Is your company’s annual bonus expense
in line with its recent financial performance? Do top performers receive a larger bonus than their lower-performing peers?
The current economic climate is the perfect
reason to review your company’s bonus and
incentive plans.
During prosperous times, employees come
to expect bonuses, and the company has less
trouble justifying the expense. So bonuses
lose their meaning and become automatic or
entitlements. If there’s little to no growth in
your company’s 2009 forecast, now’s the time
to revisit those incentive plan fundamentals
and make the necessary adjustments.
“Now that executive compensation is subject to new SEC disclosure rules, CEOs are
realizing that the same philosophies around
executive bonus and incentives must cascade down through the organization,” says
Ann Costelloe, San Francisco office practice
leader of executive compensation for Watson
Wyatt Worldwide. “They’re wondering how
they can justify paying employees profit sharing or incentives if the company’s financial
results are lower than the prior year, yet still
incent employees to achieve stretch goals.”
Smart Business spoke with Costelloe
about how executives can calibrate employee bonuses and incentives to mesh with 2009
forecasts and still maintain motivation.
What’s the first step to calibrate annual
bonus and incentive plans with results?
Executives should start at the macro level
by revisiting the philosophy behind the plan
to make certain it’s still appropriate. Next,
make certain the plan is motivating employees toward the main business drivers. At all
times, a plan should be self-funding in that
the incremental gain to the company should
more than pay for the bonuses to employees.
If it’s a profit-sharing plan, where all employees share in the overall company results,
should you pay employees the same percentage if the company doesn’t achieve a profit
increase? Or is the percent of profit shared
appropriate and affordable given the financial performance of the company?
The questions are: What results should we
be rewarding? Are there specific business
drivers and return (e.g. return to shareholders) that we must achieve and exceed before
we can afford to pay a bonus? Should employees still have an opportunity to earn the
same bonus if they meet individual goals, but
the company misses its broader target?
What’s the next step?
Establish companywide financial goals that
include the appropriate amount of growth
that is both achievable and affordable but by
no means a given. This is the first step to
assuring that the employees’ collective performance will fund the bonus expense. Then
cascade the goals down through management to each division, group and individual.
Understanding the extent to which company
performance versus individual performance
will impact an employee’s personal reward is
critical. I advocate giving employees no more
than three goals, so that an individual isn’t
juggling too many targets. A goal that impacts
only a small fraction of an employee’s ultimate reward (e.g. 10 to 15 percent) will likely
receive no attention versus goals that impact
a significant portion of the reward. Bonuses
and incentives should be earned for achieving results, not completing activities, and if
it’s a true incentive plan, those who achieve at
higher levels should earn larger bonuses than
their lower-performing counterparts.
When determining the bonus amount that
will motivate employees, there’s no one-size-fits-all number. Instead, the percentage must
coincide with the company’s philosophy, the
industry, the maturity level of the company
and the targeted return to shareholders.
How should plan changes be communicated?
Initially, the CEO should communicate the
plan change, including the reasons behind it,
because employees are much more likely to
embrace change if they understand why it’s
necessary. Employees need to understand
how bonuses payments are calibrated to
company-expected results and to what
extent the bar for performance measurement
has changed. CEOs should then provide periodic updates, detailing how the company is
tracking toward those goals. This strategy
creates line of sight between the employees
and the company’s mission, and it also keeps
the employees focused and motivated, especially if they’re working toward stretch goals.
Which plan structures are the most effective?
I don’t favor all-or-nothing plans because
they can be a little scary, and they often fail to
motivate employees. A scaled system, which
financially rewards employees at a level
that’s commensurate with their performance,
is fair and the expense is calibrated to the
achievement. The key here is to ensure that
employees at all levels know what performance, outcomes and results are expected and
how they will be measured so that rewards
line up with results delivered.
I also encourage employers to set aside a
pool of funds to reward and retain top performers. It’s best if the opportunity is embedded within the plan structure because you
don’t always want to be managing by exception. If your company is hitting or exceeding
its bonus plan targets every year, there’s a
good chance the plan isn’t working properly
because the bar is set too low. When a plan is
structured correctly, you won’t hit the goal
every year, nor will you consistently miss or
overachieve.
ANN COSTELLOE is the San Francisco office practice leader of executive compensation for Watson Wyatt Worldwide. Reach her at
(415) 733-4244 or [email protected].
