Ten Enduring Truths of Pay Design
it is necessary to apply judgment
because of external factors that may
have aff ected the organization's
financial outcome. The solution lies in
finding a place in the middle where
the range of compensation is based
on specific defi ned criteria under
control of the individual modified by
the application of limited discretion
to reflect broader corporate factors.
7. Formulas are dumb
They are an easy crutch for those that do
not want to think or have hard
conversations.
They appeal to those who think
linearly and on a single dimension.
By defi nition, formulas are dumb
creatures - they do not think or
adapt. They can only operate at a
mechanical level. It is very diffi cult
to reduce work responsibilities to
a simple formula which pays a %
of profi t or growth or sales. The
formula will get the employee to
focus on one thing only and jobs are
obviously more nuanced than that.
So a formula which provides structure
and (limited) discretion is the most
suitable combination for eff ective
plans.
8. Extraordinary pay gets you
extraordinary results
Great pay leads to the virtuous cycle
of getting and motivating the best
people which leads to the best results
that leads to the ability to pay more.
Using pay as the plug to "make
the numbers" will result in a vicious
downward cycle.
A very frequent concern I have
heard from clients over the years
is that the incentive plan pays too
much. Although the plan pays
on the basis of targets achieved,
there are some people who make
a disproportionately more money.
My fi rst question to these concerns
is does high reward mean that as an
institution you made more money?
Organizations need to have variance.
There has to be a balance between
people who get paid more money
for extraordinary outcomes at both
individual and organizational levels
and the people with lesser rewards
due to their lack of performance. It is
this variation that drives the success
of an organization. Results that have
positive long and short term fi nancial
implications for the institutions
allows them to share that success
with their employees. It is a simple
cycle – people get paid well, it drives
their performance up, the institution
performs better and exceeds targets,
the best people are rewarded and the
cycle goes on. This is what we call the
virtuous cycle of performance.
The opposite of this is using
pay to plug your fi nancial number.
Assume at the end of the year
the organization is short versus
budget, and decides to take it out
of the employee’s pocket. What
this will result in is a disgruntled
employee workforce who hasn’t
been suffi ciently invested in. Either
they will depart or redefi ne their
contributions in the subsequent years.
This will impact the organization’s
fi nancial goals for the next year and
there is a downward spiral.
9. Everything takes time
Pay changes will not change behavior,
culture engagement or productivity
overnight.
A great incentive plan was never
created in a day. They never work in
the fi rst year primarily because there
are trust and legacy issues. There
has to be a record of success that
the programs organizations have in
place are rewarding the right people.
People feel the connection between
what they have done and how they
are being recognized. Properly
designed, carefully communicated
and implemented, in conjunction
with clear strategic priorities is a
clear accelerator of all of the above
factors. A series of successes will help
organizations realize that the plans
work eff ectively. Mostly organizations
are always trying to fi x something
that is broken. This approach doesn’t
work because they never invest in the
gestation period to make a program
successful.
10. Uncertainty carries a high
discount rate
Lack of clarity around how much and
why I get paid will make the ultimate
payment worth much less than it costs.
The eff ects are amplifi ed if the pay
is held contingent into the future.
Any compensation plan with an
uncertainty on the actual payout
makes that compensation plan
less valuable than something that
is certain. For example, while the
salary of an employee is certain, the
incentives are linked to multiple
factors. One external factor for
example could be the corporate
performance over three years. All
of a sudden, the incentive becomes
less valuable as it will be paid out
over 3 years pay with a clawback
attached to it. We have done a lot
of empirical studies and every time
there is a trade off , employees will
put a higher discount on the more
uncertain compensation. The thing
to note, is that this form of pay is
highly ineffi cient. This is because
the organization mostly like will
ultimately pay out the money but to
the individual it had limited incentive
and retention impact because it is
uncertain. Hence organizations need
to make sure that the uncertainty of
delivery doesn't discount the value
of compensation.
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