Incentive plans alive and well

Attention to key design features essential to optimize plan impact

By Claudine Kapel

Incentive plans are everywhere.

That’s a major finding of new research by WorldatWork, Deloitte Consulting and Vivient Consulting.

The WorldatWork recently released three research reports covering incentive pay practices in publicly traded companies, privately held companies and not-for-profit/government organizations.

“Incentive programs are alive and well at companies from all different sectors,” the WorldatWork reports. “The data shows no indication of companies pulling back or reducing the use of these types programs.”

The research found annual incentive plans were highly prevalent. Some 90 per cent of the publicly traded organizations in the study had annual incentive plans, as did 86 per cent of the privately held organizations. In addition, 76 per cent of the not-for-profit and government organizations in the study also had annual incentive plans in place.

The findings for the publicly traded organizations showed that 99 per cent of the respondents in this group use some sort of short-term incentive plan, with the annual incentive plan being the predominant type of plan offered. Findings reflect responses from more than 350 U.S. companies.

The research also found the design features of short-term incentive plans in privately held companies and non-for-profit and government organizations were “very similar” to those in publicly traded companies.

Other types of short-term incentive plans most commonly used by the publicly traded survey participants included:

  • Spot cash awards (65 per cent).
  • Retention bonus (59 per cent).
  • Annual discretionary bonus plan (38 per cent).
  • Project bonus (30 per cent).
  • Team / small group incentives (28 per cent).
  • Profit-sharing plans (16 per cent).

With consideration to the full spectrum of potential plan types, 49 per cent of respondents from publicly traded organizations reported they have two to five plans in place. While 17 per cent reported having only one plan in place, 14 per cent reported having 26 or more plans in place.

But just because incentive plans are highly prevalent doesn’t mean all plans are delivering optimal value. It’s important to regularly review incentive plans to ensure they remain effective and aligned with the business strategy.

The findings for the publicly traded organizations show 43 per cent of respondents modified their short-term incentive plan design or goals for their current performance year. When asked to define what prompted the change, 72 per cent of those who made plan modifications said they did so as part of the regular annual review and update of their plan.

Performance measures are a key design element of any incentive plan. Ideally, you want your plan to emphasize a few critical measures. Having too many measures will dilute the potential impact of the plan because it sets up too many priorities for employees to focus on, each potentially with a low weighting.

The findings for the publicly traded organizations suggest many plans are tightly focused. Some 56 per cent of respondents indicated their annual incentive plan has one to three measures, while 36 per cent reported their plan has four to six measures. Only eight per cent reported having a plan with seven or more measures.

The most commonly used performance measures included:

  • Overall individual performance (48 per cent).
  • Revenue (43 per cent).
  • Achievement of specific individual goals (39 per cent).
  • EBIT/EBITDA (33 per cent).

Another key consideration when developing incentive plans is to ensure there are design safeguards so the plan does not yield unintended or unaffordable incentive awards. The findings for the publicly traded organizations illustrate these types of design practices:

  • 75 per cent of respondents indicated their plan specifies a performance gate or minimum performance threshold that must be achieved before any incentive or bonus award can be earned.
  • 83 per cent of respondents said their plan specifies a maximum or a cap on payout amounts. Of these, 30 per cent reported their maximum payout is capped at between 175.1 per cent and 200 per cent of target.

Incentive plans are generally regarded as strong vehicles for aligning employee performance with organizational goals by linking rewards to the achievement of specific objectives. So it’s not surprising annual incentive plans are so prevalent.

But the impact of a plan depends on the effectiveness of its design, as well as how it is communicated. Organizations that regularly review their plans and ensure they remain in alignment with business priorities and competitive market practice will be the most likely to translate such plans into a competitive advantage.

Claudine Kapel

Claudine Kapel is principal of Kapel and Associates Inc., a human resources consulting firm specializing in compensation design, performance management, and employee communications. Claudine is also the co-author of The HR Manager’s Guide to Total Rewards and Straight Talk on Managing Human Resources.
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