Profit sharing is a generic term for different forms of participation that can be divided into four groups: income, performance, profit or appreciation participation.
The idea of allowing employees to participate in the success or capital of their work-providing company has been discussed in politics, business and the church since the 19th century. The focus is always on new aspects and objectives.
Against the background of the shortage of skilled workers, the motivational and retention effects of employee participation gain particular attention in this context. Because, as a study by the Gallup Institute shows, only 14 percent of employees have a close relationship with their company, 15 percent have already given their notice internally and over 70 percent do “work according to regulations”. It is therefore of great importance for companies to motivate employees in the long term and to reduce the fluctuation rate. This goes hand in hand with the identification of employees with the company. Employee participation models can make a significant contribution to this.
Due to its complexity and complexity, this topic also attracts attention in politics. In 2009, for example, the federal government passed a new version of the law on financial employee participation (“Employee Capital Participation Act”), in which the financial (tax) support for employee participation models was increased and the possibilities for technical implementation were expanded. In doing so, the federal government pursued the goal of increasing the participation of employees in the success and capital of their employing companies.
And even today the interest in this matter is not decreasing. On May 20, 2019, the employee participation conference took place at the headquarters of Allianz Global Investors GmbH in Frankfurt am Main. "The conference, which is unique in Germany, informs companies and representatives from politics, associations and trade unions about opportunities and possibilities for employees to financially participate in their companies."
Definition of employee participation
In the context of variable remuneration, the term employee participation is understood to mean the participation of employees in the success or capital of the employing company, which goes beyond the contractually fixed remuneration component. The company's performance serves as a reference value.
Basically, two types of employee participation can be distinguished:
- the equity stake and
- the profit sharing.
With profit sharing, the employees receive a pro rata special bonus based on the company's profit for the period, which is distributed in addition to the regularly paid remuneration. Equity participation, on the other hand, turns employees into investors and lets them participate in the company's equity or debt. Both basic forms can form an independent participation model or be combined. The latter is often common in practice.
Expectations of employee participation models
From a business perspective, various aspects play a role when introducing employee participation models. Above all, however, in most cases the aim is to promote the motivation of employees and to strengthen their loyalty to the company. Employees should learn to identify with the company's goals, as their own performance and success are reflected in the company's success and ultimately in individual remuneration. The company hopes that this will increase the productivity of its employees in order to generate an increase in performance. The prerequisite for the motivation effect is that the employees also have a direct influence on the company's output and are aware of their own responsibility in this regard. If this connection is not apparent, the expected incentive effect will not occur. In addition, this presupposes the general assumption that the money factor is an incentive for employees that leads to greater motivation. Basically, of course, it can be seen that employee motivation is not due to just one criterion. A participation model can create new incentives, but topics such as organization of working hours, personnel development and management, and the general corporate climate also play a major role.
Since the equity base in many companies in Germany is relatively low, employee participation can and should also help to secure the company's liquidity in financially difficult times and thus protect it from possible bankruptcy.
Especially against the background of the shortage of skilled workers, it is becoming increasingly important for companies to retain employees in the company over the long term. Employee participation can also make a significant contribution by promoting the identification of those involved with the employing company. A corporate culture based on partnership based on mutual acceptance and trust is a prerequisite for achieving these goals. Employee participation is thus an instrument for increasing the company identification of employees that can be used by companies. But it cannot stand on its own and replace the framework conditions.
Basics of profit-sharing
Employee profit-sharing models can be classified under labor law in the category of wage and salary payments. As a result, contributions in the form of wage tax and social security contributions are also incurred on profit contributions.
Employees can participate in the company's success through various aspects, but this can quickly become obscure. Systems that are primarily intended to increase employee motivation are treated under different aspects than those that focus on implementing flexible remuneration components. The cost of maintaining and managing the profit-sharing system, which must be checked beforehand, is also decisive. In everyday life, group investments in the form of participation in the annual financial statements (balance sheet) have prevailed over individual participation. This has to do with the fact that performance sharing and profit sharing have the disadvantage that they are only measured on the market or on operational performance.
Both models assume that performance and yield can be measured independently in the form of increasing profits, but this does not necessarily have to be the case. As a result, it can happen that profit shares have to be paid without the current earnings situation of the economist reflecting this. Profit-sharing systems combine market and internal aspects that only become profit shares if only measurable success is demonstrated. These statements also count for the individual-oriented systems, but there are additional aspects that can address the lack of market orientation.
The current demands from trade unions and employee associations make the high priority for flexible remuneration methods clear. On the basis of fixed wage and salary components, employees and managers should receive performance and / or success-related income components. Two trends can be clearly seen here.
On the one hand, it can be seen that success-oriented systems are replacing performance-oriented systems. The new direction makes it clear that general performance is not enough if success is not generated at an appropriate level. In addition, it is suggested to the employees that performance is only sufficient if this can be seen from the success and its assessment basis.
On the other hand, it becomes clear that group-oriented participation systems are often more popular than individual assessments. Individually allocable remuneration can in individual cases lead to a measurable increase in motivation. However, it does not show to what extent the success of the company will noticeably increase as a result. The group-oriented assessment increases the sense of community and the possibility of achieving greater goals.
Dimensions of profit-sharing
"The strategic starting points (dimensions of profit sharing) when choosing the optimal form of participation ask about the time horizon (short or long-term incentives), the mechanisms of motivational psychology (individual or group orientation) and the possible starting points (performance, income, profit or value). "
Short or long term incentives
The short-term incentives include the established systems of profit-sharing, whereby the measurement of success relates to a financial year. Some try to make these intervals even shorter and shorten them to a quarter or even just a month. This would make it much easier for the employees to establish the connection between the service provided and the resulting benefit (profit sharing). This would result in a greater motivation boost being exerted on the employees, which still plays an important role.
Companies also need not to lose their employees in order to be able to use the professional competence and the acquired operational know-how productively in the long term (company loyalty). A variant of this are the company's stock options, which only become noticeable to the employee after a certain period of time, often several years and provided that the employment relationship is still in place. This form is often used by executives.
By trying to tie the workforce to the company in this way, it is possible to plan with them in the long term. Thus z. B. new markets are opened up and new products or product groups are developed and brought onto the market.
Individual or group orientation
Group orientation can be summarized by distributing a share of the success calculated for a given group of employees according to fixed guidelines to the eligible employees. It serves to strengthen groupthink, a sense of community and general togetherness.
In the case of group orientation, additional pressure can be called on from the employees, which occurs due to the goals set in the group. This is not a problem until the pressure rises to a measurable level. Another problem is the sharing of the success of the services provided with the group members, which can lead to individual employees not reaching or using their full performance level. In practice, however, this rarely occurs because the “group” creates a control committee that checks itself and recognizes and compensates for individual weaknesses more quickly (search for a solution). The strengths of an individual employee can, however, be brought to light much more easily and thus the best possible result can be achieved. "A chain is only as strong as its weakest link".
In the case of individual orientation, on the other hand, only the performance of the individual employee is assessed and, if necessary, rewarded. The amount of the financial support is to be defined by various measurable parameters. On the one hand, the success rate can be measured by the number of pieces produced depending on the time. On the other hand, it is possible to evaluate the quality of the service provided. This variant enables the employees to identify themselves directly with their performance and the resulting remuneration.
The profit-sharing scheme can basically be divided into four forms based on different reference values. The various forms of employee participation are divided into performance participation, profit-oriented profit-sharing, profit-oriented profit-sharing and virtual participation systems.
Profit sharing, also known as profit-oriented profit sharing, is the form that has prevailed in operational practice over profit sharing and performance sharing by individual or all employees. In the group-oriented form of profit sharing, a distinction can be made between distribution profit sharing, asset profit sharing, and balance sheet profit sharing.
Above all, the profit sharing scheme has significant advantages and is the most common form of profit sharing in Germany. The influencing of internal and market aspects is prevented, creating a sufficient assessment basis for the participation. Since distribution profit sharing and asset profit sharing are not relevant in practice, we will not go into these two types further below.
A significant advantage of the balance sheet profit sharing is that the participation in the company's success is only due when the numbers are “in the black”, ie only when a profit is made. In addition, the various systems of profit sharing are simple, clear and hardly trigger any potential for conflict, as they are set up on the basis of negotiated and compromise solutions. When it comes to the introduction and maintenance of the system, profit-oriented participation makes few demands on the company.
Before introducing profit sharing, some aspects need to be regulated, determined and negotiated. In order to create a basis for the later success of an employee participation, it is recommended to set up a company and service agreement for the introduction, in particular to prevent misinterpretation of the employees.
An analysis by the Hans Böckler Foundation of several company agreements regulating profit-sharing resulted in a subdivision into three profit-sharing systems. A division is often made into “pure profit-sharing”, the combination of profit-sharing and other forms of profit-sharing and profit-sharing exclusively for the financing of an equity participation.
The exclusive profit-sharing, which is also to be understood under the pure profit-sharing, does not use any other key figures besides the profit to measure the participation.
When combining profit-sharing with other forms of profit-sharing, other key performance indicators are taken into account in addition to profit. B. the quality of the products or the productivity of the employees.
Profit sharing to finance an equity investment is understood to mean a combination of equity and profit sharing. Profit sharing is agreed in advance, but this should or must be reinvested in the company. This serves the financing effect of a capital participation.
Income sharing can also be referred to as income-oriented participation. With this form of participation, the reference value is different from that of the profit participation declared in advance. Turnover or value added is most often used as the assessment basis. Another possibility would be to use gross or net income as a reference. The gross or net profit makes it clear that the success of a company depends not only on the efficient use of production factors, but also on the success of its sales.
A distribution to the employees takes place even if no profit is generated, this represents the essential difference to profit sharing. In contrast to the entrepreneurial internal, performance-oriented approach, the market development, with an external perspective, is in the foreground.
The high dependence on external conditions can lead to a problem, as sales can also be achieved with disproportionate costs and consequently little or no profit is generated. The economy can be cited as an example of an external condition, which can only be influenced to a limited extent in many areas. As a result, profit sharing is also less susceptible to influence.
A fair distribution key must be established in advance for the employees to share in the company's earnings. In order to define these and all other details of profit sharing fairly, a business and a psychological perspective on this form of profit sharing is necessary. Such a distribution key must be determined individually for each company so that it is perceived as understandable and fair by the employees.
In the context of performance sharing, the amount of the performance share is measured based on the total employee performance. Systems in the sense of performance sharing have been in great demand since the 1950s, but the use of this type of participation has increasingly declined. A performance target is defined in advance, and if this target is exceeded there is a share in the success. The amount of the distribution is also defined in advance so that there is a fixed overall goal. The performance target is usually the normal performance to be created for the employee. For this purpose, measurable parameters must be adhered to in order to get a comparable result. The participation system does not have to be applied to an entire company, but can also be introduced for departments or work groups.
The performance participation is to be distinguished from the performance wages, because it is based on the performance of several people and also rewards them in the sense of a bonus distribution. In addition, the performance target does not necessarily have to be based on the market, but can be related to any target to be set. This can have a negative impact on the company. B. Bonuses also have to be paid if it has sold fewer products, but the performance sharing in this case is not based on the sales volume. This disadvantage for the company can be an advantage for employees, as they are measured by their own strength and not by e.g. B. fluctuating profits.
This form of profit-sharing is therefore used less and less in companies. As part of an individualized performance sharing, the employee receives an individualized motivation to increase performance. The team aspect is less important here, but rather it is about putting together a worthwhile remuneration package for the employee. Problems with performance sharing are the above-mentioned risk of a payout in problematic times, as well as the setting of the performance framework, as this often leads to a potential for discussion between employer and employee. In addition, increased employee performance in disadvantageous situations does not always result in a profit for the company. The performance sharing therefore leads to a high level of effort in terms of maintaining the system and setting the right goals for the employees. Piecework wages are a very early form of individual performance sharing. Performance-based pay can be freely combined with other forms of employee participation to create a more complex bonus pay system.
Virtual participation systems
The virtual participation systems, like the performance sharing schemes, have a previously defined objective against which the amount and the actual distribution of a bonus is measured. However, they are not based on performance, but on the capital market. The virtual participation systems can be divided into stock options, phantom stocks and stock appreciation rights. This type of remuneration falls under long-term variable remuneration or long-term incentives. They are still assigned to profit-sharing, as it is a very indirect form of equity participation and does not affect the duration of an equity participation. The incentive here is that a price increase also has positive effects on the employee. These systems are therefore more interesting for positions in management. The long-term orientation of these options also gives the employee the incentive to work for a long-term increase in the value of the company, because this is the only way that his profit sharing has value.
If there is participation in the form of stock options, a number of shares is set at a certain price at the beginning of a period, which the employee can purchase when he has achieved the goals set by the company. This has the advantage that if the stock market value increases, the employee can purchase the shares at a lower price and thus generate a profit. If there is no increase in the share value, the purchase right simply expires. The company has the advantage that the money is initially invested in the company itself, and shareholder value can also increase. The participation system thus contributes to the active development of the company and increased employee loyalty. A disadvantage of stock options can be that the value of the shares is diluted because the company brings new shares to the stock exchange for the investments. The existing shareholder, whose shares no longer have the same share in the company, suffer from this. If the stock market price falls, the stock options also lose their appeal and can lead to dissatisfaction among those involved. In order to avoid this, other parameters such as the stock index can also be measured.
Stock Appreciation Rights (SAR)
With Stock Appreciation Rights, the beneficiaries receive a payment based on the value of the company or the share value. Here, the target and quantity of the shares are again defined in advance. This participation system can therefore also be used in companies that are not listed on the stock exchange. For such companies, company value indicators are then used to measure success. In contrast to stock options, the employee does not hold a share in the company at any time. Another advantage is that there is no action on the stock exchange and therefore no change in the share value. One disadvantage is that there is an unexpectedly high distribution to the beneficiaries, as there has also been an unexpected increase in price.
Phantom stocks are a way for the company to share in both the company's profits and losses. Thus the phantom stocks are treated as a virtual equity investment. It is measured against a simulated price development of the company. If the actual value at the end of the period is below the simulated one, the employee must participate in the negative development and pay for it within the agreed framework. However, there is a model in which companies offer to buy back the shares at the reference price in order to reduce the risk for employees and increase the attractiveness of this participation system. The beneficiary is treated as a fictitious partner. However, participation in shareholders' meetings is not justified. Even within the framework of this participation system, the company does not have to be on the stock exchange and no real shares have to exist. If this is the case, then the company value is measured.
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