Welcome back. In this video, we're talking about tying pay to performance evaluations. So what are our options for tying pay to performance evaluations? There's going to be a lot of options because performance evaluations can be tied to any element of the pay mix. So again, the pay mix includes our cash, base cash, our short term incentives, our long term incentives and out benefits and perquisites. But remember except for tying our performance evaluations to our base pay we're talking about tying them to raises. If we're tying our performance evaluations to short term incentives, we're usually talking about tying them to bonuses, we're tying them to long term incentives, we're tying them to option grants. And if we're tying them prerequisites, we're tying them to things like maybe reserved parking or perhaps a nicer larger office. Or if we're tying performance evaluations to non cash awards, we might be talking about employee reward program or perhaps better job assignments. And so we're going to have a lot of different options again for tying performance evaluations to the different ways that we can pay people. But let's start off with tying our performance evaluations to base cash. Well one method again is to tie our performance evaluations to our base cash through raises. So for example, as we talked about criteria for raise and promotions what we can do is we can make it so we get a larger raise when we have a higher performance evaluation and also when we're lower in our pay range for that grade. And so typically when we're talking about tying pay to raises we're talking about tying evaluations to those different evaluations specifically that assess current productive skills. That is we're thinking about tying our performance evaluations to different measures that try to capture the things that makes employees continuously valuable as opposed to having done a particular contributions in the past or having high future potential. And again, those raises are reflected with moving up within our pay grades. The other method is to tie our performance evaluations to things like short term incentives. When we tie evaluations of things a short term incentive we're usually talking about rewarding people for their prior accomplishments. So one method is the simply a tie fixed bonus to the different performance evaluations. So for example, if our employees ratings for outstanding they might get a $2,000 bonus, and a smaller bonuses for lower performance ratings. Another method which is popular for budgetary reasons, is to instead allocate points or claims on a bonus pool based on ones performance evaluation. So let's look at an example of how that works. Say that we have a bonus pool and we have these three different employees. One employee has 2,00 points, one employee who has slightly worse performance has 1,000 points and then a third employee has slightly worse performance gets 500 points. So what we're going to do is we're going to distribute that bonus pool that we budgeted for this purpose. To these three employees on the basis of their accumulated points. So let's go through an example of our doing of calculations. So let's say that Susan gets 1,000 points and her division as a whole is allocated $200,000 bonus pool. Maybe that was because her division had $200,000 in cost savings, for example. So let's also suppose that employees in her division, if you added all of their points together, you would get 100,000 points. So then you would take that $200,000 in that bonus pool divided it by the total number of outstanding points. And you figure that each point is worth about $2 of that bonus pool. And so therefore Susan, who was awarded 1,000 points based on her contributions and based on her performance evaluation, those 1,000 points to be worth a total of $2,000 from that bonus pool. So an advantage of a bonus pool is that it helps budgeting because in this case the firm knew that they were going to allocate $200,000 to that bonus pool. And it also can create cooperation among employees so they can improve the size of that divisions bonus. So for example, if that division was tying that bonus pool to something like cost savings, then they can encourage employees to get together to try to figure out ways to make more money therefore, maximizing the size of that bonus pool. One of the disadvantages of a bonus pool is it can also create competition. That's because the more points my colleagues have, the larger number of outstanding points in our total. That means that each one of my points will be worth a little bit less as it becomes diluted. Another disadvantage is that it can also be bureaucratic to administer. And it also potentially could be misaligned to business objectives and that's why we want to make sure that our bonus pool is aligned to our business objectives enough the way that we distribute points awards employees for their contributions to meeting those objectives. So next, let's get to tying performance evaluations to long term incentives. So as we're tying performance evaluations to base cash to reward employees for their accumulation of productive abilities. When we're tying it to short term incentives, we're tying to prior accomplishments. We're usually using performance evaluations and giving long term incentives like stock options to pay them for their future potential within the organization. And so one example of how these could work is that for employees who have outstanding performance ratings or perhaps have a rates have outstanding future potential for their work within the firm. We'll give them larger option grants than we would to those who perhaps have ratings for less potential within the firm. And remember, the reason why we might do this is because long term incentives such as stock option are especially valuable to workers who plan to stay. And on of the pejorative terms for short stock options is golden handcuffs. That's because if you leave the organization too early, then you're forgoing any of the options which have invested. And if this terminology sounds familiar to you, you can always just look ahead and look at our video on stock options. There's also non monetary awards. And so these would be things like parking spaces or a rewards program or a recognition or so on. And this will be something that we will talk about in the last lesson of the course. And so just as an example, we can take an example of Microsoft. So Microsoft again is an organization that again requires very highly skilled employees and programmers, and so on. And they're also very known for their system of performance evaluation. The way that Microsoft employees are evaluated, they're rated on both they're current skills, and those performance ratings contribute to their raises and to their promotions. Then they're also rated on their future potential to the organization and the more highly you're rated on your future potential to work within Microsoft, the more you'll be given stock options. Which again are going to particularly valuable for employees who do end up staying at Microsoft to realize that potential. And then Microsoft also gives bonuses in proportion to one's short term wins over the prior year. And again, these are a way of motivating employees who seemingly had some contribution to the organization in the most recent past. And so just to give an overview again, we usually think about salary as good evaluations lead to raises and we usually tie those to parts of the prior evaluations that measure current skills. Short term incentives, they're tied to bonuses and we're usually rewarding prior accomplishments. And then when promise evaluations are trying to measure future potential then we might give them something like an option grant. Next up, we're talking about should pay even be based on these performance evaluations at all. Thanks, I'll see you next time.
