Delivering incentive compensation plans that work.

• Author: Bolten, Randall
• Position: COMPENSATION

Employees with "skin in the game" work harder and smarter. Though senior executives and salespeople have been the traditional recipients of highly leveraged compensation plans, line managers, sales support staff, marketing staff, engineering project team members and many other employees will also work harder and smarter with the right compensation plans motivating them.

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But why are there so many horror stories related to incentive compensation plans? How could a world-leading company like American International Group Inc. implement plans that paid out hundreds of millions of dollars in the same year the company almost went out of business?

The message is this: Incentive plans can be expensive, and the more expensive they are, the more effective they're likely to be. And because they're so effective, the more disastrous they can be if poorly conceived or executed. Moreover, with greater expense comes greater visibility--not only internally, but with the investment community and even the general public.

Creating incentive compensation plans that actually work involves: thoughtful, intelligent construction; clear, powerful communication to all of the recipients; and clearly identified roles. And the CFO is essential for ensuring the plan's success.

Intelligent Construction

A well-designed plan must face tests in a number of areas. In each, ask the following questions:

* Metrics tie to enterprise objectives. Do the compensation metrics (such as revenues, new customers, profits, completion timeliness, number of cold calls, presentations given, etc.) have a logical relationship to and impact on top-level corporate, functional or departmental objectives?

* Metrics are comprehensible. Can most employees understand the metrics on which their compensation is based? Do they understand how their actions affect these metrics? Are the metrics objectively measurable? Do the metrics routinely appear in regularly published management reports?

For example, it is fine to assert that, say, "return on net corporate tangible assets" (RONCTA) is highly correlated with stock price, but if employees don't understand how RONCTA is calculated or how their own performance relates to it, this assertion is meaningless.

* Plan works over a range of performance. Does the plan "behave properly" across the entire range of likely performance outcomes? Are overachievers properly rewarded? Do underachievers see smaller paychecks?

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