Should Variable Pay be Cut in Times of Variable Performance?

Results of a recent Towers Perrin "pulse" survey were released today.  There are a number of interesting findings here, but one in particular caught my eye.

In examining how companies are likely to respond to the economic crisis in a number of reward areas, the survey asked about plans to reduce annual incentives/bonuses.  Survey participants responded as follows:

• Very likely - 18%
• Somewhat likely - 21%
• Somewhat unlikely - 23%
• Very unlikely - 25%
• Too soon to tell - 13%

My interpretation of this - which is important here - is that it indicates plans to reduce the incentive/bonus program and its award opportunities, not merely that the participants are expecting lower payouts due to lower results.  The latter makes complete sense, the former - to me - makes very little and prompts concern.  According to the survey, 39% of respondents are likely to reduce annual incentive/bonuses and another 13% haven't yet decided.  Meaning - again, if I am interpreting this accurately - that over half have not yet determined whether they will follow through on the commitments of their existing incentive/bonus plans.

Is it just me or does anyone else see some deep flaws in the whole concept and application of variable pay underlying these results (results, by the way, that I have seen mirrored in other recent research)?  As I was raised to understand it, the beauty of variable pay programs and the reason for their surging popularity in recent years is that - when well designed and executed - they pay out in good times and they don't pay out in bad times.  Not only does this allow you to reward performance without building up fixed (payroll) costs, but the particular nature of incentives makes them especially effective at focusing attention and driving results.

If this is true, then wouldn't this make variable plans a particularly attractive tool in a down economy?  Why would organizations feel compelled to mess with them at a time like this?

My guess?  A couple of possibilities come immediately to mind:

1) The incentive plans are "discretionary" plans, not tied in a specific and measurable way to particular performance results.  See here and here for more thoughts on discretionary incentive plans (hint: I'm not a fan).  In the end, they are too often based on the degree of generosity felt by top management at year end - a generosity not likely to be felt at the end of a bad year.

2) The incentive plans are poorly designed, with awards based on measures that don't really align with what it takes to make the organization profitable.  One possible design flaw could be the failure to include an upfront gate or hurdle, which protects the organization from paying out when it cannot afford to do so.

Bottom line: I hope these organizations are thinking through the implications very carefully before taking a hatchet to their plans.  Variable pay can be a powerful tool in challenging economic times, but their effectiveness is entirely predicated on trust - as in, if you do X, we promise to pay you Y.  Break this trust even once and the road ahead for future variable pay attempts will be difficult at best.

Readers, what's your take?

Comments

[Totally Consumed]

I would view the removal of my variable pay (bonus), the same as a cut in my base rate of pay; and start looking for another job, immediately.

[Andy Klemm]

Cutting back on what was a well-designed incentive plan would establish a level of mistrust from which the employer could probably never recover. As Ann Bares writes they must pay out in good times and not in bad times. The other commentator reflects what will happen with all of the employer's previously valued employees.

[Ann Bares]

TC:

I can't argue with your logic. Who wants to work for an employer who renegs on the bonus plan? Not exactly a trust builder.

Andy:

Agreed. Hopefully these employers are thinking through the implications of breaking that trust. Or the plans were not well-designed to begin with. But I don't think that fact - assuming it is true - will go very far in mitigating the mistrust that follows taking a hatchet to the plan.

Thanks - both - for sharing your thoughts here!

[Bud Crystal]

Your contention that 39% of companies have "discretionary" incentive plans is patently absurd. The companies that Towers Perrin surveyed are all part of the Fortune 500. I would estimate that at least 85% of these companies have formal, metric-based annual incentives. Not sure why the author of the article doesn't realize that.

Due to the timing of the survey, many of the companies were hopeful that 4th quarter performance might recover. If this survey were conducted in early January, there would be more clarity around payout plans. Nonetheless, my prediction is that at least 25% of companies that do not meet the minimum performance requirements in their annual incentive plans will still make bonus payouts. They are afraid of losing top performers. They should however, not make payouts from these plans, and instead provide special retention awards (of stock or cash) for their top performers - those top 25% or so employees that they believe they can't afford to lose.

[Ann Bares]

Mr. Crystal:

I appreciate your taking the time to read and comment on the blog.

To be clear, it was not my intent to contend that 39% of the companies surveyed by Towers Perrin have discretionary incentive plans. It was not even my intent to contend that I am correctly interpreting the data (I think I attempted to make this point a couple of times). My intent was only to call attention to a finding that surprised me and to ask questions about what might be taking place in these situations and why.

To the extent that this data simply represents the fact that plans are anticipated to pay out at lower levels due to financial and operating performance, I would not challenge the logic. Your prediction that some organizations will step out and make payouts to top performers, regardless and outside of plan results, in order to retain these performers, also makes sense.

I don't know that we are in disagreement here, but inarguably you have the greater experience and information to have a strong sense of what lies beneath these statistics - and I am glad you took the time to share your thoughts here.

[KD]

Ann -

Your points were clear to me, so don't sweat it. Here's another thought - if 25% of companies with annual bonus plans that don't make the numbers are still making payouts, that means the essence of the plan is that it can be discretionary in nature...

Which is one of the big points you raised. You can have an annual plan, but if it's discretionary in nature, people know that it's random. Not a great design...

That said, I don't blame companies for making discretionary payouts on their annual plans to keep talent stable. But that makes it discretionary, and that's why companies who have a history of doing that would feel the need to eliminate the "annual bonus plan" all together...

Because the people will expect a payout regardless of the results...

KD

[Ann Bares]

KD:

Thanks for clarifying my points better than I could have. You raise a good issue regarding the double-edged sword nature of making discretionary payouts in a year like this one.

Also, while the particular data I chose to feature from Towers Perrin does - as Bud Crystal points out - feature Fortune 500 companies, the point I hoped to make and the questions I meant to raise here are broader ones. Most of us work in and serve companies that are not in the Fortune 500, and the landscape there is different and more varied. My experience would suggest that the lure of discretionary incentive plans is stronger among smaller, privately-held, and fast-growing companies.

At any rate - good discussion on all counts. Thanks!