Variable pay

KEY POINTS

variable pay strategies bind overall earnings to variations in corporate performance, so employees are forced to shoulder more of the business risks - rewarding the upside and penalising the downside of performance;

the potential rewards make variable pay schemes appealing to many employees, while the link to performance and their ability to promote a common interest between staff and management make such arrangements increasingly attractive to employers;

also enticing for employers is that they tend to be non-consolidated payments so they do not increase fixed labour costs;

variable rewards are especially attractive in periods of low inflation because fairly large rises in total pay can be awarded to high performers to compensate for relatively low increases in salaries without incurring substantial additional fixed costs;

incentives focus attention on what needs to be done to receive an additional payment, while rewards are retrospective, paying for what has already been accomplished. Bonuses and the like are incentive schemes and are linked to achieving specific, mainly short-term business objectives, whereas long-term incentives, based on three- to five-year objectives, with payments at the end of the performance period, tend to be linked to broader organisational aims, such as improving employee commitment and loyalty;

team-based rewards are linked to some measure of team performance or the achievement of agreed team objectives and may be shared equally or proportionately among team members;

thus far at least, relatively few employers seem to have adopted team reward, and where such arrangements do exist they are invariably bonus schemes;

there is evidence that all-employee share plans are becoming more popular; and

share schemes are generally designed to link the interests of the recipients with those of shareholders; improve motivation; generate acceptance for the concept of variable pay; help build a new corporate culture; enhance performance; and boost recruitment and retention.

Variable pay strategies such as profit sharing and incentive plans bind overall earnings to variations in corporate performance. While the typical potential rewards from variable elements of remuneration can be substantial, employees are forced to shoulder more of the business risks - rewarding the "upside" and penalising the "downside" of performance. The potential rewards make variable pay schemes appealing to many employees, while the link to performance and their ability to promote a common interest between staff and management make such arrangements increasingly attractive to employers. Variable pay is also enticing for employers, as bonuses and profit sharing payouts, for example, tend to be non-consolidated payments so they do not increase fixed labour costs (some also have considerable tax benefits). Non-consolidation is especially important in a low inflationary climate, because fairly large rises in total pay can be awarded to high performers to compensate for relatively low increases in salaries without incurring substantial additional fixed costs. And some pay-at-risk schemes can also reward people immediately after achievement, providing a clear link between the award and performance. As a result of these and other possible advantages, variable pay as a proportion of the overall remuneration package is of growing importance in many organisations.

For example, profit sharing can significantly boost earnings at a time of relatively low inflation - to which annual rises to base pay are invariably linked. This point is best illustrated by comparing median levels of pay increases with examples of profit-sharing payouts. In the three years from March 1998 to February 2001, the monthly median pay increase recorded by the IRS pay databank hovered between 2.8% and 3.5%.¹ At the same time, the all-items retail price index fluctuated between a low of 1.1% and a high of 4.2%.² In contrast, eligible Lloyds TSB (formerly two separate entities - Lloyds Bank and TSB ) staff received on average profit-sharing payments worth 10.5% of base salary in 2000; 9.5% in 1999 and 10.5% in 1998.³ The awards can be taken as either shares or cash payable in March each year.

Figures from the Office for National Statistics (ONS) underline the impact that profit-sharing payouts and other incentive payments can have on earnings in the financial services sector. The ONS found that bonus payments to staff in financial services companies, including profit and performance-related awards, added 2% to the overall provisional measure of average earnings in the UK in the 12 months to February 2001.⁴ The average increase in the earnings index (AEI) for the period amounted to 6% including bonuses and 4.1% excluding bonuses. Statisticians at the ONS concluded that: "The net impact of bonus payments on the AEI in the year to February 2001 [1.9%] resulted almost exclusively from significant growth in bonuses in [the] financial" sector.

INCENTIVES AND REWARDS

Incentives focus attention on what needs to be done to receive an additional payment, while rewards are retrospective, paying for what has already been accomplished. Bonuses and the like are incentive schemes and are linked to achieving specific business objectives. Many incentive arrangements are short-term and are based on specific "line-of-sight" financial and operational measures, with frequent payouts, ranging from one month to one year. Long-term incentives, based on three- to five-year objectives, with payments at the end of the performance period tend to be linked to broader organisational aims, such as improving employee commitment and loyalty. Generally, these arrangements can be described as rewards as employees benefit most from staying in post, although they also provide individuals with an incentive to do so.

Choice of variable pay system will depend on the main aim of its introduction. For example, if the rationale is to improve product quality or customer service, then establishing a corporate profit-sharing scheme is unlikely to produce the desired effect, as the outcome is too remote and subject to factors outside the control of the workforce to alter behaviour greatly at low levels within the organisation. On the other hand, if the aim is to stimulate interest in company growth and develop greater employee commitment and involvement, then profit sharing might well have a positive impact. Making equity arrangements a cornerstone of the remuneration package is fraught with risks for employers (and employees) as stock market volatility can undermine their motivational impact. Nonetheless, the tight labour market dictates that companies, particularly in sectors experiencing skills shortages, offer these forms of incentives to recruit and keep a high-quality workforce.

Corporate aims of variable pay systems, other than promoting a more entrepreneurial culture among the workforce by placing some of their potential remuneration at risk, vary and are largely dependent on the type of scheme.

For example, Rachel Short, NatWest's compensation and benefits manager, explains that the philosophy underpinning the bank's use of employee share schemes is that it "remains committed to providing opportunities for staff to acquire shares as a means of encouraging employee participation".⁵ The bank believes that the schemes motivate employees, can improve performance and promote a common interest between shareholders and staff. Also, in the UK financial services sector, such schemes are standard and aid recruitment and retention. Indeed, as chapter two explained, share schemes are invariably designed to aid staff retention. This is the case at Asda, for instance, which in 1995 extended its share option scheme (Colleague Share Ownership Plan), previously only available to directors, to cover all staff, and considers it an "important factor in motivating and retaining a wider group of colleagues".⁶

Concrete operational and performance targets for bonus payments include the following examples:

At BorgWarner Automotive's plant in Margam, South Wales, an individual attendance bonus is payable monthly for each period without absence. This is clearly a very effective inducement to attend work, with the vast majority of employees collecting the maximum bonus annually (worth £340 in 2000).⁷

BP Amoco has introduced a flexible reward scheme that also encourages employees to consider the environmental impact of their business actions. The company is split into 150 semi- autonomous units made up of several teams, each one of which receives bonuses according to its financial performance and environmental practices. They can choose to receive the bonus in cash, shares or benefits.⁸

At HSBC Bank an incentive scheme is linked to personal and corporate performance.⁹ The incentive plan sets out expected "on-target" awards for staff depending on their grade and the nature of their jobs. These target awards are paid to staff if both their individual performance targets and the bank's financial goals (ROE) are achieved. The actual amount paid is determined by the application of a personal performance factor (ranging from 0.0 to 2.0) and a corporate performance factor (ranging from 0.0 to 1.5) to these target levels. The maximum bonus can range from 22.5% to 36% of salary.

Examples of bonus arrangements in 20 organisations are summarised in figure 5.1 (below).

Figure 5.1: Bonus arrangements in 20 organisations

Organisation	System summary
Asda	"All Colleague Bonus" scheme based on the profit performance of individual stores. All full-time hourly paid employees with at least one year's service are eligible for bonuses of up to £250 a year (pro rata for part-timers).
BNFL	Basic pay can be enhanced by up to £1,000 for all band 3 (managers), 4 (team leaders) and 5 (industrial) staff meeting shared work targets agreed at the beginning of the financial year and payable at the end of year. In addition, band 3 employees can earn up to 5% of basic salary for the achievement of personal targets.
BorgWarner Automotive	Productivity reward scheme based on efficiency savings. A bonus is paid when the percentage of monthly overtime falls below 3% of sales. The benefit is divided 60:40 in favour of employees. Company also operates a suggestion reward scheme in which any resulting savings are shared equally between employees and the firm.
British Gas Trading	Enhanced performance payment (EPP), linked directly to the profits of parent company Centrica, is paid annually in December and is worth a maximum 2% of base salary. EPPs are awarded to all qualifying staff when performance exceeds corporate targets, which are jointly agreed between management and trade unions annually. The amount is 30% of additional profit up to a limit of 2% of base salary costs, excluding premium payments.
Claverham	Incentive scheme based on the achievement of profit and schedule-adherence targets. Worth up to £500, half of the scheme bonus is payable in cash, with the remainder consolidated into basic pay rates.
Gala Clubs	Marketplace bonus covering up to six clubs in a region, which pool their collective business targets. The bonus is determined according to each club's contribution and performance against the overall targets. Paid at half-yearly intervals, the bonus is worth the equivalent of two weeks' gross salary to each employee. Nationally, there are around 25 marketplace teams. Club bonus scheme operates in around 90 clubs. It is also paid twice yearly and is linked to attainment of club operating profit levels. If targets are met, the bonus is worth 15p an hour for every hour worked during the relevant half-year bonus period. Annually, the bonus is worth about two weeks' pay per employee.
GKN Westland Helicopters	Profit-sharing scheme whereby employees receive lump sum cash payment if certain profit levels are reached. Scheme introduced in 1999 as part of the company's PRP-exit strategy.
Halifax Direct	Annual bonus scheme called Sharing in success was launched in January 2000. The scheme is based on three key performance measures: customer service - the aim is to achieve satisfactory rating for at least 90% of calls monitored, which if achieved attracts 100% of the bonus share worth 2.5% of base pay; sales performance - annual monetary targets are set for each area, including for mortgages and credit cards, and 100% attainment attracts a bonus of 2.5% of salary; abandoned calls hurdle - if annual target for unanswered calls is exceeded (5% or less) overall bonus is reduced by 50%.
HSBC Bank	Incentive scheme linking payments to personal and corporate performance. The incentive plan sets out expected "on-target" awards for staff depending on their grade and the nature of their jobs. These target awards are paid to staff if both their individual performance targets and the bank's financial goals (ROE) are achieved. The actual amount paid is determined by the application of a personal performance factor (ranging from 0.0 to 2.0) and a corporate performance factor (ranging from 0.0 to 1.5) to these target levels. The maximum bonus can range from 22.5% to 36% of salary.
John Lewis Partnership	Annual cash bonus paid to all 40,000 employees who are known as partners in the business. The amount to be distributed in the form of a bonus is determined by the company's central board, five members of which are elected by the company's central council - itself an elected body. The pool is based on the total profits of the group (including John Lewis department stores and Waitrose supermarkets), less a retained sum for investment. The 2000 overall bonus pot was valued at around £78 million, and was worth 15% of salary.
Kemira Agro UK	Bonus payments to all staff based on a sliding scale: 0.3% of salary if operating income is minus £5 million, rising to a maximum of 3% if income reaches £5 million.
Manchester Airport	Flat-rate performance bonus fund whereby all profits above business plan targets are split equally between employees, company and shareholders. In 1999, the standard payment was £1,000 for a full-time worker (pro rata for part-timers).
Peugeot	Profit-related bonus paying tax-free lump sums to employees when corporate profits are £30 million or more. First introduced in 1991, workers received £480 on average in 2000.
Philips Components, Durham	Staff covered by the teamworking pay structure all participate in a gainsharing scheme. Providing predetermined output and yield levels are met, teams qualify for a bonus payment. Each team is allocated an award - bronze, silver or gold - and individual team members receive an equal share of the appropriate bonus.
Pizza Express	Restaurant staff, from managers to hourly paid grades, are eligible for bonuses in two key areas: costs - each unit's performance against a set of three agreed targets, covering food costs, labour costs and variable costs (energy, maintenance, crockery, paper etc); and sales - payments linked to sales achieved each month. Payments under each scheme are awarded monthly as an unconsolidated cash sum.
Pret A Manger	Mystery shopper bonus scheme paid weekly and linked to the number of hours worked. Independent "shoppers" award units points for efficiency, quality and speed of service. Unit scores of at least 90% trigger the bonus. Current bonus rate is 75p an hour.
Royal Bank of Scotland	Business unit schemes cover the majority of staff, who have the opportunity to earn bonus payments (worth a maximum of 20% of basic pay) or incentive payments up to 50%. Performance may be measured on an individual or team basis (or a combination of both) with funding provided according to each business unit.
Severn Trent Water	A quality payment scheme links total salaries to the achievement of key quality targets for water purity and customer service. If all targets are met, a payment worth 10% of salary is made. Reductions in the full quality payment are made in steps of one or two percentage points depending on the severity of the incident or failure involved.
Terex Equipment	Gainsharing scheme offers all employees at the Motherwell-based firm the opportunity to benefit from a potential 5% unconsolidated payment. Distributions are made twice yearly in July and January, and are dependent on four key parameters, each worth up to 1.25% a year if targets are met. These are: operating expense (as a percentage of sales revenue); operating profit; inventory value; and productivity. All payments from the scheme are subject to tax and national insurance.
TRW Automotive Seatbelt Systems	Success sharing plan - a gainsharing arrangement - based on a formula (currently absence, fault reduction, productivity and ideas for continuous improvement), which divides efficiency savings equally between employees and the company.

TEAM REWARDS

Team-based rewards are linked to some measure of team performance or the achievement of agreed team objectives and may be shared equally or proportionately among team members. Reward schemes that link pay to some measure of team performance have become a feature of remuneration practice in a number of UK workplaces over the past decade. Aimed at encouraging closer teamworking and more cooperative behaviour, their advocates claim they can provide an incentive to improve business performance and deliver organisational goals.

Research shows that there is no single definitive approach to introducing team reward. Strategies vary according to the type of organisation, the nature of teamworking and the particular goals of the business. Team pay in practice is thus strongly influenced by the organisation's context and circumstances. What matters is best fit rather than best practice. Although it is not exclusively a bonus arrangement, most examples of team reward in the UK are group-based incentive schemes.

Why team reward?

The growth of team pay - which emerged as part of the "new reward agenda" of the 1990s - reflects the rapid spread of teamworking throughout UK industry, particularly in manufacturing. To meet the challenges of a more competitive economic environment, employers have used teamworking to underpin new approaches to work organisation - such as total quality management, continuous improvement, business re-engineering and customer care initiatives - that have been introduced over recent years.

De-layered organisational structures and the constant drive to improve quality, profitability and customer service have led employers increasingly to look to team-based pay systems as a way of supporting their teamworking arrangements, while also maximising employee potential and improving business performance. Interest in team pay has also reflected a growing reaction by some employers against individual merit schemes, which can cut across the teamwork ethic (see Rewarding contribution). Instead of concentrating solely on individual performance, team pay seeks to encourage group effort and cooperation, encouraging employees to focus on their contribution to wider team and business objectives.

Extent of team reward

Thus far at least, relatively few employers seem to have adopted team reward, despite the growing numbers of employers concerned about the efficacy of individual merit schemes. The latest Pay and Benefits Bulletin pay prospects survey found that team-based pay remains at the margins of current reward practice, operated by just 5% of survey respondents (one in 20 employers).¹⁰

Other studies have confirmed the low incidence of team reward. Research by the Institute for Employment Studies (IES) found that, while as many of two-fifths of the 400 surveyed organisations had established formal initiatives to encourage teamworking, most were still using individual or organisation-wide wage schemes such as merit pay or profit sharing.¹¹ Only 6% of employers had team bonus schemes for senior managers, 9% awarded them for other managers and 11% gave them to white-collar staff below managerial level. But the proportion doubled in the case of manual workers, where 27% of employers paid team bonuses. Overall, only one in 10 respondents claimed to have team-based payment systems in place.

Similarly, research by the Industrial Society found that, while the vast majority (86%) of organisations had increased their use of teamworking over the previous two years, only one in 10 said that they paid a bonus based on team performance.¹² However, a survey of 98 organisations by the CIPD found a higher incidence of team reward.¹³ Almost a quarter of surveyed organisations (24%) had formal links between team performance and pay, with most concentrated in the financial services, high-tech and pharmaceutical industries:

almost nine in 10 (87%) operated team bonus or incentive schemes;

26% used team payments as part of the individual assessment process;

22% adopted team pay within the context of a competency-based reward scheme; and

just 4% operated shop-floor work- measured group incentive schemes.

Likewise, more recent studies by Towers Perrin (1999) and a joint study by the Confederation of British Industry and William M Mercer (2000) found team reward operated by 22% and 19% of organisations, respectively.¹⁴

Gauging the precise incidence of team reward rests largely on how one defines team pay. But, whatever the extent of current provision, the evidence suggests that employers are still considering it for the future. The most recent PABB survey of pay trends found that of those private sector companies planning to overhaul their pay systems in the next year, 10% were contemplating the introduction of team-based pay - slightly up on the figure found in the previous survey (though below that recorded in the preceding three years). Indeed, PABB's annual surveys have consistently shown that team pay is more talked about than practised. Like other research, PABB's findings reveal a considerable discrepancy between the number of organisations that say they plan to introduce team reward and those that have actually introduced a formal scheme.

Types of team reward

As was stated at the outset, it is not possible to prescribe a standard approach to team pay - there are many different varieties of teams, many types of schemes and a wide range of payment systems.

American compensation expert Ed Lawler has identified three main approaches to team rewards:

individuals are rewarded for their contribution to the team (the most common approach);

organisations reward the team as a whole for its performance; or

teams are paid in accordance with the success of the business.¹⁵

According to Marc Thompson of the IES, the choice of payment systems should depend on the type of team.¹¹ He argues that unconsolidated bonuses are the most appropriate method for temporary teams, while permanent teams tend to adopt one of two systems: either a modification of performance-related pay, where appraisal incorporates a teamworking element or some form of bonus scheme; or skills/competency-based pay.

The main methods of providing team pay for white-collar staff (managerial, professional, technical and clerical) is to distribute a cash sum related to team performance among team members. However, the way the bonus pool is calculated and distributed varies considerably according to the organisation's requirements and circumstances, the types of team and the performance measures used.

By contrast, team pay schemes operating for manual workers have tended to be more straightforward, with bonuses linked either to the physical output of teams or the time saved on team tasks. Some organisations operate multi-factor schemes where team payments are tied to a variety of targets such as attendance, quality and customer service, alongside the traditional productivity measures.

The following examples reveal how team bonuses operate in practice:

Pipeline-inspection company PII operates a team-based bonus scheme for its 40 field crew employees which aims to reinforce its team-based operations, relate rewards to the completion of team targets and encourage group effort and cooperation.¹⁶ The field crews are responsible for conducting pipeline inspections (identifying leaks, cracks, corrosion, dents etc) and preparing a written report which is sold to the respective client.

The size of these project teams varies according to the nature and size of work being undertaken, although they typically range from two employees up to four. Team rewards are linked to the field crew's overall performance. Where an inspection is successfully completed on time and to the customer's satisfaction, crew members are each paid a team bonus (in addition to their salary) which may be worth up to 50% of base pay. The size of bonus for each team member varies according to the size of the team; the achievement of quality standards required; and the bonus available on that particular job.

IBC Vehicles' multi-factor scheme offers its 1,400 manufacturing employees the opportunity to earn a non-consolidated bonus worth up to 1% of basic salary.¹⁶ The bonus is linked to the performance of the whole manufacturing operation in relation to four key targets - health and safety, attendance, product quality and meeting the production schedule - which each account for a quarter of the potential award. These are "hit and miss" targets (set by the parent company General Motors) with a fixed payment made for reaching the set level of achievement. Under the terms of the most recent pay review, employees were awarded an on-target payment of 1% in December 2000.

Other manufacturing operations prefer to employ a system of gainsharing - a formula-based bonus scheme that allows employees to share in the financial gains and efficiency savings made by the organisation as a result of improved performance (see Trends in reward management). At Philips Components, for example, a subsidiary of the Dutch electronics giant, around 760 of the company's 890-strong workforce who are covered by a teamworking pay structure participate in a gainsharing scheme.¹⁷ This delivers a bonus payment to team members paid in addition to their basic salary rise. Provided that predetermined output and yield levels are met, teams qualify for a bonus payment. Each team is allocated an award - bronze, silver or gold - and individual team members receive an equal share of the appropriate bonus.

In the retail sector, team-based pay has sometimes been used to replace traditional commission payments. Next Retail, for example, awards its (approximately) 13,000 store-based staff a team bonus linked to the attainment of monthly sales targets.¹⁶ Where an individual store successfully achieves its predetermined sales targets then all employees in that outlet receive a bonus payment, calculated as a percentage of base salary. The bonus is paid on top of the annual performance-related salary review, effective in February each year.

The concept of tailoring team reward to improve the performance of a particular site or division is also a feature of the bonus scheme operated at Gala Clubs, the UK's largest bingo operator.¹⁸ The company's Marketplace scheme comprises a bonus pooling arrangement whereby clubs in a given city or region pool their collective business targets. The business contribution of each club to the collective targets is agreed between clubs' general managers and area operations managers. The bonus is determined according to each clubs' contribution and performance against the overall targets. It is available to all club employees from general manager to team member. Paid at half-yearly intervals, the bonus is worth the equivalent of two weeks' gross pay of each individual employee, and is awarded pro-rata against their weekly hours worked and hourly rate. If targets are met each year, employees receive an unconsolidated bonus worth one month's salary.

Team rewards have also become a common feature of call centre remuneration, with team bonus schemes operated by a third of respondents to a recent IRS survey.¹⁹ At Sitel Consulting, employees receive a bonus tied to a combination of individual and team performance measures relating to quantity, attitude/customer service and product knowledge. Payments worth up to 5% of gross salary are available, with the bonus weighted 80% to individual and 20% to team performance. By contrast, Halifax Direct links bonus payments to a combination of individual, team and whole centre performance. The four key elements of the bonus scheme include individual sales targets; customer service "hurdles"; team sales; and call centre performance. The team component is worth 2.5% of individual salary for on-target performance, rising to 5% for "exceeding" targets.

Problems and issues

Despite the complexities associated with the introduction of team pay, once implemented, it can deliver a range of potential advantages. One of the principal benefits is that it provides an incentive to improve team performance. Research by the CIPD found that over half of respondents (52%) with team pay were confident it had improved business performance, although only 22% could actually quantify the performance increase.¹³

As well as providing an incentive to improve performance, team reward may also encourage teamworking and greater cooperation, helping to clarify team goals, integrate organisational and team objectives and enhance flexible working through multiskilling.

But introducing a successful team reward scheme is no easy task. The practical difficulties involved can often prove insurmountable. To work effectively team reward needs to fit with an organisation's structure and overall business objectives.

Teams need to be clearly defined and performance measures and appraisal methods must be fair and perceived to be fair by individual employees.

For it to be effective, team pay must therefore meet a host of stringent criteria. Failure to do so can lead to serious drawbacks. Individual employees may be demotivated - by removing the focus on individual contribution; organisational flexibility may be prejudiced - by encouraging staff to stay in high-performing, well-rewarded teams; and pressure to conform may impede corporate performance - by encouraging teams to maintain output only at the level required to trigger the financial reward.

Organisations looking to introduce team pay should thus tread carefully. As the CIPD's good practice guide points out:

"The case for team pay looks good in theory but there are some formidable disadvantages. The criteria for success are exacting and it has not been proved that team pay for white-collar workers will inevitably be effective".¹³

Figure 5.2 (below) summarises the pros and cons of team-based rewards.

Figure 5.2: Pros and cons of team pay

	Pros		Cons
	encourages teamworking and cooperative behaviour		effectiveness depends on the existence of well-managed and mature teams which may be hard to identify and may not be best motivated by purely financial reward
	clarifies team goals and priorities and provides for the integration of organisational and team objectives		it is not easy to get people to think in terms of what impact their performance has on other people
	reinforces organisational change in the direction of an increased emphasis on teams in flatter and process-based organisations		identifying individual team members' contribution may be a problem that might demotivate individual contributors
	acts as a lever for cultural change in the direction of, for example, quality and customer care		peer pressure that compels individuals to conform to group norms could be undesirable and appear oppressive
	enhances flexible working within teams and encourages multiskilling		pressure to conform, which is heightened by team pay, could result in the team maintaining its output at lowest common denominator levels
	provides an incentive for the group collectively to improve performance and the team process		it can be difficult to develop performance measures and a method of rating team or processes performance that are seen to be fair
	encourages less effective performers to improve in order to meet team standards		problems of uncooperative behaviour may be shifted from individuals in teams to the relationship between teams
	serves as a means of developing self-managed or self-directed teams		organisational flexibility may be prejudiced -people in cohesive, high-performing and well-rewarded teams may be unwilling to move, and it could be difficult to reassign work between teams or to break up teams in response to developments
Source: CIPD guide on team reward, Chartered Institute of Personnel and Development, 1996

FAIR SHARES FOR ALL

Announcing his proposal for all-employee share ownership plans (AESOPs) in the 1999 Budget, the Chancellor Gordon Brown described it as "the biggest boost for employee shareholding our country has ever seen ... and the most tax-advantaged scheme of its kind". AESOPs, which, among other things, allow firms to give up to £3,000 worth of shares a year to each employee, free of income tax, were introduced in the Finance Act 2000, along with the Enterprise management incentive (EMI), which is designed to help small, higher-risk firms recruit and retain key individuals. AESOPs and EMIs follow a raft of other schemes from various governments to encourage employees to acquire shares in the companies for which they work: Save as you earn (SAYE) schemes, which enable participating individuals to save between £5 and £250 each month to purchase options to discounted company shares, were established in the Finance Act 1980; Company share option plans (CSOPs), another share option arrangement, replaced discretionary (or executive) share option plans in May 1996; and tax concessions on profit sharing schemes (referred to as approved profit-sharing, APS), started in 1978, although the introduction of AESOPs will lead to approved arrangements being phased out between April 2001 and December 2002 (summary details of AESOPs, CSOPs, EMIs and SAYEs can be found in figure 5.3).

Share options - the right to buy shares in a company at an advantageous price at some future date - are generally associated with a company's senior managers and executives. A glance at the remuneration section of any annual report will show that most businesses grant share options to their senior managers. However, the evidence suggests that all-employee share plans are becoming more popular. Inland Revenue figures show that around 990,000 employees were granted options under a SAYE scheme in 1998-99 (more than double the number five years earlier), and that the average value of the equity to each individual was £3,000. Some 112 SAYE schemes and 493 CSOPs were approved in 1999-2000 and the combined cost of income tax relief on both arrangements in 1998-99 was £480 million. Provisional Inland Revenue figures reveal that as of the beginning of May 2001 more than 300 companies employing around 200,000 employees had applied for approval of an AESOP. Of these, more than 100 had received approval and a further 100 were awaiting final authorisation.²⁰

In terms of which companies offer share schemes to employees, Inland Revenue figures for April 2000 show that 92% of FTSE 100 companies and 68% of FTSE 250 firms offer employees a savings-related scheme; and CSOPs operate in 91% and 82% of the top 100 and 250 companies respectively.

Why share schemes?

Executive share options are generally designed to link the interests of the recipients with those of shareholders. Companies appear to have similar aims with their all-employee share option schemes. Manufacturing business Caradon, which operates SAYE and CSOP arrangements has six core aims of its equity-based reward systems: to link its interests with those of its employees; to improve motivation; to encourage variable pay; to help build a new corporate culture; to enhance performance; and to boost recruitment and retention.²¹ Similarly, food manufacturer Sara Lee Bakery, which also runs SAYE and CSOP schemes, aims to align employees' interests with those of the company, to improve staff motivation, and to aid recruitment and retention (see further examples in figure 5.4).²²

An earlier Management Review - Financial participation - revealed that the most common reason for introducing an IR-approved share-save scheme among surveyed employers was to increase employee stakeholding/commitment to the organisation, mentioned by all respondents with SAYE schemes, followed by the desire to increase employee motivation, cited by 80% of those with these schemes.⁵ Many companies also report that they have introduced employee share schemes simply as a way of ensuring that staff enjoy some of the rewards of success. Proshare, the non-profit-making organisation promoting wider share ownership, found in 1998 that 58% of respondents to a survey examining employee share ownership schemes saw them as a chance to "share rewards with employees".²² Among companies that support the notion of sharing success with staff is Asda, which claims to operate "Britain's biggest public company employee share ownership scheme" and believes that share ownership gives staff the "chance to share in the success they have created".⁶ Vodafone says that it is "committed to the principle that all employees should be able to participate in the company's success by assistance with share ownership."²³

As we have seen, share ownership plans can be particularly beneficial in promoting greater employee loyalty and in aiding recruitment. Like share-based profit-sharing schemes and unlike profit-sharing schemes that pay out annual cash bonuses, company share ownership plans can act as a long-term incentive. This is particularly the case where the scheme is an Inland Revenue-approved one based on share options, as the individual cannot realise the value of the benefit until some future specified time when the option can be "exercised" and the shares bought. If employees leave the company, they may forfeit the chance to enjoy the rewards.

In a competitive labour market, share schemes can help to match remuneration packages elsewhere, particularly among people with scarce and highly sought after skills. It was noted earlier that NatWest acknowledges that some form of financial participation benefit is a standard part of the employment package within financial services.

Employees cannot lose with share options. Profit-sharing schemes can involve a degree of risk to the employee's basic remuneration package - although they rarely do - but share option schemes entail no such risk: if the shares increase in value, the employee can realise a gain; if not, the employee loses nothing. In the case of the SAYE scheme, participants buy the shares at a discounted price - not less than 80% of the value when the option is granted - and receive a built-in capital gain. If the share price stagnates or falls, employees with an SAYE savings plan can simply take their savings instead, plus the associated tax-free bonus. There is no risk to employees in holding the share option, although a risk arises once they have used their savings to acquire equity. Also, given the volatility of the stock market, if share options form a major feature of the reward package, such as in the dotcom sector, employees risk earning less than would otherwise be the case for the duration of the scheme without any guarantee of a windfall.

One of the key selling points for the new AESOPs is the flexibility they allow firms to attach performance conditions to the award of free shares. In this way, AESOPs enable employers to "recognise individual or team performance" by offering different employees varied amounts of shares over the minimum but below the maximum (see rules governing schemes in figure 5.3). Because performance conditions can be attached to AESOPs, they can be more properly described as variable pay than SAYE schemes.

Problems and issues

The price of the shares in which employees might invest depends heavily on influences other than corporate performance that are outside the control of either the company or employees. Prices can, of course, go down as well as up. Neither a "bear market" (steadily falling share prices across the stock market) or its reverse, a "bull market", is related to individual company performance. A company may have had an exceptionally good year on all measures of corporate performance, but its share price may not mirror this if overall share values are falling. Under such circumstances, the impact of shareholding on employee motivation and commitment, and significantly retention, is likely to be at best negligible. Moreover, if share values remain low for a long period, staff may push for higher salaries as a form of compensation. Even the incentive impact of relatively risk-free SAYE schemes can be undermined by a collapse in share price. The overall value of the remuneration package will diminish as a result. For example, the positive benefits typically associated with employee share schemes, such as recruitment and retention, have suffered at food retailer Somerfield as a result of the company's share value being "underwater" - that is, below the option price offered to those participating in both discretionary management schemes and the all-employee SAYE arrangement.²¹

A question mark hangs over the ability of share schemes to alter employee attitudes, especially as such schemes tend to favour the higher paid. Generally, share schemes are poor motivators because of the lack of a direct link between individual performance and share allocation, although the flexibility in this regard afforded by AESOPs may help to overcome this difficulty.

There is a fundamental problem with shares for which employees are required to pay. Research has suggested that, under profit-sharing schemes that give staff the opportunity to take cash instead of shares, lower level employees are more likely to take this option with higher-grade staff tending to take shares.⁵ A similar picture is evident with share schemes in which employees invest their own money. Although Inland Revenue rules stipulate that SAYE schemes, for example, must be open to all staff with at least five years' service, actual participation often depends on the individual's financial ability to commit him or herself to a three or five-year savings plan. AESOPs, which allow employers to grant up to £3,000 worth of free shares annually to each employee, overcome the problem of lack of finance preventing participation in share schemes. However, New Bridge Street Consultants has cautioned: "While the share purchase element [of AESOPs] will be attractive to middle and senior management, the risk of loss and the more limited tax reliefs available for basic rate taxpayers will limit the attraction of this element to the wider workforce."²⁴

Companies can also expect some of the shares bought under the various schemes to be sold fairly quickly, as the cost of acquiring the equity will be met from the profit from selling them on. One commentator has suggested that once employees have sold their shareholding there is no longer any incentive for them to cooperate with management and to work harder, so that any positive effect of share ownership in these areas is likely to be transitory.²⁵

Share schemes will, meanwhile, result in a dilution of equity and may potentially reduce the values of existing shareholders' stakes. NatWest has experienced this problem. The bank generally offers a new share-save scheme each year, but was unable to do so in 1991 and 1994 because it had to limit the number of shares it could issue under the Association of British Insurers' then provisions.

A further potential drawback of share schemes is their complexity and the additional administrative burden of operating them. Several companies reporting their experiences of share schemes to IRS highlighted these two factors as the main disadvantages of such arrangements.²¹ For example, Allied Distillers, which operates SAYE schemes, said that administrative hassles, complexity and the risk of share price dilution are the three primary problems with share plans, while PII Group, which runs a CSOP for all staff, identifies the complexity of such schemes as the major drawback.

The advantages and disadvantages of employee share option schemes are summarised in figure 5.5 (below).

Figure 5.5: Pros and cons of employee share option schemes

	Pros		Cons
	common interest between staff and shareholders		external factors can adversely affect share price
	improved employee commitment and motivation		not an indicator of individual contribution
	culture change		little risk factor
	aids recruitment and retention, especially among higher paid		low participation
	increased business awareness among staff		inequality of allocation
	generates interest in share performance		dilution of equity
	low-cost alternative to cash-based profit-sharing schemes		can breed resentment among staff where senior executives acquire large share options
	can be linked to performance targets		complex rules
	substantial potential reward		participation dependent on ability to purchase shares

PROFIT SHARING

Following the introduction of AESOPs, Inland Revenue-approved profit sharing schemes are being phased out between April 2001 and December 2002, and all appropriations under existing schemes must be made before 1 January 2003. Such schemes have proved popular with both employers and employees - 99 schemes were approved in 1999-2000 and 890,000 people received share allocations under profit-sharing arrangements in 1998-99, each receiving an average value of appropriation worth £750. Despite the imminent demise of IR-approved profit-sharing schemes, employers will continue to have the option of offering unapproved cash-based profit-sharing incentives (see figure 5.6 for a brief explanation of such schemes).

Companies with unapproved schemes can make cash payments - calculated as a percentage of salary or as fixed sum, or as a variable amount based on individual performance - to staff from a profit-sharing pool which attracts no tax concessions. More than a third of respondents to the earlier Management Review survey looking at financial participation had a non-approved profit-related bonus scheme.⁵ These included utility ScottishPower, engineering business Hosiden Besson, financial services company Visa International, general manufacturer T&D Industries, electrical retailer Dixons, rail business Eurotunnel and mobile phone company Nokia. Several companies with approved profit-sharing arrangements also give employees the option of taking the bonus in cash rather than shares. Unlike the award of shares, cash bonuses under an approved scheme do not attract favourable tax treatment and payments are subject to normal income tax and national insurance rules.

Profit sharing has a long history in the UK and, with the withdrawal of approved schemes, some firms are likely to adopt straight profit-linked bonus arrangements increasing the number of employers already using such methods to give employees a share of financial success. Cash-based profit-sharing schemes are similar to traditional incentive schemes, which tend to focus on short-term gain. Some unapproved cash bonus schemes link the level of an employee's profit share to his or her individual performance. Unapproved schemes allow employers far more flexibility in deciding who is eligible to participate. IRS' recent survey of financial participation found that around a third of the sample with non-approved schemes said that the bonuses were available to all employees; a third to a majority of the workforce; and a third included only a minority of staff, most commonly managers.⁵

The design of unapproved schemes is left entirely to the employer, so there is a lot of variety in the way profit is distributed. Generally, distribution of the bonus pool - the amount of which is usually determined by a set formula or at the discretion of the company board - is by way of a percentage of salary.

Examples of unapproved profit-sharing arrangements include the following:

The 650-strong workforce at Electrolux's Spennymoor site each receive a flat-rate annual payment worth £50 if the company reaches predetermined profit targets.²⁶

GKN Westland Helicopters awards its 2,300 technical, production and clerical staff a profit-sharing payment whereby employees receive a cash lump sum if certain predetermined profit levels are reached.²⁷ The scheme was introduced in 1999 as part of the company's Inland Revenue-approved profit-related pay (PRP) exit strategy.

Employees at Basingstoke-based aerospace supplier Lodge, which is part of Smith Industries, are eligible to participate in an incentive bonus scheme that can deliver up to 5% on basic pay, depending on the financial performance of the business.²⁸ This is measured by assessing profits as a proportion of operating costs. Payments from the scheme are made after the annual accounts have been audited following the financial year-end in August, with up to 2.5% of profits set aside for distribution.

John Lewis Partnership's annual cash bonus is paid to all permanent employees who are known as "partners" in the business. The amount to be distributed in the form of a bonus is determined by the company's central board, five members of which are elected by the company's central council - itself an elected body. The size of the pool is based on three main criteria: total profits of the group (including John Lewis department stores and Waitrose supermarkets); the level of profit that needs to be retained for reinvestment; and the cost of each 1% of bonus (for example, in 1996, 1% of bonus required funding of £3.8 million).²⁹ The 2001 overall bonus pot was valued at around £58 million (more than 38% of the company's profit for the year to January 2001), and was worth on average 10% of salary.³⁰ The partnership bonus has been registered with the Inland Revenue as a PRP scheme, allowing 85% of the payment to be paid tax-free. The phasing out of IR-approved PRP arrangements meant that the 2000 bonus was the last to enjoy favourable tax treatment.

A feature of News International's three- year pay deal agreed in 2000 and covering around 3,500 employees at three sites (Wapping, Knowsley and Kinning Park) was a profit-related bonus payable each October for the duration of the agreement.³¹ The scheme is linked to the operating profit of the newspaper and publishing organisation and payments were worth 0.5% of salary in both 2000 and 2001, and 1% in 2002.

Problems and issues

As with share schemes, profit sharing is generally employed to increase employee stakeholding in the business, to improve motivation and aid recruitment and retention. However, several significant drawbacks to profit sharing have been identified, notably the lack of a real direct link between individual performance and profitability. MR11 reported that some organisations with unapproved schemes found difficulty in linking individual performance to overall profit levels in a meaningful way.⁵ For example, Eurotunnel pointed out that the "target is remote for shop floor and doesn't distinguish high/low performance". Norwich Union, too, said that a drawback was that profit sharing could be "too remote" from individual performance. In the same vein, Oracle Corporation UK, declared that a profit-related bonus was "not a true performance bonus".

Although few profit-sharing schemes involve a real risk to the employee's basic salary, they do nevertheless raise expectations among employees that they will receive a payment. However, these expectations can be dashed by circumstances outside the control of both staff and company. As with share price, profitability can be adversely affected by numerous external factors that can prevent a payout even when, on alternative measures, corporate performance has significantly improved. A reduction in profit-related payouts because of external circumstances can have an adverse effect on employee involvement. One survey respondent to the earlier Management Review examination of financial participation, manufacturer Robert McBride, acknowledged this potential difficulty, suggesting that the "'feast and famine' effect creates imbalance in employee perception".⁵

Profit-sharing schemes, because awards are generally allocated as a percentage of salary, tend to favour higher earners and are therefore considered unfair by some. A profit-sharing payment worth 9% of salary is of greater financial benefit to someone on £35,000 a year than to someone on £12,000, although its relative value might be worth more to those on lower salaries. Schemes that are not linked in any way to individual performance also run the risk of creating tension in the workplace. Where staff are equally rewarded without reference to their contribution, there is the potential for animosity on the part of those who have worked hard towards colleagues whose efforts have been less obvious.

An obvious drawback of non-approved schemes is the lack of tax breaks, but some organisations believe this is compensated for by the ability to match remuneration to company objectives rather than Inland Revenue regulations.

The advantages and disadvantages of cash-based profit sharing schemes are summarised in figure 5.7 (below).

Figure 5.7: Pros and cons of non-approved profit sharing

	Pros		Cons
	wage flexibility; lower fixed labour costs		tenuous link between individual performance and profitability
	common interest between staff and shareholders		external factors can adversely affect profits
	improved employee commitment and motivation		not an indicator of individual contribution
	culture change		too little risk
	aids recruitment and retention		raises expectations
	increased business awareness among staff		inequality of allocation
	helps to focus staff on business objectives		potential cost
	aids partnership between employers and		can breed resentment among staff if not linked employees to individual performance
	no dilution of equity		no tax benefits

Figure 5.3: How AESOP, EMI, CSOP and SAYE schemes work

All employee share ownership plan (AESOP)

What is an all-employee share ownership plan?

Under an AESOP employees can purchase shares - described as partnership shares - from pre-income tax and pre-National Insurance salary up to the value of £125 each month (companies can establish a minimum of not more than £10 a month). Employees can receive awards of shares through one of two ways, or a combination of both:

free shares up to a maximum value of £3,000 per tax year (allocation may be performance-related, although special rules apply);

employer matches the number of partnership shares with further free shares (maximum award is two matching shares for each partnership share)

Free shares are purchased by a company-funded "AESOP trust" and held for at least three years to receive the full tax benefit. Dividends paid on shares while they are in the scheme will be tax free if they are used to purchase additional equity (the maximum amount that can be reinvested is £1,500). These "dividend" shares are also held in trust for at least three years, after which time they can be sold.

Rules

All employees must be able to participate in the scheme on the same terms, either by receiving the same value of shares or an amount varied by level of remuneration, length of service or number of hours worked (special rules apply for performance-related allocations). Companies may set a qualifying period for participation of up to 18 months' employment. All employees are eligible to participate.

Tax advantages

Staff - Income tax and NI contributions are not charged when free shares are awarded or when partnership shares are purchased. Employees who keep their shares for at least five years pay no income tax or NI on those shares, and employees who keep their shares for at least three years only pay income tax and NI on the initial value of the shares - any increase in value is free of income tax and NI. Employees who sell their shares will be liable to capital gains tax (CGT) only on any increase in their value after they have been withdrawn from the trust. In the 2001 Budget, the Chancellor removed the stamp duty charge normally made when an employee buys shares from an AESOP trust.

Business - Employers receive corporation tax relief on the costs of establishing and operating a AESOP, including the cost of free and matching shares, as well as the cost of providing partnership shares when this exceeds contributions from employees. Also, employers will not pay NI on shares held in trust for at least five years.

Company share option plan (CSOP)

What is a company share option plan?

A company scheme under which employees are given the right - an option - to purchase, now or in the future, a set number of shares in the business at the current price. There is a £30,000 ceiling on the number of shares an individual can hold at any one time. CSOPs attract certain tax advantages. A single scheme may be established to cover a group of companies where one company is the controlling business.

Rules

The scheme must grant share options only to full-time directors (working at least 25 hours a week) and other staff employed by the company at the time the option is granted. It is up to the company to decide who can take part. Under certain circumstances, some directors or employees are excluded if they have a material interest. Generally someone who owns more than 10% of the company's shares or where a share option plan would, if exercised, give a person more than 10% of the total number of shares, is excluded from participating. Shares must be part of ordinary share capital (eg, attracting a dividend and, where applicable, bonuses) in the company that has established the scheme. The company must be quoted on a recognised stock exchange or be an unquoted company that is not controlled by another unquoted business. Shares allocated under a CSOP give the holder the same rights, in terms of voting rights and the payment of dividends and other income, as those of other shareholders. The price shares is fixed at the time the option is granted; shares must not be discounted. There is a ceiling of £30,000 on the total value of the shares (at the time an option is granted) over which a person can hold an option. This figure includes all share options granted under one or more CSOPs, but not those held under a savings-related share option scheme.

Approved CSOPs may include additional conditions before a share option can be exercised. Such provisions may include a requirement for the business to float or for the option-holder to meet specific job-related performance targets. Any additional conditions must be clearly outlined in the approved scheme.

Tax advantages

Staff - Directors and employees covered by an IR-approved CSOP will pay no income tax on their share option when it is granted or when they exercise their right to buy shares, subject to the following conditions: that it is more than three years and less than 10 years since the option was received and it is more than three years since a separate option was exercised for which tax relief was given. Income tax is payable where an individual gives up a share option in return for money or something else of value. Capital gains tax, less CGT allowance, may be payable on the amount of money received from selling any shares.

Business - A company may offset the costs of setting up an approved CSOP in calculating its profits for corporation tax purposes.

Enterprise management incentive (EMI)

What is an enterprise management incentive?

Enterprise management incentives are designed for smaller, relatively new, companies to help them recruit and retain high calibre staff. Independent companies with gross assets not exceeding £15 million can award EMI options over shares to any number of staff worth up to £100,000. The overall value of options that can be awarded is £3 million.

Rules

Inland Revenue approval is not necessary, although companies granting EMI options must notify the IR within 92 days of the offer in order for it to qualify for tax relief. There is no requirement on companies to obtain prior approval for alteration to share capital (for example, to obtain further finance or prior to flotation).

Tax advantages

Staff - Income tax and NI contributions are not charged when EMI options are exercised. If and when the shares are sold, capital gains tax taper relief starts from the date the options were granted.

Business - Tax credit given for any payment made for an EMI option.

SAVE-AS-YOU-EARN (SAYE) share option plan

What is an approved SAYE scheme?

A scheme under which employees are given the right - an option - to purchase, at a specified future date, shares from monies saved under a save-as-you-earn contract. Staff save a fixed monthly amount, between £5 and £250, for a specified period - three or five years (savings may be left in the account for an additional two years) - and they may purchase shares in the company when the savings contract ends or opt to take the proceeds, including a tax-free bonus or interest payment, in cash. SAYE share option schemes attract certain tax advantages. A single scheme may be established to cover a group of companies where one company is the controlling business.

Rules

The scheme must, at any given time, be open to every employee and full-time director (working at least 25 hours a week) of the company which has established the scheme who resides in the UK and has been employed by the business for at least five years. A company may, at its discretion, also include staff with less than five years' service. Participation therefore is based on eligibility rather than board selection and no employee can be forced to participate.

An individual cannot participate in a scheme if he or she has a material interest in, or is in control of, a close company (one that is controlled by five or fewer shareholders) whose shares may by acquired via the scheme. A material interest arises where an individual owns more than 25% of the company's shares or where a share option plan would, if exercised, give a person more than 25% of the total number of shares. Under such circumstances a share option cannot be exercised unless the employee concerned sells enough shares to bring his or her total shareholding below the 25% ceiling and waits a further 12 months.

Former employees, including those who have retired and those made redundant, must exercise their options within six months of the date of cessation of employment or their rights will lapse.

All employees and directors are covered by similar terms, although the actual allocation of shares may be determined, for example, on a sliding scale of length of service or level of pay. The price of the shares is fixed at the time the option is granted and, although it may be discounted, the price must not be less than 80% of the current market value of the shares. Shares must be part of ordinary share capital (attracting a dividend and, where applicable, bonuses) in companies quoted on a recognised stock exchange or in an unquoted company, which is not controlled by another unquoted business.

Participants will know at the outset how many shares they will have the right to purchase at the end of the contract and they must exercise the option in the six months after the designated savings agreement ends.

Savings contract

A special savings contract with a building society or bank, in which participants invest a fixed amount per month over a set period, begins when the share option is granted. Employers may offer participants the choice of a savings contract over three years (36 monthly contributions), five years (60 monthly contributions) or seven years (60 contributions, which are left in the account to mature for a further two years). The current fixed monthly minimum and maximum savings limits are £5 and £250 and the money is normally deducted automatically from wages or salary (special arrangements are available for weekly paid staff). Individuals can participate in more than one scheme but the total monthly amount saved under all schemes must not exceed the maximum savings amount. The SAYE contract attracts a bonus based on the length of contract - a three-year contract pays a bonus equal to three monthly contributions; a five-year contract pays a bonus equal to nine monthly contributions; and a seven-year contract pays a bonus equal to 18 monthly contributions.

Participants who do not complete the term of their savings contract will receive the savings plus, if payments have been made for more than one year, tax-free interest. Former employees may continue to make payments subject to agreement with the building society or bank.

Tax advantages

Staff - Directors and employees covered by IR-approved SAYE share option schemes will pay no income tax on their share option when it is granted or when they exercise their right to buy shares or on any increase in share value between when the option was granted and when it is exercised. Savings also attract a tax-free bonus. Capital gains tax, less CGT allowance, is payable on the profit or gain (that is the amount received from selling the shares less the cost of the shares and less any indexation allowance) if the shares are sold.

Business - A company may offset the costs of setting up an approved SAYE share option scheme in calculating its profits for corporation tax purposes.

Figure 5.4: Share schemes in five companies

Company: Caradon

Main area of activity: Manufacturing

Approx. number of employees: 15,000

Types of scheme used: The firm uses three different schemes - an Inland Revenue-approved company share option plan (CSOP) for senior management, introduced in 1996; a save-as-you-earn (SAYE) scheme open to all UK employees, which commenced in 1996; and a further discretionary share option scheme for the 50 most senior managers, implemented in 1998. Caradon collects data on take-up rates for all three of its schemes, but does not consult with employees about major issues such as the effectiveness of share schemes or the performance of the company's shares on the market.

Performance targets: Awards under all the above schemes are linked to the growth of the company's share price.

Objectives of share schemes: The company cites six core aims of its equity-based reward systems - to link its interests with those of its employees; to improve motivation; to encourage variable pay; to help to build a new corporate culture; to enhance performance; and to boost recruitment and retention.

Disadvantages of share schemes: Risks for employees and share price dilution (following the issue of new shares to cover the schemes) are listed as the main hindrances of share-based remuneration.

Overall results: In general, share schemes have had little impact. As there has been "no change" on key employment areas such as absence, business awareness, job satisfaction, commitment, employee relations, recruitment and retention and performance measures such as productivity, profits and quality, the company says share schemes have been "ineffective" when set against their stated objectives.

Planned changes: The company says it will "definitely" introduce the Government's planned all-employee share scheme (AESOP) at some point in the coming year, believing it will appeal to all employees.

Company: Lincoln Financial Group

Main area of activity: Financial services

Approx. number of employees: 1,450

Types of scheme used: The company uses two schemes - a save-as-you-earn (SAYE) arrangement, introduced in 1999, eligible to all employees on completion of one years' service; and discretionary share options for senior managers.

Performance targets: Only the discretionary scheme has performance criteria, although the company does not specify the form these take.

Objectives of share schemes: Lincoln lists four key aims - to link the employer's and employees' interests; to increase business awareness; to reward employees efficiently; and to enhance performance.

Disadvantages of share schemes: The legal and financial complexity of share schemes and the need to use consultants in their design and implementation are listed as the main hindrances.

Overall results: Lincoln says its two schemes have been "very effective" in meeting their objectives, with the primary beneficial impact being on levels of business awareness. However, in other key areas the firm believes there has been no real change.

Planned changes: The company has no plans to modify its approach to share incentives in the immediate future, and says it is unlikely that it will implement the new all-employee share scheme (AESOP).

Company: Somerfield

Main area of activity: Retail

Approx. number of employees: 70,000

Types of scheme used: Three types of scheme are used, all introduced in 1996. There is an approved employee share ownership plan (ESOP) for managers, an Inland Revenue-approved company share option plan (CSOP) for senior management, and a save-as-you-earn (SAYE) scheme for all employees. Somerfield monitors take-up rates on all three schemes and consults with its workforce about share-based reward.

Performance targets: The company states that "in the past, some share option awards have been linked to performance".

Objectives of share schemes: The company cites seven core aims of its share schemes - to link the employer's and employees' interests; to increase business awareness; to improve motivation; to incentivise the workforce; to help build a new corporate culture; to enhance performance; and to boost recruitment and retention.

Disadvantages of share schemes: Somerfield says the main problem with share schemes is their complexity.

Overall results: In general, the company believes the level of its share price determines how effective its schemes are in relation to their objectives. As Somerfield's share price is currently "underwater" or less than the price of employees' options, its equity incentives are rated as "ineffective". At the moment, although business awareness has increased - albeit perhaps for the wrong reasons - share schemes have had a negative effect on both recruitment and retention and profits/performance.

Planned changes: The are no new initiatives in the pipeline, but the company says it may "possibly" introduce the new all-employee share scheme (AESOP) "at some point".

Company: Johnson Matthey

Main area of activity: Development of advanced materials technology

Approx. number of employees: 6,000 globally

Types of scheme used: The firm uses four types of scheme. Inland Revenue-approved profit-sharing is open to all UK employees, an Inland Revenue-approved company share option plan (CSOP) is available to UK managers and discretionary share options are offered to management on a worldwide basis. The latter two schemes were both introduced in 1985, and extended to cover middle and lower management in 1997. In addition, a long-term incentive plan (L-tip) was introduced in 1998 for senior managers and directors. Data is collected on the take-up rates of each scheme.

Performance targets: Not surprisingly, distributions of shares under the approved profit-sharing scheme are determined by the attainment of certain profit targets. For the two managerial share option schemes, earnings per share (EPS) is the main performance criterion.

Objectives of share schemes: Six key aims cited - aligning interests of employees with those of the employer; increasing business sense; improving commitment; incentivising the workforce; rewarding staff in an efficient way; and boosting recruitment and retention.

Disadvantages of share schemes: Three bugbears listed - the complexity of share schemes, their cost, and the risk of share price dilution.

Overall results: Johnson Matthey says its financial participation schemes have been "very effective" in achieving their objectives. It says business awareness, employee commitment, workplace relations and recruitment and retention have all benefited from its various share schemes.

Planned changes: The company says it is planning to introduce new initiatives in the next 12 months, possibly in the form of the all-employee share scheme (AESOP). Changes are "dependent on UK legislation".

Company: RP Scherer Europe

Main area of activity: Pharmaceutical and healthcare equipment manufacture

Approx. number of employees: 700 in the UK and 2,000 in Europe as a whole

Types of scheme used: At the moment, the company only operates a discretionary share option scheme for senior managers which, because of the fact that the firm is US-owned, is an American "stock grant scheme". This was launched in 1999, and the company "will be introducing one for all employees soon".

Performance targets: No targets were specified.

Objectives of share schemes: Four main aims - to align employees' and company's interests; to increase motivation; to enhance performance; and as part of the firm's retention strategy.

Disadvantages of share schemes: None cited.

Overall results: The company says it is "too early to determine" the success of its approach, but notes improvements in business awareness and recruitment and retention.

Planned changes: "We are developing plans to roll out a US-style 423B plan [all-employee share scheme] internationally," the company says. It may consider using the UK all-employee share scheme if the international scheme can be accommodated into the new legislation.

Source: Pay and Benefits Bulletin 496, May 2000

Figure 5.6: Cash-based profit-sharing schemes

What is an unapproved profit-sharing scheme?

Variable reward schemes that link cash bonuses to company performance. Participation in a profit-sharing scheme is at the company's discretion, but generally all employees are included, subject to qualifying criteria, such as length of service. Payments are made from a profit-sharing pool and are fully liable to income tax and National Insurance. Employers are free to decide the size of the profit pool available for distribution to staff, although the bonus budget in some companies is based on a set formula. For example, payments may be triggered when a predetermined profit level is reached, with the size of the bonus or the pool increased on a sliding scale once the profit target is exceeded. Typically, individual payments are a fixed percentage of salary, although under some schemes eligibility is dependent on individual performance.

¹Pay and Benefits Bulletin.

²Office for National Statistics.

³Pay and Benefits Bulletin.

⁴"Bonus payments and the average earnings index", Office for National Statistics (2001).

⁵"Financial participation", IRS Management Review 11, October 1998.

⁶"Staff retention", IRS Management Review 13, April 1999.

⁷"Partnership at work", IRS Management Review 17, April 2000.

⁸Reported in Personnel Today, 20 February 2001.

⁹"Performance management", IRS Management Review 20, January 2001.

¹⁰"Pay prospects for 2000/01 - a survey of the private sector", Pay and Benefits Bulletin 507, November 2000.

¹¹Teamworking and pay, Marc Thompson (1995), Institute for Employment Studies.

¹²"Teambuilding", Managing best practice 19, Industrial Society (1996).

¹³Rewarding teams, Michael Armstrong (2000), Chartered Institute of Personnel and Development good practice guide, Short Run Press, Exeter, ISBN 0 85292 860 2.

¹⁴Euro rewards 2000: reward challenges and changes, Towers Perrin (1999); Employment Trends survey 2000: measuring flexibility in the labour market, Confederation of British Industry and William M Mercer (2000).

¹⁵"Tricky but not impossible", Across the board, Edward Lawler (1997).

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¹⁷"Philips Components, Durham: 12-month pay freeze", Pay and Benefits Bulletin 497, June 2000.

¹⁸"Rewards and bonuses at Gala Clubs", Pay and Benefits Bulletin 513, February 2001.

¹⁹"Call centres 2: benchmarking bonuses", Pay and Benefits Bulletin 506, October 2000.

²⁰Inland Revenue figures, 8 May 2001.

²¹"Assessing the value of share ownership", Pay and Benefits Bulletin 496, May 2000.

²²Employee share ownership research, Proshare (1998).

²³Vodafone Group plc annual report 1996.

²⁴Quoted in "Assessing the value of share ownership", Pay and Benefits Bulletin 496, May 2000.

²⁵"Employee share ownership and cooperative efficiency", M Ford (1991), Manchester University Centre for Law and Business, working paper 9.

²⁶"Electrolux Cookers, Spennymoor: 3% on paybill", Pay and Benefits Bulletin 506, October 2000.

²⁷"GKN Westland Helicopters: second stage of two-year deal", Pay and Benefits Bulletin 480, September 1999.

²⁸"Lodge, Basingstoke: 3.5% rise plus incentive scheme", Pay and Benefits Bulletin 495, May 2000.

²⁹The Gazette, John Lewis Partnership newspaper, 2 March 1996.

³⁰John Lewis Partnership, press release, 26 April 2001.

³¹"News International: Wapping pay deal", Pay and Benefits Bulletin 503, September 2000.