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Nov 25, 2014

Short-term incentive plans delivering pay for performance

But attention needed to ensure plans effectively balance motivation and affordability

By Claudine Kapel

Given the modest budgets available to recognize top performers through salary increases, it’s not surprising short-term incentive plans are increasingly being seen as the pay-for-performance rock stars.

The Conference Board of Canada’s Compensation Planning Outlook 2015 found most of the survey respondents have at least one short-term incentive plan in place. Fully 92 per cent of the private sector respondents reported having at least one plan in place, as did 56 per cent of the public sector respondents.

The survey results reflect responses from 382 Canadian organizations.

The majority of respondents with short-term incentive plans (79 per cent) provide outstanding or top performers with incentive awards that are up to twice the amount given to satisfactory performers. Further, 15 per cent provide incentive payouts that are two to three times the average payout for satisfactory performance and six per cent offer more than three times the average payout to their top performers.

Nearly half of the survey respondents reported average actual payouts in 2014 exceeded targets. The actual cost of short-term incentive plans averaged 11.0 per cent of total base pay spending, higher than the 10.8 per cent that was planned for the year.

Respondents have set a comparable target for short-term incentive awards in 2015.

The majority of respondents indicated their plans were either effective or highly effective at meeting their top three plan objectives:

  • Driving organizational performance (67 per cent)
  • Driving individual performance (69 per cent)
  • Linking individual performance to corporate performance (64 per cent).

The research also found eligibility for incentive payouts runs deep in many organizations.

Although plan participation is most prevalent at senior management levels, the majority of respondents indicated non-unionized clerical and production employees were also bonus eligible:

  • Senior executives (97 per cent)
  • Executives (95 per cent)
  • Management (94 per cent)
  • Professional – technical and non-technical (85 per cent)
  • Clerical and support (73 per cent)
  • Technical and skilled trades (64 per cent)
  • Service and production (59 percent).

The Conference Board notes target award opportunities vary widely across employee groups and industries. It observes organizations in the oil and gas and natural resources industries have the highest targets overall and across most employee groups. In contrast, the government sector – including the federal government, provincial governments and municipalities, but excluding Crown corporations – have the most conservative targets.

Given the potentially significant dollars associated with annual incentive plans, it’s critical to ensure plan designs effectively balance motivational considerations with plan affordability. To optimize a plan’s ability to drive desired behaviours and results, many plans include individual objectives among the measures used to determine incentive payouts.

The challenge with individual measures is that their achievement doesn’t always correlate with organizational performance. For example, the fact most employees complete their assigned projects on time and on budget doesn’t necessarily mean the organization will be profitable or achieve its corporate objectives.

In fact, employees are generally most likely to achieve their individual objectives, regardless of how the organization is doing overall.

That doesn’t mean you shouldn’t include individual objectives among your incentive plan metrics. An overemphasis on corporate results will limit the motivational impact of an incentive plan because employees may not see how they can influence higher-level metrics. To that end, the Conference Board’s research found only 11 per cent of respondents had profit sharing plans – which typically do not reward individual achievements.

To help balance motivation and affordability considerations in your incentive plan design, consider the following questions:

  • How are individual objectives defined? Can you clearly measure the extent to which an objective has been achieved? To what extent does the objective connect with or support the achievement of broader organizational objectives?
  • How are individual objectives weighted relative to corporate objectives?
  • How does overall organizational performance impact award calculations? Is there a mechanism for reducing or eliminating payouts tied to individual objectives in the event that corporate financial objectives have not been achieved?
  • Do employees understand how their work contributes to the achievement of organizational objectives, even indirectly?

Annual incentive plans can deliver significant compensation dollars to employees. Getting the design right is critical to ensure the plan delivers a meaningful return on investment. 

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