Incentives

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Description of Incentives. Explanation.

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Definition Incentives. Description.

An Incentive is any extrinsic reward factor that motivates an employee or manager or team to achieve an important business goal on top of his/her/their intrinsic motivation. It is a factor aiming to shape or direct behavior. In an optimal form, executives and employees should be remunerated well (but cost-effectively) where they deserve it, and not where they do not. Pay-offs for failure should be kept to a minimum. Furthermore, to be effective, a layered or gradual approach is better than an all-or-nothing incentive. A smart executive reward scheme is one of the pillars to ensure entrepreneurial behavior and maximizing shareholder value (Compare: Value Based Management). An incentive is unlike coercion, in that coerced work is motivated by the threat or use of violence, punishment or negative action, while an incentive is a positive stimulation. Incentives can also be used as Anti Hostile Takeover Mechanisms.

categories of incentives. Classes

Financial Incentive. Also called, Remunerative Incentive, this category involves offering a material reward (often in the form of money) in exchange for certain results or behavior. In business, this is the most important category. The many variants include:
- Profit sharing (the traditional, oldest approach).
- Merit pay (merit wage or salary increase, often depending on the results of an appraisal).
- Scientific Management (Taylor) and Piece-Rate systems (very effective on productivity, but may lead to quality issues).
- Pay for Performance or Gain Sharing.
Moral Incentive. Where a particular behavior is widely regarded as the right thing to do, or as particularly admirable, or where the failure to act in a certain way is condemned as indecent.
Coercive Incentive. Where a failure to behave in a certain way or to achieve certain results can be expected to result in physical force being used.

Furthermore, incentives can be either a:

Personal Incentive (motivating a specific individual person).
Social Incentive (motivating any individual in certain circumstances).

Limitations of incentives. Disadvantages

The complexity of organizations and human beings, imperfect knowledge at the moment of incentive definition, and unintended consequences after implementation makes defining and implementing incentives much more complex than many people think. Also the communication of an incentive plan, its measurement (Compare: Economic Value Added) and its management (Compare: Performance Management) are factors that should not be neglected. Imperfect incentives or poorly managed ones can easily lead to unexpected windfalls or to unintentional side effects.

For example, employee Employee Stock Options aim at increasing the productivity of the Chief Executive Officer and other top executives by offering a remunerative incentive if they make the stock price rise. The problem is that CEOs can increase the stock price by either:

Making sound decisions and reaping the rewards of a long-term share price increase, or
By fudging or fabricating accounting information to give the illusion of economic success, and reaping profits from the short-term price increase by selling before the truth comes out.

Similarly, paying corporate executives proportionately to the size or revenues of their firm may cause them to pursue mergers to grow their companies, to the detriment of their shareholders' interest.

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