Organizational Incentive Programs: Profit Sharing, Gain Sharing, and Employee Stock Ownership - Lesson | Study.com (2024)

Frank explains that one approach is to grant stock options to his employees. An employee stock option is a contractual right that entitles an employee to purchase shares of the company's stock at a set price sometime in the future. Employees must hold the stock options for a specific period of time before exercising them, which is called the vesting period. The more successful the company becomes, the more valuable the stock options will tend to be. Carl asks how, and Frank gives an example.

Let's say that Ed, the employee, is granted the option to purchase 1,000 shares of a company's stock at $10 a share, which is the price per share at the time the option was granted. Ed works hard to make the company a success, and by the time Ed has the right to exercise the options, the company stock is trading at $15 a share. Ed gets to buy up to $15,000 of stock for only $10,000.

Frank tells Carl that profit sharing is another option. In profit sharing, employees are rewarded if a company's profits increase. It's a way for employees to have an added stake in the company's success. Frank explains that a profit-sharing plan has a formula that provides a fixed percentage of profits that will be divided among employees. Consequently, employees are motivated to perform well so the company profits increase, which results in a cut of the profits for them.

Frank also tells Carl about gain sharing. Gain sharing focuses on employee participation in management and rewarding employees for increases in efficiency that result in cost savings. Instead of sharing in increases in profits, employees share in the gains realized by the savings due to reduction in waste and increases in efficiency. Carl looks a bit confused, so Frank provides an example.

Let's say that it costs a toy factory $10.00 to produce a certain toy. Under a gain-sharing plan, employees are encouraged to participate with management to find ways to more efficiently produce the toy. If the employees are successful in reducing the cost to produce the toy from $10.00 to $9.00 per unit, they will share in the gain from efficiency by taking a share of the cost savings pursuant to an established formula.

Let's review what we've learned. Companies can employ different compensation strategies to help align the company's interests with those of employees. Some strategies include stock options, profit sharing and gain-sharing plans. A grant of stock options gives employees the right to purchase company stock at a predetermined price in the future. If the company does well, the employee will be able to purchase the stock below market rate. A profit-sharing plan allows employees to share in an increase in profits, while a gain-sharing plan allows employees to share in the savings realized through increases in efficiency.

You should be able to describe three incentive programs companies can employ to improve employee performance after watching this video lesson.