Compensation Cafe

When 10% Feels More Like 20%

Whoopee, the economy is in recovery mode!  But where are the pompoms (and the enthusiasm) when you need them?

If you're an economist, indeed we have officially left the recession in the dust, or maybe in the mud. If, however, you're unemployed or feeling like you're hanging onto your job by your (slipping) fingernails, where's your economic love?

That's the not-so-secret dirty secret of the labor markets: they tend to peak shortly after the economy peaks, but tend to recover well after the so-called recovery has began. For those unlucky enough to have been impacted by the 2001 recession (a pretty minor one by most economic standards), you may recall that the labor market took a fairly big hit, and then it didn't start to rebound in any significant way until more than a year after the recession was officially declared dead. Judging by the depth of this recession, and the anticipated weak recovery, it could be like that this time around too.

The "official" U.S. unemployment rate today is 10.0%, but the real unemployment/underemployment rate is far higher. By by the broadest government measure of unemployment, which includes some of the "underemployed" (normally full-time workers working part-time to get by) and those who have given up on looking for employment right now, the rate is 17.5%, or about one-sixth of the labor force. In a few of the harder-hit states, the rate exceeds 20%.  If you add in the full-time workers who've accepted jobs outside of their chosen profession and/or at wages well below what they had been accustomed to  making, the rate is easily a few points higher than 17.5%.

So, with about one-fifth of labor market participants unemployed or underemployed in some fashion, where is the jobs recovery? (When 60 Minutes interviewed President Obama recently and the topic switched to jobs, he said he'd prefer to keep talking about Afghanistan instead, which is understandable, considering the millions of jobs that have been lost since his inauguration). 

There will indeed eventually be be a jobs recovery, but it's likely going to be in the second phase of the overall recovery, when growth reaches the the level where employers feel more confident, and have a pressing need to expand their workforces.  Right now though, most employers are extremely reluctant to begin hiring and to expand their fixed costs, even as business conditions have started to improve. Many -- if not most -- employers are still shell-shocked from the 2008-2009 period.

The good news for now is that it appears the labor market is bottoming, or possibly that we have already hit bottom (only history will tell).  The November job loss count of just 11,000 jobs nationally (seasonally adjusted) was the lowest monthly tally of job losses in nearly a year and a half. If December's data is similarly good, than maybe we are at the bottom,  If not, then we'll probably just skim around the bottom for a while before turning upward sometime in the first half of 2010.

Additional good news, in form of increased temporary worker hiring, is already happening. In November 52,000 temporary workers were hired, and these count as "employed," and this contributed significantly to the low number of total job losses reported last month.  Eventually, businesses will feel comfortable enough to start converting some of these temporary worker slots into full-time "regular" employees.

So, what does this impending recovery mean for wages? First of all, don't expect much of an up-tick anytime soon. Recovering labor markets are like a Sloth on a Sunday stroll (slooooow moving), since it's a supply/demand market.  As long as the supply of labor exceeds demand, there's not much impetus for hiring wages to increase (and those who remained employed will mostly receive very modest pay increases in 2010 and beyond). So, until the supply/demand equation gets re-balanced, don't expect much on the upside. Demand will eventually pull wages upward, but not until most of the excess supply is soaked up.

This labor market funk will pass within the next few months, and we'll be at the bottom or moving slightly upward soon. Don't expect an upward surge though, but a bottom for sure (my fingers crossed), and then a slow but steady improvement.

Cheers and Happy New Year to you all, and to a better 2010 for workers and businesses alike!

Doug Sayed, SPHR, CCP, is Principal at Applied HR Strategies, a Seattle-area compensation consultancy, and the developer of the StrategicPay Series, a series of "hands on" do it yourself (DIY) guides to developing sound, strategic compensation programs.  The first guide in the Series, the Base Pay Toolkit is now available.

The Secret Ingredient

I’m not a big fan of New Year’s resolutions because they so often tend to fall to the wayside as the winter months progress.  I do however believe that improvement is a continual and ongoing process, and the start of a new year is natural time to look at what we want to continue to work towards.  One of the things that I’m going to keep trying to get better at this year is the thing that can make or break any compensation plan, the secret ingredient to success:  communication and training.

It doesn’t matter how much research you’ve done or how thoroughly you understand your audience; if you don’t train the line managers how to properly use the tools, and even more importantly, why to use them; your plan won’t be as successful as it otherwise could be.  Compensation professionals are frequently the more analytic folks on the HR team who tend to be more comfortable with research and spreadsheets, (or maybe I’m just projecting myself onto all compensation people…) and the roll-out of the wonderful new programs can be the least comfortable part of the design process.  But it is the most crucial to the success of any new program.

End users need to understand why a new plan has been created and what is intended to be accomplished.  Perhaps we’ve put together a new incentive program to drive sales, or to drive customer satisfaction.  If the line managers understand the purpose, they’ll be more likely to embrace the new program.  They’ll also be able to make value judgments in any unusual circumstances if they understand the principles and purpose behind the program.  As a side note, if they’ve been involved in the design, you’ll have an even better chance of buy-in.  They also need to understand how it works well enough to talk to their staff about it, and of course less complicated is better.  People need to understand what to do and how to do it in order to provide the desired behaviors and results.

Don’t think that you have to do this alone because there are resources to help with the roll-out process.  A company’s training department can be HR’s best friend.  They can generally help to make sure any presentations or materials speak to the correct audience.  Sometimes they can even do the presenting and training, after all that is their strength and why the company employs them.  If you don’t have a training department you can find seminars on how to present, or do research on your own.  There are a plethora of resources (some better than others) on the web to guide you through materials development and presentation.  Take advantage of the resources you have to help you to be more successful.

If the roll-out and training are handled correctly, the chances of success of your new program are greatly increased.  No one wants to spend months working and getting all the appropriate approvals to simply fail when it comes time to implement.  So my unending improvement journey for 2010 will focus on properly communicating our compensation plans.  Here’s to a wonderful New Year’s and a great start to 2010!

Darcy Dees, CCP works as the Compensation Manager for Rock Bottom Restaurants, Inc., headquartered in Louisville, CO.  She has worked with RBR for nearly 10 years helping to develop many of the compensation and performance management programs the company uses today.  She spends what little free time she has hiking and reading.
The opinions expressed here are the personal opinions of Darcy Dees. Content published here is not monitored or approved by Rock Bottom Restaurants, Inc. before it is posted and does not necessarily represent the views and opinions of Rock Bottom Restaurants, Inc.

Image:  Creative Commons Photo "Ingredients" by Gill Rickson

Benefits Shifting Away from Entitlement to Pay-For-Performance?

Three recent events have caused me to think that employers are no longer thinking of benefits as entitlements; but instead are making benefits a part of their effort to build a performance-based culture.

First, as reported on the Compensation Cafe by Becky Regan on July 10, 2009, IBM's chief HR officer Randall MacDonald talks about making retirement benefits performance-related in an interview in Business Week Magazine "IBM Reinvents the 401(k)":

IBM aims to push the envelope further. "Suppose you made a 401(k) plan that was performance-based?" MacDonald asks. "If everybody gets paid on performance, shouldn't there be benefits based on performance? That's what it means to be a performance-based culture."  

Frankly, I think this trend has already started de facto by the number of companies that suspended their 401(k) contributions during the recent economic downturn.

The second event demonstrating the shift in benefits to performance-based pay is a personal story.  My brother-in-law recently joined a local government entity that truly appreciates the value of his civil engineering work.  Because the employer's vacation entitlement is longevity-based, he had very little earned vacation time.  Further, because it is a governmental entity, there is not a lot of money for salary increases or cash awards.  So the employer got creative ... they gave him an extra week of paid time-off.  Since my brother-in-law's girl-friend is on the other side of the continent, the paid time-off was more valuable than any modest salary increase or cash award that the employer could have scraped up.

There is other interest in linking performance to paid-time-off policies showing up on WorldatWork's Online Community (see Performance-Based PTO Plans).

Third, remember the good ole holiday turkey?  It has turned into a holiday bonus; and SHRM is now reporting that holiday bonuses at many companies are no longer given to everyone ... just to those that have excelled at their jobs.  SHRM reports:

Most companies are tying the size of year-end bonus checks to the performance of the company and/or individual. According to Challenger's survey, 63 percent of those awarding holiday bonuses are basing them on performance.

Hewitt, an HR consultancy, similarly found that holiday bonuses are being replaced by variable pay programs, which have increasingly emerged as the primary pay for performance vehicle for employers and make up a greater portion of an employee’s overall compensation package.

Is nothing sacred anymore??? 

Frankly, the tide has turned.  Any forward-looking employer has to ask how they can get the most out of their personnel expenditures.  Will they get more out of their benefit plans by making them an entitlement related to mere employment or longevity, or will they get more out of their benefits by linking them to successful performance?

Got any similar stories to share about benefits becoming performance-based?  Share them by pressing the "Comments" link below; then scroll down to "Post a Comment".

Guest blogger Paul Weatherhead is a Pay Program Manager for the US Postal Service.  His primary pay program is their award winning Pay-For-Performance program, but he also is involved with other pay and benefit policy issues at the USPS.  Paul actively participates in the WorldatWork professional association as an instructor, author, speaker, reviewer, and blogger.  In his spare time he teaches human resource management courses for the University of South Carolina.  He can be reached at cpaulwd@yahoo.com

All I Want for Christmas

I once had a really great boss.  She spoke honestly, listened sincerely, never took credit for someone else’s work and balanced her own heavy workload with coaching and developing the people on her team. 

She was one of those rare people who can make a run to Starbucks feel like mentoring.

One year at Christmas I got my regular Christmas bonus and a small gift from my boss with a card.  It was an orange cinnamon scented candle from L’Occitane, exquisitely wrapped.  Just a simple gesture of thoughtfulness.  The card included a hand-written message thanking me for several specific contributions I had made over the year.

Now, I’m a rational person.  If I had to choose between a scented candle from my manager and a cash bonus, I’d take the money. 

But the gift meant more.  In particular, the thoughtfulness behind the gift and the personal message that said she was paying attention and valued my work.

If you manage a team, you may not be able to give your team a Christmas bonus this year.  Fortunately, that needn’t stop you from giving small gifts of your own with a personal message of thanks.

I’ve had several other great bosses with different strengths and personalities but one thing they all had in common was that they showed appreciation for my work.

Human assets only appreciate if you appreciate them, after all.

So, don’t give people  the same old song this Christmas about how there’s no money for raises or bonuses.  Why not give them something to sing about?

Merry Christmas!

Picture courtesy of L'Occitane website.  No free L'Occitane products were received for mentioning L'Occitane in this post.

Laura Schroeder is the Product Manager for Compensation Solutions at Workday, headquartered in Pleasanton, CA.  She has more than twelve years of experience designing, developing, implementing and evangelizing Human Capital Management (HCM) solutions in the US, Asia and Europe.   Her articles and interviews on HCM topics have been published in national and European trade journals.  She currently lives in Munich, Germany and enjoys reading, writing and spending time with friends and family.  

Social Entrepreneurship & Navigating NonProfit Sales Incentives

The age of social entrepreneurship, where the lines between traditional business and charitable ventures start to blur, has brought some interesting challenges to compensation design.  One particular challenge is that of appropriately rewarding the growing crop of sales roles in these organizations.

Traditionally, the rainmaking in nonprofits has happened in the area of development or fundraising.  With a careful eye on the regulations governing tax-exempt organizations, which prohibit revenue sharing or private inurement/benefit (where any part of the net earnings of a charitable organization inures to the benefit of a private shareholder or individual), fundraising professionals have been strongly discouraged from accepting compensation based directly on fundraising contributions.

But the world is changing and (as usual) I'm not sure the applicable regulations are keeping apace.  As nonprofits find their traditional funding sources drying up or even disappearing, manyare becoming more creative and more entrepreneurial, developing more self-sustaining business models.  While there are certainly hazards along this path, I think it is by and large a good and exciting trend.

In their quest for self-funding, however, more and more of these organizations are bringing sales and business development talent on board.  They then must determine an appropriate reward approach for a profession which customarily features highly leveraged compensation plans featuring commissions or incentive awards tied to sales results.

And there is very little guidance out there - by the IRS or any other regulatory bodies.  Attorneys I've consulted who specialize in working with nonprofits will only say that this is a very complex area of law and one which must be carefully navigated.

Which isn't a lot of help to the nonprofit leaders trying to navigate this brave new world or those of us advising them along their journey.

So ... Dear IRS Tax Exempt Unit:  We could really use your help here.  Please get on the stick.

In the meantime, I offer a few thoughts to those of us - nonprofits and their advisors - trying to do the right thing in designing rewards in the area.  

Pay attention to total cash opportunity.  While sales staff may not be disqualified persons by the IRS' definition, you will want to be sure that the package you put in place to reward sales performance is reasonable in light of competitive practices and cannot be construed as an excess benefit transaction.  This is not the private sector, where it is OK for an exceptional salesperson to make way more than the CEO.

Keep variable pay at a conservative level.  This may mean setting incentive targets at 15% to 20% of base, rather than at for-profit levels.  And yes, that means more pressure on effectively managing your sales talent, since you cannot depend on the commission plan (and a 50/50 pay mix) to drive the low performers out the door.

Use broader, not-exclusively-financial metrics.  Rather than a simple commission approach where the salesperson earns a percent of the revenues brought to the organization, consider a broader, more holistic set of performance measures for reward purposes.  Yes, even for salespeople.

Honor the charitable mission.  Ensure that some element of the reward package includes measures tied to the charitable purpose and mission of the organization.

Those are my thoughts.  Readers, particularly those who work in or regularly advise nonprofits, let's hear yours!

Ann Bares is the Editor of Compensation Café,  Author of Compensation Force and Managing Partner of Altura Consulting Group LLC, where she provides compensation consulting services to a wide range of client organizations.  She earned her M.B.A. at Northwestern University’s Kellogg School, enjoys reading in her spare time.  Follow her on Twitter at @annbares.

Re-Gifting You Some Wonderful Advice

You know it’s true.  Sometime over the holidays, you’ll find yourself in front of your computer, just fiddling around. If you don’t have time today, check out these columns then. The first two are short and snappy, with real insights.  The third is pure wonder. You’ll be at home, so you may have sometime to really think about them – they deserve it.

In the meantime, here’s a few gifts that I received from them.

• Retaining Star Performers in Trying Times by Amy Gallo, with quote by Jay Conger
  “Companies tend to by more controlling in tough times . . . It’s important to counter that tendency.”  Important advice at a time when more companies are wandering into more restrictive forms of compensation like Variable Pay.

• Why We Don’t Care About Information Overload by Tom Davenport
  “We undervalue our own attention . . . We open junk mail, we watch junk television, we read junk email. It would take investment of attention to save our attention, and most people just aren't willing to invest.” It’s a provocative argument for putting up, happily but not wisely, with all that noise.  Or it’s a trenchant wake up call.  You decide.

• What Matters Now by Seth Godin
  “It turns out that the connected economy doesn’t respect this natural instinct [of thinking of yourself first]. Instead, we’re rewarded for being generous.  Generous with our time and money, but most of all being generous with our art . . . This is your art, it’s what you do.  You touch people or projects and make them better.” 

Join Seth and 70 other innovators and entrepreneurs – download their beautiful PDF – of “big thoughts and small actions” that we can think about and do in 2010. (Even the much talked about Daniel Pink is in there.  He overdoes it again, but at the same time shines a bright light on some bad business habits we’ve taken for granted.)

Have yourselves a merry, merry one!

Bah Humbug!

It’s that time again.  The end of the year, when managers everywhere turn their thoughts to – bonuses!  The calculators are out and everyone from sales managers to the executive suite tries to figure out how fat that check will be.

I’ve been around the block more than a few times, and I can tell you that the same bad script repeats itself year upon year for the annual management bonus process:  objectives created at the last minute, embellished accomplishments dutifully recorded, problems and shortcomings diminished or forgotten and assessment forms looked at with disdain – as in, how do I fill this out to maximize my results?

The process is flawed, yet the foxes are in charge of the chicken coup – and they offer little hope for reform.  Why?  For those in charge the process works, and self-interest pays its own rewards.

Cynical?  You bet.  For many of us in the trenches true pay for performance is an elusive concept best left in Compensation 101 textbooks, suitable only for life as it should be, not as it is.  Sad to say, but senior management is often the worst offender.  I’ve seen executives manipulate, er, adjust financial results to ensure that their bonus awards wouldn’t be reduced.  Senior staff deserves competitive bonus awards, don’t they?

While studies have suggested that the entitlement mentality has weakened through this recession, I’m convinced that it’s still alive and well wherever rewards are viewed as payment due for time served, not the result of job performance.

But we go on hoping, one company and one client at a time, trying to persuade leadership that it is primarily good performance that should provide rewards; that tenure isn’t a compensable factor, that incentive payments should be deserved, not simply an act of delayed compensation.  Lower level employees are expected to earn their rewards; shouldn’t the same case be said for management?

Have you ever told an executive that their bonus would be reduced because of either corporate or – dare I suggest individual performance issues?  They would look aghast at the possibility.  I’ve taken calls from spouses asking when the checks would be cut – and then become upset when told of the review process and that the Board has to approve.  The common attitude is, times up! – where’s the money?

Will the situation be any different for the bonus cycle in 2010?  I hope so, but bucking the trend of human nature is far from a sure bet.

To make a change you need to stand up and speak up.  The process is starting now, so it’s not too late to have an impact, to instill a management pay-for-performance philosophy in your company - one step at a time.  

·         Performance appraisal shouldn’t be an activity list (I was very busy) but a focused statement of achievement against objectives

·         Let the assessment tell you the rating, not the other way around (how do I fill out this form to give a 4 rating?)

·         Confirm that the language in the assessment form corresponds to the performance rating.  Oh yes, you have to check.

·         Assessment forms should be required before an incentive payment is made – negating an old procrastination trick

·         For the 2010 cycle, start with having objectives established early in the year, not in a rush at the end

It’s Christmas, the season of light, cheer and new beginnings, so let’s be optimistic.  Prove me wrong and get it right.  Or at least start.

Merry Christmas and Happy Holidays to you and yours

Chuck Csizmar CCP is founder and Principal of CMC Compensation Group, providing global compensation consulting services to a wide variety of industries and non-profit organizations.  He is also associated with several HR Consulting firms as a contributing consultant.  With over 30 years Rewards experience Chuck is a broad based subject matter expert with a specialty in international and expatriate compensation.  He lives in Central Florida (near The Mouse) and enjoys growing fruit and managing (?) a brood of cats. 

Image: Creative Commons photo by Ivan Walsh

Pay For Performance, Really?

Most companies today claim to pay for performance.  It makes sense, who wouldn’t want to spend their money on an area that provides the highest return?  But are you paying enough to make it worth your employee’s extra effort?  Even more importantly, do your employees believe that they will receive higher pay if they outperform their peers?
 
Why does pay for performance matter?  I used to work in a unionized public sector environment where pay was determined solely by job level and years of experience.  I was giving a review to a solid performer one time who actually said to me, “I don’t have any reason to work any harder, that guy who’s worked here longer than I have makes more money than I do even though he doesn’t do as good a job.”  Now, I would never recommend saying that to one’s supervisor as it certainly colored my opinion of her; but I did have to acknowledge (internally) that she wasn’t totally off base.  The pay system that we were bound by didn’t reward performance at all and I couldn’t give anything other than the prescribed increase.  This was a fairly young girl who made this comment, but I’d bet that employees probably share these feelings to some degree in any environment where performance doesn’t have a direct tie to pay.  Not good if you need your employee’s full efforts to succeed.

There is another business reason to pay for performance that may just get your CFO on board.  According to Hay Group surveys of “most admired” companies, more than half of those identified companies provide pay increases to their top performers that are over two times larger than those provided to their average performers.  They truly differentiate the rewards given and really pay for performance.  Since companies that receive the most admired rating consistently outperform their competitors financially, emulating their best pay principles is probably not a bad idea.

It’s easy to test and see if you really do pay for performance by comparing the total remuneration package of your top performers to that of your average performers.  If an appreciable difference doesn’t exist, you might want to reconsider how you give your rewards out.  You may even be able to reallocate funds from lower performers to fund the rewards for your top performers.  If you do differentiate pay for top performers then you should communicate that to all of your employees to encourage more effort and better results from all employees who will believe they’ll be rewarded for those efforts.

Darcy Dees, CCP works as the Compensation Manager for Rock Bottom Restaurants, Inc., headquartered in Louisville, CO.  She has worked with RBR for nearly 10 years helping to develop many of the compensation and performance management programs the company uses today.  She spends what little free time she has hiking and reading.
The opinions expressed here are the personal opinions of Darcy Dees. Content published here is not monitored or approved by Rock Bottom Restaurants, Inc. before it is posted and does not necessarily represent the views and opinions of Rock Bottom Restaurants, Inc.

Image:  Creative Commons Photo "Don't Hide.  Be Different!" by pasatraspaso

Federal Government Pay Explodes For 6-Figure Jobs

It used to be that the public sector couldn't compete with the private sector in terms of paying their employees.  However, that's not the case anymore according to a recent USA Today article "For Feds, More Get 6-Figure Salary."

Now, the best advise for job seekers appears to be to go to work for the Federal government. Federal workers are reaping the employment boom in both terms of pay and the sheer number of added jobs.  More jobs have been added between December, '07 through June,'09 (source: Office of Personnel Management) at a rate of 10,000 jobs per month than anytime since the creation of Medicare and Medicaid in the 1960's.

Their experience directly contrasts the private sector's employment picture during the same time frame, in which 7.3 million jobs have been lost.

Yet, not only has the number of jobs risen dramatically in Federal government, their pay has exponentially increased as well.  According to the Office of Personnel Management, employees earning $100,000 or more equaled 382,758 people in June, or a 46% increase from December of '07. Those who make more than $150,000 per year numbered 66,538 in June, or a 119% increase.  And for the highest tier reported in the article who make more than $170,000 per year, they numbered 22,157 representing a 93% increase since December of 2007 through June of this year. 

This apparent turnaround in Federal jobs and compensation is simply stunning! 

When I graduated from college several decades ago, none of my classmates went to work for the public sector, unless it was to do a gig in the Peace Corps or to work as a teacher for the State.  And later, when I worked as a HR Director for several companies in the State capitol, it was our biggest competitor for our employees because of their rich benefits package and promise of job security.  But Federal jobs weren't even on the radar screen for most people I knew.

According to the USA Today article, "when the recession started, the Transportation Department had only one person earning a salary of $170,000 or more.  Eighteen months later, 1,690 employees had salaries above $170,000." 

This trend is repeating itself throughout the Federal government, in large agencies and small agencies, with technical and non-technical jobs.  Jessica Klement, government affairs director for the Federal Managers Association, says the federal workforce is highly paid because they employ highly skilled employees such as lawyers, scientists, and physicians. 

USA Today analyzed the Office of Personnel Management's database that tracks salaries of more than 2 million federal workers, excluding the White House, the Postal Service, intelligence agencies and uniformed military personnel.  Their study showed that the average federal worker's annual pay is $71,206 as compared to the private sector's average at $40,331. 

Granted, I don't know whether that's a legitimate comparison using salary only or total compensation, or their methodology. Even so, it appears to demonstrate the huge ramp up in pay that the Federal workers have realized over the past few years.

The key reasons cited for the dramatic increase in Federal pay rates include:

1. Pay hikes.  Federal employees received across-the-board raises of 3% in January of 2008 and 3.9% in January of 2009.
2. New pay system.  Merit increases using a new National Security Pay Scale for the Defense Department began in January of 2008 in addition to the pay hikes mentioned in #1.
3. Pay caps were eased.  Many top civil servants cannot earn more than an agency's leader, but if Congress raises the leader's salary, others get raises too.  Example: When the Federal Aviation Administration Chief's salary rose, nearly 1,700 employees had their salaries lifted above the $170,000 limit too.

I wonder what the Pay Czar, Kenneth Feinberg has to say about the pay rates of Federal employees?

Becky Regan is the founder and President of Regan HR, Inc., a human resources consulting firm specializing in compensation consulting for California employers and purveyor of online HR products. A former Corporate Human Resources Director (10,000+ employees) with more than 25 years of HR work experience in many industries, her team works with private, public and non-profit clients.  Becky is passionate about designing HR programs and compensation plans that build organizations.

Flickr photo courtesy of autodetailer.

Executive Compensation: The Real RIsk

Although the correlation between executive pay and risk hasn’t been proven, there seems to be general agreement that a well-designed executive compensation package should allow for some risk while discouraging excessive risk-taking with an appropriate mix of long-term incentives and focus on performance based pay. 

However, there are a few problems with this:

•Focus on the Wrong Kind of Risk: When business analysts argue that executive compensation should encourage an appropriate level of risk-taking, they seem to be talking about bold acquisitions or moving into a new area of business to support long-term growth.  But there are other kinds of risk, for example, the risk to long-term company viability created by dramatic layoffs and other draconian cost cutting measures.  Executive compensation packages don’t typically guard against this kind of risk. 

•Flawed Definition of Pay for Performance: It seems reasonable to assert that executive pay should be based on performance, although my last post about tying rewards to creative endeavors discusses why this might not be such a great idea.  The problem is that when we talk about performance with respect to executives, for the most part we’re talking about share price.  Unfortunately, although share price is supposed to take long-term risks into account based on the efficient market hypothesis, we have seen how easy it is to inflate the perceived value of financial assets, at least for a while.

•Short-Term Incentives Disguised as Long-Term Incentives: According to the recent Workspan article ‘How Well Do You Understand the Relationship Between Pay and Risk?’, stock is generally the favored long-term incentive. The problem is that if you have a LOT of shares a .01 cent increase starts to look like real money in the short-term.  So, you can hold out for the long-term pay off, which will require luck, skill, and investment, or you can lay off a third of your key personnel and cancel the Christmas party and cash in now.  It takes a special sort of leader to take the high road when everyone else is cuttings costs and the rewards are far from assured.

•Executive Compensation is Set by Other Executives: There has been recent outcry that the government doesn’t have the expertise to control executive compensation, but do executives?  In his recent post ‘Why You Want Rich People to Set Your Pay,’ Bob Sutton noted that the higher the Board of Directors is compensated, the higher they will compensate the CEO on their watch.  This is possibly why we see so many outrageous examples of golden parachute agreements that provide former executives and their wives with lifetime tanning and poodle walking services.  (I made that up but it probably exists - see New Yorker article ‘The Pay Problem: What’s to be Done About CEO Compensation’ by David Owen for more sobering examples of golden parachute agreements.)

•No One is Watching the Watchers: Most company shareholders own a small number of shares, likely as part of a diversified portfolio managed by a fund manager and hidden in some sort of investment fund.  Although they may vote on Board elections, they have little actual power over the Board.  Theoretically, large fund managers can influence Board members but in practice they probably sell other lucrative fund management services such as 401K administration to the same company.  And although long-term company health is definitely a bonus, large investors make plenty of change on short-term windfall gains and the smaller investors who invest with them also benefit.  So, unless the entire system actually melts down, who’s complaining?

Despite claims that it’s difficult to understand the relationship between pay and risk, it's really not. Executive incentives tend to discourage long-term thinking and reward more short-term means of maximizing shareholder value. 

And that's pretty much what happens. 

Cartoon courtesy of Joshua Kennon.

Laura Schroeder is the Product Manager for Compensation Solutions at Workday, headquartered in Pleasanton, CA.  She has more than twelve years of experience designing, developing, implementing and evangelizing Human Capital Management (HCM) solutions in the US, Asia and Europe.   Her articles and interviews on HCM topics have been published in national and European trade journals.  She currently lives in Munich, Germany and enjoys reading, writing and spending time with friends and family.