Question

13. Suppose a firm offers a divisional manager linear pay-for-performance contract based on the revenues of the division the manager leads. The manager’s pay includes a fixed yearly salary F and a fraction of the division’s revenue a that is paid to the manager. Suppose the demand for this type of divisional manager increases, meaning that the firm has to increase this manager’s pay in order to retain him or her. Should the firm do this by increasing the salary F, the commission a, or both? Explain in detail

THE ANSWER SHOULD BE TAKEN FROM"economies of strategy 6th edition"

you are kindly requested to write a detailed answer

Answer 1

Solution:-

* One of the major concept of discussion in behaviorial economics and organizational economics is pay-for-performance program. It is a system of employee payment in the United States that links compensation to measures of work quality or goals. There are various criterias to calculate pay for performance matrix and also there are types of system in this program. Some organizations provide the total wage basis this concept. However, mostly, firms provide a fixed amount as salary and in addition to that it provides a variable amount to the employee basis his performance/work quality. The above question falls under the second criteria.

* If this manager is in demand, that means he is getting an opportunity to earn more of total wage outside asompared to the company he is working. To retain a good employee the company would like to give a reasonable increase in pay to the employee. However, it also has to consider the cost it will incur by virtue of doing this. The company needs to consider the fact that increase in both salary F and salary A is a huge cost as it will have to then raise the pay bar for each and every employee at that level in every division.

* However, if the company increases only the commission A, it will reduce the overall profit each division is earning, as a fraction of profit of the division is paid to the manager as commission. Increase in salary A will reduce profit.The company will loose bigger part of profit to retain the employee.

* As mentioned in third part, to retain the employee and survive the business profitably, the firm may choose to increase salary F to a certain level. It may give promotion to the employee or it may increase the basic pay the employee is getting. iIn this scenario, the employee satisfaction level is increased. He is motivated more towards his work. Also, he will earn more excellence as he will be working on same field and will help the firm achieve better business results. He will continue getting commisssion part also. This way company will be able to retain the employee and manage the cost.

So, the best solution is to increase salary F.

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