By Claudine Kapel
Incentive-based pay represents a common — and often significant — element in many executive compensation packages. But are these dollars really delivering optimal value in terms of motivating leaders and aligning their interests and actions with the highest good of the business?
New research by PwC suggests design issues with executive incentive plans are undermining the value of such plans. “Incentives have become so complex and volatile that they no longer motivate the executives they are aimed at,” PwC reports.
The “Psychology of Incentives” study, which was undertaken in conjunction with the London School of Economics and Political Science, involved more than 1,100 participants from 43 countries. The study found that when it comes to their compensation, “Executives are risk-averse, don’t like complexity and discount deferred pay.”
The study concludes: “Many features of current pay packages mean that the value executives place on them is materially lower than the cost to companies of providing them.”
As part of the study, participants were asked to choose between different scenarios regarding pay package designs and compensation opportunities. For example, participants were asked whether they would prefer:
a) 50 per cent chance of receiving a bonus of $90,000 (or nothing)
b) $41,250 for certain
c) Indifferent to a) or b).
Just over one-half of all respondents chose the certain amount.
Says PwC: “This reinforces the point that companies need to know their audience. Incentives are more likely to work for risk-takers, but not everyone likes risk to the same degree.”
The study also found executives favoured less complex incentive plans. “The message here is that uncertainty and complexity are a turnoff for most people. In almost every case, participants selected the less complicated option. The more complicated the reward, the more likely they were to choose the smaller but more certain award,” notes PwC.
This finding highlights a key challenge with long-term incentive plans, which are inherently complex. Observes PwC: “Long-term incentive plans (LTIPs) have become evermore complicated, often combined with clawback arrangements, net holding requirements and performance-based deferrals of cash bonuses in response to shareholder and regulatory pressures, and in an attempt to align pay to business performance.”
Nevertheless, nearly two-thirds agreed they valued the opportunity to participate in their organization’s long-term incentive plan (LTIP). According to PwC, “It appears that, to some degree, LTIPs are successful as a recognition tool (because those participating are seen to have a higher social status) rather than as a meaningful direct incentive.”
PwC observes paying incentives rather than salary is an investment. And like any investment, companies need to be clear about the payback. “Is the payback better performance? If so, what’s the evidence you’re getting it? Is it about cost flexibility? If so, how much do you need? Is it just that you’ve got to offer it because everyone else does? If so, have you tested that assumption?”
Although the PwC study focused specifically on executive incentive-based pay, the questions about payback represent good food for thought with respect to any kind of compensation program.
Why does your organization offer what it does? Are you getting the desired return, be it in terms of business performance and results, or the ability to attract and retain talent? Are employees clear about what actions and behaviours can help them optimize their earnings? Do employees really understand and value what they’re receiving?
Some of the questions may be challenging to answer. But in the asking, organizations can help ensure compensation programs are really driving desired performance and results.
Claudine Kapel is principal of Kapel and Associates Inc., a Toronto-based human resources and communications consulting firm specializing in the design and implementation of compensation and total rewards programs. For more information, visit www.kapelandassociates.com.