Rewards and incentives: What works best

CEO pay is something that excites a lot of interest and the structure of that pay is hotly debated by the public, academics and by shareholder associations. So how incentivised do senior executives need to be and how will your company reward and thank valuable employees and clients?
By Annie Gray.

Internationally executive incentive pay is coming in for some flack with a recent Harvard Business Review article saying that for US chief executives and other senior leaders, it is not unusual for 60-80 percent of their pay to be tied to performance yet HBR says from a review of the research on incentives and motivation, it is unclear why such a large proportion of these executives’ compensation packages would need to be variable.  

This ratio probably applies to the very largest of US corporations and in New Zealand the ratios are much more modest.  Strategic Pay’s chief executive John McGill  doubts our equivalent ratios would exceed 30 percent for the small number of organisations it would affect.

However, he says that while variable pay/performance pay is easy enough to get wrong and a dangerous tool in some ways, its use should be a lot more wide-spread and it should be part of the thinking in New Zealand around pay.

The use and acceptance of incentive pay is becoming greater but he would like to see spread further down the ranks, and not just be limited to senior executives.

“There is more acceptance of what it is and what it can do, the growth has been real.”

Strategic Pay’s 2017 Policies and Practices Review, which contains data on about 1000 New Zealand organisations found that the percentage of organisations with incentive or variable pay schemes was growing.

Fifty-one percent of participating organisations offer some form of variable pay scheme. The analysis is based on just those organisations that offer such schemes and found that some 69 percent  offered short term incentives; 66 percent bonuses; 22 percent long term incentives and 17 percent offered commission. McGill believes their data is reasonably representative of New Zealand companies, although it does have a bias towards larger organisations.

But it wasn’t just the CEO whose pay was variable. Strategic Pay found that of the employees eligible in organisations offering a scheme 76 percent of senior management and 54 percent of middle management were offered short term incentives and 74 percent of senior management and 12 percent of middle management were offered long term incentives (see chart).

McGill says everyone likes the idea that when times are good you share in the company’s profitability but what happens in a bad year, if a corporation does not have the money to spare are the salary rates able to adjust?

In a tough environment the tradition in New Zealand was to shed jobs but this variable pay, he suggests, would be a way of delaying that day, but notes that is not well accepted as yet.

He refers to his own company where they share a five to six percent bonus across the whole organisation in good year. But in a quieter year there will not be any bonus and because they are not spending that money, that helps the financial health of the company.

“What is very important here is communication, you are asking people to buy into something they are not familiar with,” and he notes a lot of organisations have not been particularly forthcoming about how they are going financially.

If you are going to base somebody’s pay on the health of the organisation you need to communicate how the financials are going, otherwise it doesn’t mean a lot to them.

“This is how we are going – we are on track but a bit behind – you are informing them of what is happening.”

McGill says incentives have become accepted but there is resistance in some areas and it would not be right in some organisations. He is starting to see growth across all levels of organisations, but that can only happen slowly.

What groups have to see is that it’s working and middle managers might start to push for it and then people below them.

“One of the big impediments is that we are not good in New Zealand at  performance management of staff. Performance management seems negative but it should be just a tool to get and keep alignment and it has to be seen to be fair and you have to have reasonable administration tools around it.”

And if you are not used to a PMS you are not used to setting goals and monitoring and that might possibly mean a struggle with incentive pay.

In a recent article, McGill noted that incentive pay is one tool organisations can use from their kitbag.

“To see it as the silver bullet is wrong. Career development, job satisfaction, and how individuals relate to their employer are amongst other important considerations employers understand and juggle. Getting and keeping the mix right for your organisation is the challenge management teams face when it comes to the interface with employees. Any tool that can advance this should be used,” he wrote.

Jim Arrowsmith, a professor in the School of Management at Massey University sees a sense that incentive pay is something that comes in for a lot of criticism with shareholders associations saying the criteria for the pay is too easy and doesn’t necessarily reflect individual contribution.

He says long-term incentives will always be popular in the private sector and can run to three years, sometimes five years and be linked to share value or benchmarked against industry peers. 

He notes there is a lot of research in the United Kingdom saying incentive pay is too problematic now and that two thirds of CEO pay in the United States is in incentives where the base pay is massive anyway. Japan and Germany hardly use incentives in comparison and their firms are amongst the best in the world.

He says it pays to remember that New Zealand CEOs operate in an international labour market and even in universities it’s hard to recruit from the US with the New Zealand salary levels.

But some CEOS have a different sort of motivation, they come for the lifestyle rather than viewing a role just in terms of pay. Arrowsmith’s research is in human resources and he points to flexible working terms and being able to work out of home can be a big motivation for some senior employees, along with things like the intellectual challenges or the job content or the autonomy a role might bring.

CEOs join or stay with companies for a host of factors, many of which are intrinsic such as the challenge of the task or leaving a legacy. Extrinsic factors like pay are important, not just in income terms but in esteem, but are commonly secondary to these. 

 Companies really need to ask themselves how far large bonuses are necessary – they are certainly no magic bullet in terms of performance, he says.

 

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