Variable Pay, Part I: Incentives
Prepared by Barbara D. Morrow, MBA, CCP
Besides base pay compensation, variable pay is another element that can be used to motivate and reward employees. Variable pay is compensation that is contingent on discretion, performance, or results achieved.
Incentives are any form of variable payment tied to performance. The payment may be a monetary or non-monetary. Unlike cash bonuses, incentives are based on performance goals that are predetermined.
Incentives plans enable organizations to deliver targeted results while rewarding employees who are responsible for those results. Incentive plans can be designed to focus on three levels of performance as listed below:
These incentives are based on the results of an individual relative to his/her job responsibility.
These awards are based on how a group of similarly functioned individuals perform collectively to achieve results.
These incentives represent broader plans based on total company or group performance.
Regardless of the level being targeted, an incentive plan will include the following design elements:
This portion of the plan includes criteria used to determine eligibility such as employment status, length of service, individual performance, whether payouts will be given to people who leave the organization, etc.
Target incentive is the guideline incentive percentage expected for a position and represents what the employee ought to earn if the organization achieves 100% of the plan’s performance criteria. It is often expressed as a percentage of pay or midpoint, although it also can be expressed in terms of dollars.
In some companies, high performers may have a higher target incentive percentage. Poor performers may not be eligible for an award.
Performance criteria must measurable and within the participants’ control. Criteria may consist of financial and/or operational measures. Weights may be assigned to each criterion. Sometimes there is a minimum threshold that must be met before the incentive plan will pay out. Maximum payouts are typically designed to control costs and prevent windfalls. The example below shows how an organization’s performance results affect the actual bonus payout for an individual.
Salary Target Perfor-
Range Target Incentive mance
Grade Midpoint % Award Criteria Notes Award
8 $50,000 10% $5000 90% (a) $4500
8 $50,000 10% $5000 100% (b) $5000
8 $50,000 10% $5000 120% (c) $5500
(a) Results are below performance goals
(b) Results meet performance goals
(c) Results excel performance goals
Each plan sets a time for payment of bonuses. Typically, incentive plans are most effective when rewards are given soon after the results are measured. Companies may pay out incentives in separate checks to highlight the reward.
In order for an incentive plan to be effective, senior management must support that the plan will reinforce their business strategy; goals should be easy to understand and have some ‘stretch’ so that the payout is not automatic; the size of the award should be motivational; and communication of the plan design and purpose to management and employees is essential.
Source: WorldatWork’s Handbook of Compensation, Benefits & Total Rewards
Barbara Morrow is a Compensation Consultant at Strategic Workplace Solutions, Inc. She helps organizations understand total reward strategies and develop base and incentive compensation programs.