Expect More From Senior Executive Variable Compensation

By Joel Myers

More and more companies – both public and private – are expecting more return from their senior executive variable compensation plans. And well they should. A sobered economy is impacting the bottom line for many firms. Their senior management, in turn, is beginning to feel a pinch in their bonus and variable compensation plans. Whether flush economy or bear market, variable compensation plans offer employers an opportunity to energize their senior team and positively impact the business. It's high time the "bar get raised" in terms of mutual expectations from those plans.

Variable compensation plans, i.e. bonuses and incentives, have been around for ages. By definition, they should focus, motivate and reward employees for reaching specific goals. They are, essentially, results-driven compensation programs. They should be a win-win for employees and employers alike. Far too often, neither side "wins" to the extent possible. Why is that and what can be done about it?

How to Strengthen Your Variable Comp Plan

1. Get Personal.

Basing variable compensation payouts solely on broad organizational measures such as revenue or net earnings goals just doesn't cut the mustard anymore. Employees at all levels need motivation. They need to see the results of their efforts and be rewarded for them. It is critical that variable compensation plans reward accomplishments that can be directly linked to an individual executive's contributions. The organizational, business unit or work group's goals that drive the plan must be measurable to the management in charge for a variable comp plan to fulfill its potential.

2. Get Strategic.

It's time for employers to get creative about the goals they reward. Your variable comp plan should focus management on high priority business issues. There are ample opportunities to customize reward programs based on the management and business unit in question. Potential performance areas to consider are: shortening receivables, reducing inventory, new product introductions, focus product revenue growth, reaching target profit margins, new market penetration, improved customer satisfaction, etc. Public companies have historically tended to focus on increasing earnings per share. Long criticized for throwing stock options around like candy, they are looking for new ways to focus their management team. Private companies, by definition, don't have the option of pulling incentive dollars out of the market. Today, more and more results-oriented companies, public and private alike, are expecting their senior executives to earn their incentive pay.

3. Don't be Stingy.

Far too often, variable comp plans are too numbers-driven and overly dependent on the income statement and balance sheet. If a variable pay plan is linked to the right performance measures, executives will be motivated to focus on the right things. If the plan has been designed well, the pay out will increase incrementally as company performance increases. This makes the plan self-funding.

4. Variable Plans Should Be Variable.

To fully engage top performers, a plan should encourage an opportunity to over-achieve. As the targeted performance meets and exceeds the goal threshold, payout should as well. Employers should cover their bases though, and set a ceiling for potential rewards. Likewise, employers should determine a floor where performance under a certain level will receive no reward.

5. Increase Urgency.

Short-term or annual incentive plans for senior management can play a critical role in meeting meaningful marketplace objectives. Short-term plans have the potential to drive tangible results, results that directly impact the bottom line. Setting a clear, date-driven time frame is important to maintain focus and interest.

6. Address Ownership Interest.

Publicly traded companies place executives in an ownership position with stock options; however, those options aren't quite as sweet in a struggling market. There are other disadvantages to relying solely on stock options to reward senior management. Longer-term strategic planning may get side tracked by a "quarter-to-quarter mindset". The economic advantages of stock options run the risk of drawing interest away from more performance-driven reward systems.

Ownership may not be available to executives in privately held companies. This makes other forms of long-term incentives an important part of the equation for them. The long-term compensation plan and the short-term plan must coordinate; the metrics that drive the annual incentive plan and the long-term incentive plan should be integrated to stimulate results in desired areas. The level of payout potential under both plans should, together, provide a desirable total compensation package and aid in retaining key executives.

The Bottom Line

For both public and private companies, the stakes for proven leadership today are high. Seasoned executives can make the difference in winning or losing. Adequately motivating and rewarding them is central to keeping them. Senior Executive Compensation Plans (short and long-term) can play a significant role in engaging management. Optimizing your reward system depends on linking it to strategic business objectives.

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