).The study was commissioned by the New England Compensation
Consortium and includes data from companies based in the New England
region. The participants include leading companies like: TJX
Companies, Analog Devices, Waters Corporation, Jordan's Furniture,
and Avid Technology. This is the first survey of its kind of New
England companies specifically and it reveals how variable pay plans
are used and what changes are being considered for 2005 -- in
particular with those companies that are changing their policies for
awarding stock options.
As reported by the survey companies, the
key objectives of variable pay plans are to:
Focus attention on specific objectives (71%),
Drive specific business strategies (67%),
Improve performance (58%).
The most prevalent performance measures are:
Financial metrics:
Revenue growth (60%),
Operating income (41%),
Earnings before interest and taxes (29%).
Strategic metrics:
Results from specific projects (35%),
Achievement of personal goals (23%),
Customer satisfaction (15%).
The target and actual
payouts are larger for those with higher salaries. Those making
less than $50,000 usually receive 5% of salary in a bonus. Mid-
managers and professionals earn between 10% to 15% of pay, and
executives (salaries over $150,000) earn 30% to 60% or more of their
salary in annual bonuses. There was little correlation between the
profitability of companies and their payout targets.
The survey also showed how much companies spend on variable
pay. It ranged from 10% to 15% of net income; the payouts add
about 8% to a firm's total payroll. But, how well do these plans
work? As a ratio of net income to variable pay dollars awarded,
the survey's most profitable companies produced $14 of net income
for every dollar spent on variable pay, while companies with average
profitability received $4 of net income per dollar spent in variable
pay. Most companies (63%) said their plans improved business
results; over 40% indicated these plans improved both team/unit and
individual performance.
Despite these results, there are important concerns about the
perceived effectiveness of these plans. With the high level of
importance, financial costs and clear impact on results associated
with these pay plans, we expected to see a relatively high rating of
their effectiveness. However, only 17% of the companies felt their
plans significantly exceeded their cost, while 33% said they were
moderate and 29% were break- even.
The survey showed that over 62% of the participants will be
changing their variable pay plans in 2005. The reasons for changing
the plans (based on an analysis of the survey responses and our
direct experiences in developing these plans) appear to lie in three
areas:
1. The performance measures appear to be the most
challenging element of variable plans. The problem is that many
plans do not provide a clear line of sight between one's actions
and the results on which the payouts are based. Managers and
employees don't refuse their bonus payouts, but many may not fully
understand what actions they can take to directly influence the
outcomes.
2. Executives are often concerned about the relationship
between the performance goals and payouts. What levels of
goals are sufficient to justify the increased financial costs of
the payouts (i.e., the level of challenge or stretch)? What level
of goals and payout opportunity is motivating to plan participants
(i.e., achievable and meaningful)? Further, conflicts can emerge
when different executives (or the Board of Directors) use
different frames of reference when setting goals or assessing
performance, e.g. growth from the previous year, a comparison to
internal or external benchmarks, or specific milestones of the
strategic or business plans.
3. Many companies are changing their strategy and/or
organization to respond to changing external market
conditions. This means that they need pay plans that are highly
flexible to the new realities of the business, and encourage
different behaviors or results. However, the current design and
systems of many variable pay plans do not effectively support the
ability to set and measure specific drivers of the business, and
track the performance of key business units and/or
individuals.
These reasons may explain why so many survey companies are
planning changes to their variable pay plans in 2005. In
addition, about one-third of the companies are planning to reduce
the number of stock options awarded to employees and place more
emphasis on variable pay plans. Others are seeking to integrate
their plans more closely with a new business model or with
organizational changes brought about by acquisitions and/or
divestitures.
The five primary changes in variable pay plans being
considered are:
1. Increasing the understanding of how the variable pay plan
works (47%),
2. Providing more frequent feedback on performance (43%),
3. Increasing payout opportunities (30%),
4. Improving the administrative and support systems (29%),
5. Increasing training on specific skills reflected in the
plan's measures (25%).
It is clear from the interest in the survey and our experiences
with clients, variable pay plans have clearly demonstrated their
value. The question is: How does a company realize the highest
value possible from these management and pay programs? Highly
effective companies use these plans to communicate the
organization's priorities, strengthen their performance culture and
reinforce desired behaviors. These plans are used to enhance, not
replace, effective leadership practices. Utilized effectively, these
plans make companies significantly more competitive. Hence, the
power of these plans appears to be more in how they are designed
and used than in how much money they provide to the
participants.
If you are interested in learning more about the survey or
purchasing your personal copy, please visit the Executive
Compensation Research (ECR) section of the Wilson Group website.
Just click on the survey title below:
