Compensation Cafe

Stop the $600 Annual Incentive!

As regular readers know, I am someone who does a ton of incentive compensation work. I believe in incentives and their ability to align people with the culture, strategy, and goals of a company. I know incentives work when properly designed and communicated. I also believe that managing people is more important than incentivizing them.

This is a quick article about well-meaning but misguided short-term incentive plan design. When business leaders are asked to identify critical metrics for success, we often get two types of answers. The first is a big-ticket item that aligns well with management. These metrics are important, but they may not always resonate with rank-and-file employees. The second answer is a laundry list of all the things that must be accomplished during the upcoming year. In between these answers is the real core of your incentive plan.

A few years ago I wrote about the Incentive Plan Rule of Three. This can be summarized as: “No more than three metrics (KPI), no more than three defined goal levels, no more than three incentive plans for any one individual.” This rule allows you to focus your incentive on what matters, but it also helps make those incentives meaningful.

Over the years I have seen many companies with “multi-metric” incentive plans. These plans usually have one big goal that covers 30-50% of the total incentive target and 4 or five smaller goals that break down the remainder of the incentive target. These may be great when target values are large, but they are just plain crazy for your mid-level and lower-level professionals and support staff.

Let’s do some math!

Imagine Sally makes $60,000 a year. You have created an incentive budget targeted at 10% of her pay. There are six metrics that drive the target value. The main metric covers 50% of the total, the other five metrics are evenly split at 10% each.

$60,000 * 10% = $6,000

50% of $6,000 = $3,000 (not terrible)

10% of the remaining 50% ($3,000) = $600 per “mini-metric”

This means that you are asking Sally to focus on something specific and work to attain a higher level of performance for about $2.75 per day, or $0.35 per hour. Sally must keep $0.35/hour. as related to a specific mini-metric top of mind for the next year and the hope that, after taxes, she has “won” the money to buy her kid a Lego set! To be perfectly clear. To be clear, Sally isn’t going to do that.

This is where managing beats incentivizing. The leader who chose this metric was probably right in defining it as important. But the return from the incentive plan will have no impact on the achievement of this goal. Clarifying this metric as a management goal for the leader and ensuring that they follow through on communicating and updating progress throughout the year will have far more impact. This is where compensation professionals have to educate. (Don’t “push back.”  Teach.)

With a bit of math and discussion about best practices, you can usually get leaders to reevaluate and narrow down the focus of the incentive plan and help everyone have a more incentivizing year.

Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is a leading expert on incentive plans and equity compensation issues. He has written several industry resources including a resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.

Cafe Classic: The Innovator's Dilemma, Reward Plan Edition

Editor's Note:  A salute to the late, great Clayton Christensen, the academic and management consultant who developed the theory of "disruptive innovation." 

Think that premium employment brand and strong reward package are going to help you succeed in the age of disruption?

Think again.

In his revolutionary bestseller The Innovator's Dilemma, the late Harvard Business School professor and innovation expert Clayton Christensen explored the dilemma behind innovative, well-managed companies who seem to do everything right and yet encounter a dive in their market share or even disappear entirely.  In fact and most disturbing of all, Christensen's research showed that the things that bring and secure an organization's initial success can often become the most powerful reason behind its failure.

In their chapter within the Oxford University Handbook on Organizational Climate and Culture, Mercer consultants Richard Guzzo, Haig Nalbantian and Luis Parra tell the story of a company that experienced the reward plan version of the innovator's dilemma.  Organizations -- the authors note (and many of us know from our experience) -- often become what they reward, and pay is considered a critical expression of an organization's culture.  When a company's culture, which has been a key reason for its business success, becomes an impediment to necessary change, the reward system may be a primary culprit.

The authors share the example of Digitt, a global technology and information services company.  Digitt was renowned for a strong culture that emphasized innovation, teamwork, employee participation in decisions and performance-based pay.  In studying Digitt, the authors took a "big data" dive, conducting an internal labor market (ILM) analysis that drew on up to 10 years of employee data in order to statistically measure, model and ultimately understand the most important drivers of workforce outcomes.  In addition to other findings, the analysis revealed the following two characteristics of the company's reward program:

• Digitt had a strong internal labor market that was insulated from outside labor market dynamics.  Talent was built from within, with the most successfu employees entering the organization right from school and advancing internally.  Mid and late career professional hires were infrequent.  Most open positions were filled internally through promotion or transfer.
• Because Digitt's performance rewards were predominantly group-based, pay variations reflected business unit performance much more than individual performance.  As a consequence, an employee's tenure and business unit location were the biggest drivers of pay.  There was little variation in the level of rewards flowing to the lowest performers versus the highest performers.  (In fact, the authors concluded that close to $100 million a year in rewards flowed to lowest quartile performers when all elements of "performance-based" pay were added up.)

Digitt, in the face of rising competition and technological change, found itself in a place where it had to transform both its business model and its product/service offerings -- a transition that had enormous implications for the skills and capabilities of its workforce.  It needed, in essence, to renovate its talent base. Unfortunately, the company's cultural reality, driven substantially by its reward practices, threw some substantial roadblocks into its path:

• Being handsomely paid based on their tenure and their position in declining yet still profitable business units, there was little incentive for those with outdated skills and capabilities to leave.
• In contrast, newer employees with more relevant skills and experience were disadvantaged pay-wise by a system that rewarded tenure and reflected their placement in newer business units that were still ramping up and not yet profitable enough to reap the rewards of existing incentive and profit-sharing plans.
• The problems above were exacerbated by the insulation of Digitt's internal labor market and the lack of market-sensitivity in its reward programs.  As the authors noted:

Internal labor market signals about relative value were telling lower-performing analog engineers to stay at Digitt, even as external labor market signals would have communicated depreciation of their value...

The lesson is this:  When business conditions change, as they now do at an ever quickening pace, the very culture and reward programs that created success could now be an obstacle to sustaining that success ... or even surviving.  That speaks to a level of vigilance that I suspect few of us are keeping.

I'll bet some of you are living your own version of this innovator's dilemma. 

Ann Bares is the Founder and Editor of Compensation Café,  Author of Compensation Force and Partner at Altura Consulting Group LLC, where she provides compensation consulting and survey administration services to a wide range of client organizations.  She earned her M.B.A. at Northwestern University’s Kellogg School and enjoys hiking, reading and hanging out with family in any spare time.

 Creative Commons image "Oops - Part II" by Kyle May

Cafe Classic: Don't Use Pay as a Babysitter

Editor's Note:  In this post, Chuck Csizmar addresses this Classic problem practice, a favorite of ineffective managers.  I'd wager that many of you have your own pay baby-sitting stories to share...

Have you ever used a babysitter?  This is when you have someone else assume your responsibilities while you take a break and focus on something else.  The babysitter stands in for you, is you during the period of your absence. 

Typically we think of babysitting when there’s a dependent child involved, but in the workplace it’s not uncommon for ineffective managers to use the same concept when dealing with their employees.  These managers seek to use the pay that their employees receive as a surrogate for leadership – for keeping those workers complacent, retained and generally “in line.”

The practice of manipulating rewards presumes that the employee will chase the money, and will be happy with their lot, while at the same time will not require much in the way of supervision, periodic direction or even meaningful conversation.  The thinking here is that, if I provide you with enough reward you will act as desired in order to not jeopardize those payments.  The goal is to place the employee’s attitude and performance on automatic pilot while the manager is engaged elsewhere.

So far, so good.  Not necessarily a problem.  The red flag goes up the pole when you consider whether these monies are warranted by either performance or business need, or are they simply bribes?

What are we talking about?

Scenarios where pay is used in lieu of actual management are easy to spot.

• The Grand Giveaway:  Where managers try to give away as much money as they can to as many as possible, not worrying overmuch with distinctions between individual performances.  The key is to build an employee's appreciation of their manager’s largesse.

• Title inflation: The promise of bloated and meaningless titles that distort organizational structures, for the prime purpose of rewarding employees in lieu of cash.

• Over rated performance:  Playing the good guy by over-rating performance during salary reviews.  Culprits are often seen rewarding activity over results.  So look busy!

• Assured compensation: Take the risk out of rewards and encourage an attitude of entitlement.  Everybody receives an annual merit raise, everyone earns a bonus. 

• Counter-offers: “Let’s make a deal” attitude to keep resigning employees from actually leaving; a dangerous practice that increases costs and lowers morale.

What’s the cause of this behavior?   Managers typically receive inadequate training (if any) on how to use their company’s pay programs, so many use pay as a crutch.  Spending the company’s money effectively and efficiently isn’t on the radar screen.  They use pay like a club to get an employee’s attention.  And once they have it the manager is off doing something else – with the presumption that pay will substitute as supervision and motivation while the manager is absent – kind of like a babysitter.

Weak and ineffectual managers don’t actually manage their employees, in the sense of performance direction, leadership, setting good examples and decision-making.  Instead, they want to be liked.  They want to avoid conflict and they don’t want anyone to quit.  They want employees to get along, and to help foster a friendly team atmosphere they try to manipulate pay in support of their efforts.

It’s really kind of a bribe.

So what is “managing” to these people?  It’s not about making hard decisions.  Too often it’s trying to get the most for their employees, deserved or otherwise, whether the organization gains in the process or not.  The manager is focused on their own interests, and is using someone else’s money to fund their behavior.

Why it doesn’t work

Relying on pay as a replacement for management has a short effective life cycle.

• Employees see arbitrary same-same pay treatment as de-motivating to high performers.  Why bother extending yourself if you’re going to receive the same reward as the guy doing crossword puzzles?

• Employees resent favored-son treatment and those who benefit for non-performance reasons will always become known.  There goes your morale.

• No amount of money replaces the value of honest performance direction and feedback.  Those with an interest in learning and growing appreciate the help.

• Absentee managers lose the respect of their employees, who know what’s going on.  Remember that employees leave managers, not companies.

For managers who need a crutch to help motivate and retain their employees, to help them do their jobs, the above cautions likely won’t make a difference.  Their goal is not to manage, but to get-by, to be liked by their employees and to avoid disruptions to their routine.  This is not leadership, but administration.

But for those managers who wish to make a difference, who understand that managing employees is a challenging and rewarding role, abrogating responsibility through babysitting is not an option.  They recognize it as the opposite of management, a damaging practice that will not enhance anyone’s long term career prospects.

Chuck Csizmar CCP is the 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.  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 clowder of cats.

Cafe Classic: Uncertainty Motivates No One

Editor's Note:  Part of our job, if we do it well, is to remove uncertainty and ambiguity from rewards where it can and should be done (and correctly discerning where this is true).  Dan Walter examines this in today's Classic post.

Have you ever been asked by an executive or compensation committee to create a compensation solution for a problem that was poorly or incompletely described? Nearly everyone reading this has had this happen. Admit it. As you walked away you were probably uninspired even though you may have said yes. That’s because uncertainty isn’t motivating. In fact, when you ask people about their most common driver of procrastination most will say it has something to do with not being certain of how to move forward. The list includes: big projects that require you to delve into areas where you are less than fully confident; complex calculations that require the creation of new formulas or entire tools; dark basements on stormy nights after a blackout; blog articles when you might not have a great idea. You get my point.

Compensation is fraught with uncertainty. Outside of hourly pay and salaries, much of what we do is based on variability (translate that to uncertainty.) The compensation world has lived by the mantra of “attract, motivate and retain” for so long that sometimes we believe just telling our employees that we designed a program to support these goals is reason is enough to make them occur.

Incentive plans, short and long-term, cash and equity based, depend on a level of uncertainty. The point of these programs is for participants to make the potential happen. Our job is to remove as much ambiguity as possible and allow clarity of the potential. One challenge is to make the potential clear without making promises. Another is continuing to have people focus on the potential when the sparkle of the initial rollout is long gone.

When dealing with communicating the potential without overselling, we must take the time to educate. Some of this education should be in the form of tools that allow participants to model outcomes and see the personal impact of them. Other key component is ensuring that each level of management can confidently discuss specific aspects of compensation and properly direct people to the best resources for the answers that are not their responsibility. You may be surprised when you find out how many of your managers either confidently answer questions incorrectly, or create even more uncertainty by not having any answers at all.

Keeping the spotlight on potential for the duration of the program is not as hard as most people make it out to be.  Yes, you can have a comprehensive project plan, millions of documents, videos, an intranet, self-serve kiosks and a super cool performance management system. But, the first step is far easier. Talk. Talk about compensation. Talk about the company. Talk about the goals and talk about how all of them fit together to support your company culture and strategy. Then, when the buzz has quieted a bit, talk some more.

Don’t be afraid of the goals that look like they will never be met, talk about them.  Don't avoid the plan that has underwater stock options, talk about it. In a world where uncertainty motivates no one create as much certainty as possible to drive success. Are there situations where this won't work? If so, post your comments below and let’s discuss!

Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is a leading expert on incentive plans and equity compensation issues. He has written several industry resources including a resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.

Cafe Classic: Hammers, Nails and our Compensation Biases

Editor's Note:  We all have our "best way to fix a compensation problem" biases. We work better (and produce better results) when we are aware of them.

It's called the law of the instrument.  The concept is said to have originated with philosopher Abraham Kaplan, who said "I call it the law of the instrument, and it may be formulated as follows: Give a small boy a hammer, and he will find that everything he encounters needs pounding."  The more popular version comes from Abraham Maslow's The Psychology of Science (1966) and is typically presented as "if all you have is a hammer, every problem looks like a nail."

Sound familiar?  It ought to.  The law of the instrument is alive and well in the field of compensation, compliments of the biases we all hold.

Let's start with the more general bias, that compensation is the fix for every organizational challenge.  Turnover an issue?  Pay them more!  Engagement a problem?  Pay them more!  Employees not meeting performance standards?  Put in an incentive plan (a.k.a. pay them more ... but on a variable basis)!

Never mind taking the time to understand and clearly define the problem so that we can ascertain the best solution.  Pound that hammer and move on!

Sometimes the general bias is ours.  Whether through lack or experience, maturity or confidence, we simply respond to situations with the tool we have most readily available.  Other times, we encounter bias in the leaders we are trying to serve or advise.  They want the quick fix; they don't want some HR or compensation professional digging around in their area for information or answers.  Backs up against the wall, we give them what they want.  And when it doesn't work, they rail against us for our lousy pay plan, which fails to fix a problem that had nothing to do with money in the first place.

Then there are the more specific biases we have toward a particular compensation approach or choice, either because we've had great success with it in the past or just because we find it intellectually appealing.  It may be a particular affection for broadbands, for group incentives or for skill-based pay.   It may be a specific metric that we believe belongs in every sales compensation plan, regardless of the circumstances.  It may even be that we think 360 degree feedback is always the right, or always the wrong, thing to do.  It may be a smaller, more finely tuned hammer, but we swing it just as indiscriminately.

Bottom-line, we all have our biases.  The trick is to be aware of them, be open to understanding the unique business and people reality in every organizational challenge, and be willing to explore other possibilities beyond pounding something with our favorite hammer.

That's what I think.  You?

Ann Bares is the Founder and Editor of Compensation Café,  Author of Compensation Force and Partner at Altura Consulting Group LLC, where she provides compensation consulting and survey administration services to a wide range of client organizations.  She earned her M.B.A. at Northwestern University’s Kellogg School and enjoys hiking, reading and hanging out with family in any spare time.

Creative Commons image "Hammer" by homespot hq

Cafe Classic: Compensation Practitioners Should Be Skeptical of Economic Forecasts

Editor's Note: Stephanie Thomas provides us with a Classic primer to guide us in our review and incorporation of economic forecasts into our work in designing and administering rewards.

In a recent post, my Café colleague Margaret O'Hanlon made a strong argument about understanding broader economic trends: "you have a shot at becoming a more trusted advisor if you understand what's shaping the economy shapes your company's financial and operational plans, which is shaping the company's staffing and reward plans, and so on..." She encourages readers to stay up-to-date on the economic outlook.

I completely agree; you should stay up-to-date on the economic outlook. But it's easier said than done. When there are so many voices in the forecasting space, how do you know which one to listen to? Who should be your trusted advisor?

In truth, it's hard to know. In his 1974 Nobel prize acceptance speech, Friedrich Hayek stated that "[i]t is often difficult enough for the expert, and certainly in many instances impossible for the layman, to distinguish between legitimate and illegitimate claims advanced in the name of science." Hayek describes how the scientistic error - economists' propensity to present their findings with the certainty of scientific language - led to some of the "gravest errors of economic policy." He provides a dismal commentary on the dismal science: "[w]e have indeed at the moment little cause for pride: as a profession we have made a mess of things."

I don't mean to throw my profession under the bus, but Hayek isn't wrong... When sorting through all of the prognostication that is certain to come, like it always does at the end of every year, it's hard to know who to trust. We, as economists, don't have a great track record. To try and clean up the mess we've made, I've put together a quick guide to critically evaluating some of the key economic indicators that may be coming your way.

Employment

What It Is: Employment is seen by many as the most important indicator of the health of the economy. The U.S. Bureau of Labor Statistics releases a jobs report on the first Friday of each month. The jobs report indicates the current unemployment rate and how many jobs gave been gained or lost in the economy.

Why it's important: Consumers make up nearly 70% of economic activity in the US. The employment situation of these consumers has a strong influence on the level of economic activity. The basic idea is that when people are out of work, they cut back on their purchases, which affects corporate profits.

What to consider: Employment statistics depend heavily on definitions. For example, the unemployment rate tells us the number of individuals who are "actively seeking work." It doesn't tell us about the number of discouraged workers, the number of workers who are part-time and would prefer full-time work, the number of workers who are underemployed (in terms of their skills and abilities), or where (industries or occupations) job losses or job growth will take place.

Where to learn more: Projections Overview and Highlights, 2016-26, Bureau of Labor Statistics, U.S. Department of Labor

Inflation

What It Is: Inflation measures changes in prices. The Consumer Price Index (CPI) measures changes in consumer prices and attempts to measure the degree to which life is becoming more expensive for the typical consumer. The Producer Price Index (PPI) attempts to measure changes in the prices of producer goods. I

Why it's important: Again, it comes back to the consumers. Increases in the CPI mean that because things are more expensive, consumers are more likely to cut back on their purchases, which affects corporate profits. Increases in the PPI mean that companies are more likely to pass these price increases to consumers, which further fuels increases in the CPI.

What to consider: Different measures of the CPI and PPI include different "baskets" of goods from different industries. The food and energy industries are known to be particularly volatile. If these industries are included in the "basket" of goods, the resulting metric may be more volatile. Consider looking at baskets excluding food and energy. Additionally, there is a "sweet spot" when it comes to inflation; too much inflation is bad, but deflation is bad too. Deflation can lead to decreased revenues for companies, which may translate into layoffs.

Where to learn more: Consumer Price Index and Producer Price Index, Bureau of Labor Statistics, U.S. Department of Labor

Consumer Confidence

What It Is: Consumer confidence is the degree of optimism regarding the state of the economy that consumers are expressing through their spending and saving activities. The Consumer Confidence Index (CCI) looks at consumers' opinions on current economic conditions (40%) and expectations about future economic conditions (60%).

Why it's important: Yet again, it comes back to the consumer. The basic idea is that when consumers feel confident about their future economic prospects, they are more likely to spend. When they feel less confident, they are less likely to spend. When consumers don't spend, corporate profits are negatively impacted.

What to consider: Some economists consider the CCI to be a leading indicator, or a predictor of future economic activity. Others, however, view it as a lagging indicator, or a measure of what has already happened. The argument here is that it takes time for consumers to respond to economic events. Increases in spending today may be the result of an economy that recovered several months ago. Decreases in spending may be adjustments to a recession that started several months ago. The CCI doesn't tell us what's going to happen; it tells us what already happened and if it can be expected to continue.

Where to learn more: Consumer Confidence Index, The Conference Board

The bottom line is caveat emptor - be skeptical and ask questions. Just because it sounds like science doesn't mean it is science.

Stephanie Thomas, Ph.D., is a Lecturer in the Department of Economics at Cornell University. She teaches undergraduate and graduate courses on economic theory and labor economics in the College of Arts and Sciences and in Cornell’s School of Industrial and Labor Relations. Throughout her career, Stephanie has completed research on a variety of topics including wage determination, pay gaps and inequality, and performance-based compensation systems. She frequently provides expert commentary in media outlets such as The New York Times, CBC, and NPR, and has published papers in a variety of journals. 

Cafe Classic: Performance Pay for Gig Workers?

Gig platforms are everywhere now. If you need something done, whether it’s a simple microtask or a complete overhaul of your marketing strategy, chances are there’s a gig worker on a platform somewhere that can do it for you.

Gig workers aren’t just for small start-ups anymore. In a recent report from the University of Oxford’s Internet Institute, more and more Fortune 500 companies and multinational enterprises are incorporating platform sourcing into their business models. According to this report, platform sourcing is gaining in popularity because of (1) easy access to scalable sources of labor, skills and expertise, (2) reduced start-up and transactions costs, and (3) the elimination of conventional hiring barriers.

For many of us, the gig economy is something that’s indistinct and difficult to wrap our arms around. There isn’t a lot of reliable data about this growing piece of the workforce. Well... we think it’s growing, but we don’t know for sure. The last time the U.S. Bureau of Labor Statistics surveyed the contingent workforce was in 2005! (a new survey is in progress, but results won’t be available for a while…)

If you’re thinking about tapping into the pool of gig workers, you need to think about how you’re going to pay them. On Mechanical Turk, most microtasks are paid at a fixed rate; if you complete the task successfully, you earn a few cents. Over the course of a full day, Turkers can earn an average $6.00 to $12.00 per hour. Workers on other platforms, performing more complex tasks, can earn hundreds or even thousands of dollars per month.

Regardless of the type of task or platform used, compensation is typically output-based: the pay that gig workers receive is based on the success or failure of the gig. This is fine if the outcome of the gig can be categorized as “yes, you did it” or “no, you didn’t do it.” It doesn’t work so well for gigs where the quality of the output matters.

One of the unique features about the gig economy is that workers have discretion over how much they work. But just like the non-gig economy, workers also have discretion over how much effort they put into that work. As the tasks gig workers perform become more complex and mission-critical, employers need to consider that discretionary effort, just like they do for conventional employees.

There's some interesting new research-in-progress examining performance pay for gig workers (for example, Sebastian Butschek, Patrick Kampkötter and Dirk Sliwka, "Paying Gig Workers", unpublished) and I'm excited to see what this new avenue of research will reveal. In the meantime, here are some easy and practical suggestions for paying your gig workers based on performance:

• Early delivery bonus: If the timing of deliverables and/or hard deadlines are critical to your project, consider offering an early delivery bonus (assuming quality standards are satisfied). For time-sensitive tasks, a small early delivery bonus could be the little extra incentive your gig worker needs to make sure things are wrapped up on time.
• Cost control commission: Cost control is always important. But if cost savings are make-or-break to your project, consider offering your gig worker a percentage of the cost savings she generates for you. This little commission could motivate your gig worker to find alternative suppliers who provide the same quality inputs at a lower price and be a win-win for everyone. 
• Rubric-based quality bonus: Quality bonuses can be tricky. It's hard to know how good is good, and how much better than good really good is. Rubrics can be useful here. A rubric is nothing more than a document that articulates the expectations for an assignment by listing the criteria (what counts) and describing levels of quality from poor to excellent. If you can all agree on what constitutes "poor" through "excellent" quality, you can offer a 0 / check-minus / check / check-plus bonus scheme.
• Retention / repeat worker bonus: If you have a really good gig worker, you need to actively try to maintain that relationship. According to a study by JP Morgan, one in six online platform workers is new in any given month, and more than half of platform participants quit within a year. If you find someone who does a great job and is a great fit for your organization, you might want to incentivize her to continue to accept your future gigs.

There are numerous ways to incorporate performance pay into your compensation structure for gig workers; these are just a handful of ideas to get you thinking.

Performance pay is not going to be a component of your pay strategy for all of your “gigged” tasks. But for more complex tasks, those that are time sensitive, or those that require a little more than “standard” effort, you should consider the possibility of paying for performance. I'm sure you can find a gig worker to help you think it through...

Stephanie Thomas, Ph.D., is a Lecturer in the Department of Economics at Cornell University. She teaches undergraduate and graduate courses on economic theory and labor economics in the College of Arts and Sciences and in Cornell’s School of Industrial and Labor Relations. Throughout her career, Stephanie has completed research on a variety of topics including wage determination, pay gaps and inequality, and performance-based compensation systems. She frequently provides expert commentary in media outlets such as The New York Times, CBC, and NPR, and has published papers in a variety of journals.

Cafe Classic: Trouble Getting Support for New Pay Plans?

EEditor's Note:  Maybe you’re asking the wrong questions.  Dan Walter explains in today's Classic.

I often hear statements like, “Our employees don’t value that. We asked them.” Overall, we have improved our efforts to engage our employees in the participation in new of pay programs, but perhaps we should be asking different questions.

Asking your employees if they want equity compensation or a new type of STI is kind of like asking a two-year old if they want a new kind of food.

The answer will almost always be no.

New food, like a new pay plan, is an unknown and therefore a risk. In a world with so many “knowns,” why risk it by trying something new? This is particularly the case when the new thing is different or hard to understand.

You need to explain the new thing before convincing them to try it.  Then you need to confirm that they like it.

Instead of asking people if they want to participate in a stock option plan, or telling them that they should want to be in the new annual incentive plan, think about starting the discussion with the conclusion or results.

Instead of, “Would you like to get stock options?”

Try, “Wouldn’t be great if you could be paid in a way that gives you more money as your hard work contributes to the company’s success?"

Or, “We’d like to find a way to have your pay more closely aligned with the growth of the CEO’s pay over the next few years. Let’s talk about some ways to do that.”

You just can’t expect people to inherently accept something new. You need to guide them into seeing potential solutions from new perspectives. You can start by demonstrating how the new solution is right before you ask them if they would like to try it. Every food my son has eaten (and he eats almost everything) was first consumed by an adult in front of him.

The same is true when discussing new pay with your executives or Board of Directors. You can’t just expect them to support a move from a legacy program to your new cool idea. Unlike you, they haven’t read the articles, taken the classes, and met with colleagues. They haven't been thinking about the solution and working out details in their heads for months. They may not have yet concluded that the current program isn't perfect, or that a new solution may be better.

Blindly asking if they will approve a switch from the current LTI metrics to something else won't work. Telling them that you "need" to change to RSUs from your current Stock Options is unlikely to get enthusiastic support. Try instead to show the goals or objectives the new plan is designed to achieve (go beyond the numbers and dig into the human capital goals). Then show where your legacy programs have strengths and weaknesses and how a new approach will provide better success.

Only then ask the question you need to have answered. "Can I get your support in completing a full recommendation for a new approach that may like this…?" That is when your real work begins, but that's fodder for another article. 

Of course, this doesn't work for every tool and every person (some kids are super picky), but you will find it will work for most. And, when it doesn’t, it provides new data on what you may want to consider before the next “ask.”

Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is a leading expert on incentive plans and equity compensation issues. He has written several industry resources including a resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.

Cafe Classic: The Three Gravitational Laws of Performance Pay

Editor's Note: Did you know that your performance pay programs are subject to the laws of gravity? Read on ... and Stephanie Thomas will explain!

One of the immutable truths of our universe is gravity. When you jump for joy, throw a ball, or drop your car keys, you experience gravity. If you own a cat, you probably observe gravity at work frequently; my cat pushes things off counters and tables all the time to ensure that gravity is still turned on and working properly. In short, the meaning of gravity in our day-to-day lives is "what goes up must come down."

You may not recognize the gravitational constant in its mathematical form:

G = 6.67408 X 10^-11m³kg^-1s^-2

But you certainly recognize it when you experience it, and you know that there's no getting away from gravity. 

As it turns out, gravity has implications for your performance pay programs. Whether it's the affordability of your program across business cycles, the efficacy of your program to build the value of your organization, or interest in your program (and in pay for performance in general), the gravitational adage of "what goes up must come down" couldn't be more true.

(1) Your ability to afford your performance pay program will go up and down. The expansionary and contractionary phases of the business cycle are as close to a "law" as you an get in economics. Both the length of time between expansion and contraction varies, as does the "height" of the high and the depth of the low. Sometimes we're able to sustain expansion for a relatively long period of time that results in soaring economic success. But it's not sustainable indefinitely; you will experience a downswing sooner or later. When designing your performance pay program, it's important to keep this in mind. It's easy to follow through on your performance pay promises when things are going well and the organization is financially prospering. When the downturn ultimately comes, you must ensure that you will still have the financial ability to follow through on those performance pay promises. Overpromising and underdelivering in austere times an be fatal for your pay for performance program and can threaten the very existence of your organization.

(2) The ability of your performance pay program to increase firm value will degrade over time. One of the main purposes of a performance pay program is to increase firm value. When a performance pay program is "new" it can be very effective. But over time it will lose some of its efficacy. Lazear & Gibbs describe this phenomenon as follows: "consider a measure that had previously not been used for calculating an employee's bonus. The firm believes that the measure is correlated usefully with firm value, so it decides to give the employee a bonus based on the measure. The employee now has an incentive to increase the measure's value, possibly in part through manipulative behavior. If there is manipulation, this will tend to reduce the measure's correlation with firm value - making it a less useful performance measure! The longer the employee has had a bonus based on the measure, and the greater the incentive placed on the measure, the more likely this phenomenon is to be a problem." The upshot of this is that performance pay programs are not evergreen. To maintain efficacy, they must be periodically revisited and reinvigorated. Left on its own, the efficacy of your performance pay program will fall.

(3) Interest in your program will ultimately go down. Currently, the vast majority of organizations have a variable pay plan. Twenty years ago, less than half of organizations had a variable pay plan (Hewitt Salary Increase Survey, 1990-2009). Performance pay has been in fashion for several years. But like the patchwork peasant skirts of the 1970s and the velour tracksuits of the 2000s, performance pay is likely going to fall out of fashion. When "the next big thing" arrives, everyone - your employees, your senior management, and your competitors - will forget about the advantages of well designed, tried-and-true performance pay plans. Fashion works in cycles, so performance pay may come back in fashion at some point in the future. What will you do until it does? Don't put all of your eggs in the same rewards basket. Spread things out and use a total rewards approach.  

No matter how well designed your performance pay program is, it cannot escape the inevitability of gravitational pull. What goes up must come down. If you're not prepared, your entire compensation program could collapse into a singularity of infinite gravity, a.k.a., a black hole. And we all know that black holes suck. 

Stephanie Thomas, Ph.D., is a Lecturer in the Department of Economics at Cornell University. She teaches undergraduate and graduate courses on economic theory and labor economics in the College of Arts and Sciences and in Cornell’s School of Industrial and Labor Relations. Throughout her career, Stephanie has completed research on a variety of topics including wage determination, pay gaps and inequality, and performance-based compensation systems. She frequently provides expert commentary in media outlets such as The New York Times, CBC, and NPR, and has published papers in a variety of journals. 

Image courtesy of Squashimono via Flickr

Cafe Classic: Eternal Sunshine of the Spotless Mind

Editor's Note:  There are several versions of the famous quote "Those who don’t know history are destined to repeat it" and it is attributed to individuals ranging from British statesman Winston Churchill to Spanish philosopher George Santayana.   Regardless of its roots, this statement is as true in the sphere of reward programs as it is in any other, as Dan Walter explains in his Classic post.

In the world of pay, we are almost always looking forward to the upcoming year or more. We often operate with little or no reference to our histories. If we are going to measure our success, we should probably understand the path that got us here.

I often work with companies who can provide very little information on how and why they are in their current state. They can speak in broad generalities, but the details are hard, or impossible, to grasp. None of these people are dummies. To the contrary, most are smart professionals who work hard to make the best decisions every year. How well can you explain your past decisions and actions? 

What did your survey data look like three years ago? How did pay for each position align to it? Do you have these details and do you communicate them in any reasonable way?

How about your LTI plan? What were the specific "asks" and "expectations" five or six years ago How well did you meet these objectives and did you ask your employees or executives how effective the plan was in motivating them to those achievements?

Things in the past get fuzzier over time. This is especially true for tasks that require complex decision-making and involve discretion. We make hundreds of small decisions like this every time we benchmark compensation, determine incentive pay levels, set goals, and decide on merit increase minutiae. When we look back even a couple of years, the drivers of our decisions are often difficult to explain or defend. In a data driven world, our eternally spotless minds will prove to be an insurmountable obstacle.

A growing best practice is building regular reporting summaries at critical decision and measurement points. These summaries often include pictures or easy data visualization because our brains are best at remembering images. These summaries become a diary of our past. At their best, they also include the "why" of each decision. This approach to remembering history is seen in things like "Facebook memories" and old family videos but is very new to the world of total rewards.

Imagine if as you started planning each year you could quickly review the key decisions, failures, and successes that brought you to your current position over the past several years. While there are all kinds of tools that can help with this, a simple solution is a series of slideshows. 

Build a template for each program or process. Every decision cycle, usually annually, but more often for things like sales plans, create a quick set of charts representing your current state and desired state. Put together a bullet point of why you made key decisions. Then each following year, add new slides linked back the prior slides. As time progresses, you will easily be able to track whether you’ve been delivering real value (or not).

Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is a leading expert on incentive plans and equity compensation issues. He has written several industry resources including a resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.

 

Cafe Classic: Aligning Incentives, Performance Metrics and Strategic Objectives

Editor's Note:  What can an experiment involving singing, dancing and posing teach us about performance pay?  Plenty ... as this Classic from Stephanie Thomas reveals!

How clear is the line of sight between your performance pay programs, strategically linked performance metrics and the organizational strategy? Do your managers see these performance measures as they really are (imperfect proxies for larger, intangible strategic constructs), or do they focus on the performance measures themselves as the ultimate goals?

Let's say that one of Company X's strategic objectives is to maintain its market share. This strategic objective is translated into tactical goals, one of which is retaining current customers. Assessing managers' performance in supporting the overall strategic objective of maintaining market share can be done different ways, but let's assume that Company X focuses solely on the tactical goal of retaining current customers and evaluates managers' performance through a customer satisfaction survey. Managers will receive bonuses tied directly to their survey scores.

Will Company X's managers see through the survey scores, understanding that the overall strategic objective is maintenance of market share, and ensure all their decisions are consistent with this objective? Or will managers act exclusively to maximize survey scores and paychecks, losing sight of the overall strategic objective of the firm? 

If managers focus solely on the metric, they exhibit what is known as surrogation. Choi, Hecht and Tayler describe surrogation as the situation arising when managers "fail to fully appreciate the fact that [performance] measures are merely representations of the true constructs of interest, ultimately acting as if the imperfect measures are the constructs of interest"("Lost In Translation: The Effects of Incentive Compensation on Strategy Surrogation",The Accounting Review, Vol. 87, No 4, pp. 1135-1163). Surrogation can hinder managers' ability to make decisions and take actions that are consistent with organizational strategy. 

Unfortunately, using performance pay linked to a strategically linked performance metric increases managers' propensity to exhibit surrogation. The way in which performance pay affects performance is complex and there are a variety of mechanisms in play. However, a substantial amount of research suggests that incentive pay has attention-directing effects that influence an employee's experience with performance measures. In their paper, the authors explore these attention-directing affects and address the question of whether using multiple compensated performance metrics, rather than one compensated metric, will reduce the problem of surrogation and help keep the organizational objective clearly in managers' view.

The authors design an interesting laboratory experiment to examine these hypotheses. Graduate students at highly ranked U.S. business schools were asked to create a virtual character in the computer game Spore according to the following instructions: design a creature that can socialize with other life forms such that it will become the dominant species on the planet. 

Within the game, four "traits" influence a creature's ability to socialize: sing, dance, charm and pose. Participants were informed that all four traits were equally important in a creature's ability to socialize, and were asked to keep this in mind when designing creatures.

All participants received compensation based on a post-experimental assessment of their creature's ability to achieve global domination via socialization. The top performer received $20, the second-best performer received $18, and so on. In addition, a bonus was awarded based on specific performance metrics. One group of participants (single-measure-compensation participants) received a bonus based on the creature's ability to sing: they received an additional $2 per level of "sing ability." For example, a creature with a sing ability of 4 would generate an $8 bonus. The other group (multiple-measure-compensation participants) received a bonus based on the creature's ability to sing, dance and charm" they received an addition $1 per level of sing ability, dance ability and charm ability. For example, a creature with level 3 sing, dance and charm abilities would generate a $9 bonus.

The results of this experiment are not surprising. The single-measure-compensation participants constructed creatures with higher levels of the sing ability, at the expense of the other, equally important, socialization abilities. Their creatures were less successful in achieving the overall objective of domination via socialization. This is exactly what we would expect if the participants were engaging in surrogation. Surrogation among the multiple-measure-compensation participants was statistically significantly less than among the single-measure-compensation participants, and their creatures were more successful at achieving domination through socialization.

At the end of the day, this experiment empirically confirms what many of us already know: people do what you pay them to do. When designing performance pay systems, make sure that the attention-directing effects of incentives are directing attention to the achievement of the overall strategic objectives of the organization, not just to singing, dancing and charming.

Stephanie Thomas, Ph.D., is a Lecturer in the Department of Economics at Cornell University. She teaches undergraduate and graduate courses on economic theory and labor economics in the College of Arts and Sciences and in Cornell’s School of Industrial and Labor Relations. Throughout her career, Stephanie has completed research on a variety of topics including wage determination, pay gaps and inequality, and performance-based compensation systems. She frequently provides expert commentary in media outlets such as The New York Times, CBC, and NPR, and has published papers in a variety of journals. 

Image courtesy of Electronic Arts