if they are fair for all employees and not just benefitting top management.