6 Tips for Evaluating Incentive Plan Effectiveness

April 27, 2017

 

The amount of money spent on short-term incentive compensation continues to increase as more companies take advantage of the business benefits of using variable compensation programs to reward performance. Just over half of the companies (54%) in our Variable Compensation Measurement (VCM) survey indicated that they do not  have a systematic review of their incentive plans. Hats off to those of you who already assess your plan effectiveness, but if you’re like most, here’s a quick list of things you can start doing on your own right away.

1. Annual Plan Review

The first step is simple. Build a plan review into your compensation planning calendar. You should organize a cross-section of stakeholders to participate in a working feedback session no more than 2-3 weeks after incentive payouts. In addition to compensation leadership, bring in people from finance, HR business partners, communications and representatives from business leadership.

We’ll get into more details of what to review in that session, but a good place to start in terms of getting your stakeholders engaged is to gather a high-level assessment as to:

  • What worked well
  • What needs to be tweaked
  • What needs to stop completely

2. Taking Stock of Plan Measures Used

One of temptations businesses have is to put too many measures into their variable pay plans. The thinking may be that what gets measured gets done. True, but we find that the most effective variable compensation plans are going to be focused on 3 – 4 performance measures. These measures may have a mixture of corporate, business unit and individual goals that will be commensurate with the job level. The weightings applied to each measure typically fall in the range of 15% on the low end to 50% at the upper end.

3. Performance and Payout Distribution

As you continue to peel the layers back on your assessment, analyze how the plan paid out in comparison to the performance measures in various parts of the business and at different levels of the organization. In the example below, we do see a reasonable performance distribution curve, but there is a disconnect between the amount of the payout compared to the overall performance of the business.

Distribution-of-Incentive-Payouts-Compared-to-Performance.png

You would ideally want to ensure that your distribution of targeted incentives for the year ahead more closely align to the business performance measures.

4. Assess the Plan Mechanics

Here’s where you evaluate the ‘levers’ on which the plan operates. There’s some judgment required, but you want to make sure that there is an appropriate degree of ‘stretch’ to the goals that are set and then have reasonable stakes in the ground as to what defines the threshold levels of performance and what the corresponding payout would be at that level. On the flipside, we also look at the plan mechanics to define the performance and payout curve above target.

When assessing the plan mechanics, you may also want to think about how your plan handles extenuating circumstances. Is there protection built into the plan in the event an unexpected windfall makes those ‘stretch’ goals far too easy? How are you handling unforeseen calamities that make the business goals unattainable?

Making year-end exceptions or deviations from the plan is a slippery slope that never plays out well. The better approach is to ensure your plan reasonably accommodates those potential risks in the best interests of the business.

5. Benchmark Targets and Payouts

You should annually analyze the competitiveness of payouts, targets and even plan eligibility. We recommend using our Total Compensation Measurement® survey, which provides a comprehensive assessment of all components of pay. When analyzing salary survey data for incentive pay data, you should be sure to consider multiple years of trending data, i.e., 3 years.

6. Administration Rules Review

Inevitably, there will be situations popping up during the year that strain your administration guidelines. There are countless examples of administration rules that come into question, but here are some examples:

  • Payouts to employees who have left the organization or who may be on some form of performance improvement plan
  • Changes to calculation method for incentives paid to overtime-eligible employees
  • Effort and time required to calculate and process incentive payments

In the event you do make changes, make sure you are able to update your plan documentation and communicate changes to all plan participants.

Following these six tips for evaluating the effectiveness of your incentive plans should help ensure your payroll dollars are delivering on the business results you need. Think of these tips as a ‘preventive health check’ for your variable compensation program.  You can lead a cross-functional review and compare your variable pay plan practices to our VCM survey to sharpen the focus each year.

Contact us for more information.

 

The Shifting Landscape of Variable Pay

 

 

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