Variable-pay programs base a portion of an employee’s pay on some measure of performance. The variable portion may be all or part of the paycheck, and it may be paid annually or upon attainment of benchmarks. It can also be either optional for the employee or an accepted condition of employment. Around the world, about 84 percent of companies offer some form of variable-pay plan. Most organizations (70 percent) use a combination of organization-, department-, team-, and individual-level awards.

Unfortunately, not all employees see a strong connection between pay and performance. although it seems that the type of plan matters. The piece-rate pay plan compensates production workers with a fixed sum for each unit of production completed. A pure piece-rate plan provides no base salary and pays the employee only for what they produce. A merit-based pay plan pays for individual performance based on performance appraisal ratings. If designed correctly, merit-based plans let individuals perceive a strong relationship between their performance and their rewards.

An annual bonus is a significant component of total compensation for many jobs. When times are bad, firms can cut bonuses to reduce compensation costs. A profit-sharing plan distributes compensation based on some established formula designed around a company’s profitability. Compensation can be direct cash outlays or, particularly for top managers, allocations of stock options. Do variable-pay programs increase motivation and productivity? Managers should evaluate the effectiveness of each element separately.