One of the most common questions I am asked by CEOs is “how do I determine the right pay and incentive plan for my employees?” Often, they want to know whether they should offer current cash, current stock, deferred cash, deferred stock, restricted stock or phantom options, but I like to start by asking them about their pay philosophy. Are they willing to invest (aka accept less profit for themselves) in order to attract and retain the right people? Too few CEOs balance the cost of attractive salaries, benefits and incentive packages for valued employees against the often higher cost (in other employees’ time, loss of productivity, etc.) of recruiting and training new employees (whose value is yet to be proven).
Obviously, if you want your company to grow, you need skilled people who are committed to helping you grow it. The right compensation tools, therefore, should be determined within the context of a guiding framework that is fair, competitive, consistent, scalable and sustainable.
Establishing a pay philosophy
This is simply a formal statement that clearly outlines your company’s position about employee compensation. In essence, it’s the framework or “why” behind employee pay that can serve as a frame of reference when hiring or during salary negotiations.
An example of a pay philosophy is one that offers highly competitive starting salaries to attract a strong roster of candidates. Another example might offer lower starting salaries with vesting opportunities or bonuses to develop talent and retain employees.
Other factors to consider include your company’s business objectives, financial position, location and relative standard of living, the supply of qualified talent, etc.
Questions to ask of your pay philosophy are:
- Is the overall program defensible, equitable and perceived by employees as fair?
- Is the overall program fiscally sound for the company?
- Are the programs included in the compensation philosophy and policy legally compliant?
- Can you effectively communicate the philosophy, policy and overall programs to employees?
- Are raises tied to proficiency or performance?
Keep incentive plans simple and separate from pay
Pay philosophy should be seen as a framework not a straightjacket. Within the boundaries it lays out, you can still have differing pay and incentive structures depending on roles (e.g., administrative versus sales).
It is critical that incentive plans are clearly defined, targeted and separate from pay so employees will have a clear understanding of the linkage between their efforts and behaviors to their compensation. A well-designed employee incentive compensation plan will make it easy for an employee to focus on things they can control.
Incentive plans fail when the structure is targeted too broadly and not focused on individual people or teams. A typical profit sharing plan where it is “one for all and all for one” does not motivate anyone. Productive employees resent the poor performers and lack motivation to continue their performance.
Linked to the idea of clarity for incentives programs is setting performance goals that are aligned with business objectives. Goals should be challenging enough to require real behavioral change but not so difficult that workers give up. Here are a few other considerations when setting employee goals:
- Employees need to know specifically what metric(s) will be measured. If goals are vague, managers may resort to subjectivity, opening the way to claims of unfairness, bias, and ultimately resentment.
- Balance is key and consulting with employees can help find the sweet spot between goals that are too easy and too difficult to achieve.
- If you demand results that aren’t aligned with the resources available to fulfill them, this can lead to frustration on your employees’ parts as well as your own.
- Setting incremental progress points as well as final deadlines for achieving goals promotes performance and allows for any necessary adjustments.
The key to determining pay and incentive strategies is aligning them to your long-term business goals in order to develop a fair, competitive, consistent, scalable and sustainable pay philosophy that is transparent to your workforce. This will give you the flexibility to be creative if the talent market or your financial circumstances change without jeopardizing your bottom line or company morale.
Tom Springer is a founding partner in Springer Lawson & Associates, a consultancy of former C-level executives who help mid-market companies maximize enterprise value in advance of, during, and following major business transactions or disruptions.