Big Bang Theory of Pay for Performance

The Forces of ‘Sameness’

Many factors have created the strong pull towards sameness in compensation:

• Talent shortages in 1996-1999, 2004-2007
• Greater availability of data
• More effective tools to manage data comparisons
• Regulations and government scrutiny (Why do you pay the way you do? The easy answer is we do it like everyone else, Kochanski says.)
• Shareholder scrutiny (Shareholders are increasingly and vocally interested in compensation issues.)

Combined, these factors have pulled organizations towards common compensation practices, payout levels, and program offerings, say Hellerman and Kochanski, who are Sr. Vice Presidents at Sibson Consulting. They offered their tips at WorldatWork’s Total Rewards Conference and Exhibition, held recently in San Diego.

For some organizations, sameness became an entitlement. (“When you get a reward more than once, and you don’t know why, that’s entitlement,” Hellerman says.)

Then came the economic downturn. Suddenly “sameness” was no longer the main consideration. Organizations started moving apart in compensation practices, payout levels, and program offerings. Hellerman and Kochanski call it the Big Bang.

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What Are the Characteristics of Big Bang Companies?

Sibson Consulting did a study on pay for performance in an effort to understand what happens when organizations break away from sameness and move to business-based rewards. Over 100 organizations across the country gave in-depth interviews. The findings:

• Return to sameness is a strong force
• Breaking-away from sameness is difficult, but doable. (Approximately 20% of the surveyed companies, The Big Bang Companies, succeeded)
• When breakaway is successful, business-based rewards positively sculpt an outcomes-oriented culture that rewards the “what” and the “how”

Hellerman offered a graphic to illustrate how “Big Bang” companies break away from “sameness.”

Big Bang Companies Use More and Uniquely Designed Pay Delivery Vehicles

Big Bang companies, Hellerman says, effectively transform standard pay vehicles and protocols into a portfolio of tools to differentiate and reward performance.

At Big Bang companies, the rule is incentives, not bonuses. The business-based incentive awards are earned, not “gifted.”

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Incentives That Disregard Traditional Formulae

At Big Bang companies, incentive plan performance measurement periods as well as payout timing and form, “fit” the needs and realities of the business. For example, Kochanski says, in a company that wanted to focus on profitability, you might set a stretch goal with three payout possibilities:

• If the profitability goal is met by the end of the first year, the payout is two times the established bonus.
• If profitability goal is achieved by the end of the second year, the payout is one times the established bonus.
• If profitability goals are not achieved until the third year, the bonus pays one-half of the established amount.

Meanwhile another program can start each year, so they overlap.

Another example is the long-term incentive “break-away” design. Multiple performance outcomes are rewarded in different ways, including stock options based on total sales revenue, restricted stock units (RSUs) based on EBITDA, Performance Unit Plan (PUP) payments based on other performance goals.

The plan is designed to share performance risk and increase retention. Vesting schedules are designed to provide continuous release of value. So, for example, options might vest yearly, PUPs after 4 years, and RSUs after 5 years.

Payout forms are also varied, that is, some cash, some stock options, and some full-value shares.

In tomorrow’s Advisor, Hellerman and Kochanski’s take on promotions and carve-outs, plus an introduction to BLR’s.all-in-one compensation website, Compensation.BLR.com.