Lump Sums in Lieu of Merit Increases

Must admit, I simply do not understand why so many enterprises continue to give lump sum merit increases for folks beyond their grade maximums.  Here's my thinking:

Pros =

• Pleases the employee
• Can be attributed to a need to retain the valued employee
• Permits the flexibility to continue rewarding certain individuals beyond normal limits
• Clearly communicates that range maximum control policies are not rigid
• Gives away money without being added to the semi-infinitely-compounding base pay amount
• Increases the payroll budget beyond the policy limit for the manager, so they get a bigger budget next year, too

Cons =

• Foments envy among those denied the more favorable treatment (if exceptional and not universal)
• Still "compounds," in a sense, being subject to taxes and frequently affecting other remuneration entitlements based on total annual income
• Creates a much bigger cash flow "hit" on payroll funds, with a lump sum equal to an annual increase treated as a bonus, an immediate large drain on funds
• Is completely wasted if the recipient leaves after the payment check has been cashed rather than dribbled out in paycheck increments like a salary increase
• Blurs the lines between the “lump sum in lieu of increase” and a “normal bonus” and can thus lead to double-snapshots (being paid twice for the same thing), confusion about which is for what or cancellation of one as redundant when both are actually proper
• Doesn't create any noticeable retention effect (the individual is already paid far more than any internal/external peer and will be unable to find matching income elsewhere)
• No research exists anywhere to support the claim that it is necessary
• Availability of lump-sum payments discourages the use of alternative superior non-cash rewards
• Extends and further perpetuates the total earnings disparities between peers with otherwise identical characteristics
• Misallocates scarce dollars badly needed for lower-paid peers who will never catch up despite superior output results and who thus remain more vulnerable
• Permits a department's payroll budgets to exceed the policy limits
• Clearly communicates that pay constraint measures are not serious
• Bluntly and forcefully declares that there is no upper limit to pay for any job
• If permitted as an exception, demonstrates that the pay system is fundamentally flawed

When lump-sum increases extend payroll costs beyond the levels permitted under your standard pay program, that implies that your normal program fails to meet your competitive and equitable tests.  Ok.  Then, why not redesign it accordingly rather than apply a "patch" solution like lump-sum increases?  It would seem that it would be more appropriate to consider other options:  (a) reclassify the position into a grade more appropriate for its incumbent's obvious true economic value, (b) create a special entitlement award category for the person if it's not a job-specific situation, or (c) otherwise revise the official pay administration program in order to have a more rational response with better positive effects and fewer (or less serious) negative effects.

Someone:  please enlighten me about what I obviously must be missing, since everyone seems to merely shrug and accept the concept that when someone hits the pay ceiling, the standard operating procedure is to use flat cash awards to raise employee total compensation without affecting the guaranteed base rate.  Pay policies that encourage infinite increase expectations via flat cash awards seem to be quite normal and well accepted, but where is the evidence that such lump-sums in lieu are necessary and superior to other alternatives?

E. James (Jim) Brennan is Senior Associate of ERI Economic Research Institute, the premier publisher of interactive pay and living-cost surveys. Semi-retired after over 40 years in HR corporate and consulting roles throughout the U.S. and Canada, he’s pretty much been there done that (articles, books, speeches, seminars, radio/TV, advisory posts, in-trial expert witness stuff, etc.) and will express his opinion on almost anything.

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Comments

[Laura Schroeder]

I enjoyed this post, which presented several refreshing new arguments. I think the thinking generally stops at not creating an ongoing salary burden that blinks on your 'above grade max' report. As for the one-time payroll hit, some companies distribute both bonuses and lump sums over multiple pay periods.

[E. James (Jim) Brennan]

Some negative effects from the continued largesse of lump-sum increases can be minimized and finessed, but why are doing this in the first place? Have Total Rewards professionals simply accepted the prevalent entitlement philosophy that pay always grows, no matter what? Is it merely our role to assure that personal incomes and total remuneration amounts are larger every year? If so, then lump sum increases are just another useful administrative device for our primary mission: to spend money. But I thought we had a deeper and broader purpose than that.

[Joe]

Thanks Jim. I just moved to an organization that uses lump sums more than my prior org so I appreciate timely post. Here are my quick thoughts/responses.

The pro is that is doesn't compound in the true sense of the word. The ER can provide the EE a monetary increase that keeps them "whole" for the year w/o increasing the liability of increase dollars in year two. Win-win.

Reclassing the EE to a new grade sounds like gaming the structure and destroys the integrity of the system, which is designed to catch those whose pay--for whatever reason--is above the value the ER puts on the position.

Creating a special entitlement award as an option sounds a lot like a lump sum.

Option C sounds good but I don't have viability to what that actually means.

I hope you don't take this as argumentative--I think it's a great and timely topic for me and I'm just trying to fully understand.

Joe

[E. James (Jim) Brennan]

My question goes to the issue of WHY we are continuing to assure infinite added income to people whose pay "is above the value the ER puts on the position." Why is more cash required to keep folks "whole"? At present, inflation is flat or negative, buying power is higher than before, competitive market rates are going nowhere (if not already in reverse) and your internal pay program is screaming "tilt" because the individual's remuneration has passed the limit of rational justification. What's the justification?

Maybe we comp people are addicted to dispensing funds and making EEs happy. That's what I'm trying to understand: do we have a rational purpose behind the lump sum increases not better served by other mechanisms like performance incentive bonuses and non-cash reinforcements. Those options don't carry the same entitlement implications.

[Joe]

Inflation is positive... for now. Don't know if it's as much as making EEs happy as it is keeping them in the game and away from being disgruntled, which can decrease productivity and can be contagious.

The variable mix is a point well taken but not sure if outliers are worth the design and administrative hassle.

[E. James (Jim) Brennan]

Good point, Joe, that a disgruntled senior staffer is particularly toxic. You do what you have to, but we do well to remember that there is more than one arrow in the quiver. "The game" is not always about cash.

[Paul Weatherhead]

Jim, In many of your posts on the WorldatWork community you have talked about the dangers of lemmings following each other off the cliff. So you will no doubt appreciate the fact that we take a different approach to the issue.

In our Pay-For-Performance system discussed in the Workspan article "Pay For Performance Works" (http://www.worldatwork.org/waw/adimLink?id=16925&nonav=yes) we pay our awards as salary increases. Any part of the award that would bring an employee's salary over the grade maximum is converted to a lump sum payment. If a red-circled employee is over the maximum, its all paid as a lump sum payment.

All the percentage awards are calculated on the employee's base salary, regardless of where the salary stands inside and outside the range. We do this for ease of employees understanding the link between the PFP award matrix, the percentage award, and their own base salary.

Why provide anything to someone impacted by the salary maximum? We feel that all employees can make a contribution - no matter where their salary is inside or outside of the salary range. That's why the person is employed. We feel that it keeps everyone "in the game" (so to speak) to keep them eligible for the PFP award matrix.

[TylerD]

To those saying that low inflation / CPI growth means employees don't need/deserve raises, obviously don't know much about how inflation is measured.

For most employees, those making less than 75,000 per year food and energy make up a large fraction of there expenses. CPI does not include food and energy. So "inflation" could be low or negative while your "overpaid" employees are paying more at the pump and at the grocery store. Not to mention that CPI is almost as gamed as the U3 unemployment numbers that it really tells you nothing about what it cost real people to live on a day to day basis.

[E James (Jim) Brennan]

Everyone always wants more, all need more, most believe they deserve more; and "inflation" or "CPI growth" are favored mantras proven effective for justifying raises over generations. They have waned in usefulness recently but should gain utility again as the Federal Reserve pumps bond money into the U.S. economy. Granted, those are terribly misunderstood metrics, whichever version of each you use, and neither term (which assumes a fixed arbitrary marketbasket of goods of services) accurately reflects what actual American family lifestyle costs are.

That said, what it costs your family to live is not the same as what it costs mine, and those unique individual expense decisions are beyond the control of our employers. My article was not about employee costs or family expense budgets but about one particular pay element of employER costs.

Your topic is important but this isn't the time or place to cover it. Rest assured, there have been and will be other opportunities.