"Commissions. Bonuses. Stock options. Phantom stock. ESOP. Are you considering one or more of these incentive compensation systems? Why? What are you trying to achieve? All too often, CEOs are eager to implement compensation solutions without a thoughtful analysis of what they want to accomplish. We say that we want to motivate employees. When we peel the onion, we find that CEOs really want to achieve one or more of the following:
Improve the bottom line
Grow the business
Retain key contributors
Attract talented employees
Reward excellent performance
Provide for owner succession
Let's examine some of the advantages and pitfalls of different compensation systems.
Straight salary is easy to manage and an essentially fixed expense for employers. Unfortunately, salaries increasing at 3.5 percent annually can impart a sense of entitlement in the organization. From the employee's perspective, straight salaries provide a sense of security — a baseline for one's standard of living. However, people who are motivated by sharing in the success of the business will not be satisfied with a straight salary in the long run and are likely to seek work elsewhere.
Commissions are often reserved for sales people and paid as a percentage of sales or gross margin. Commissions are attractive to employers because they are variable expenses, correlate with results and are effective with dollar-driven people. Employees who respond to financial incentives enjoy the upside earnings potential but quickly become disillusioned when the market softens. As a result, commissioned sales people are apt to change jobs frequently in search of more money. Commissions can also inhibit teamwork if employees feel the "heroes" are getting the big bucks. By the way, commissions should be based on gross margin or other profit-oriented measure so as to promote profitable sales, versus just any sales.
Bonuses can be given in cash, as benefits like time off, or in the form of merchandise. They can be awarded to everyone or just a select group. They can be short-term or long-term. They can be based on almost any measure. As a result, CEOs must be very careful in designing the bonus structure to ensure an appropriate return on investment. Bonuses based on organizational objectives like net income or EBITDA allow for employees to share in the success of the business. However, there can be a timing and functional disconnect between the business result and the individual contribution of each employee. As a result, such bonuses may not actually motivate employees to change behavior for the good of the organization. Designing the bonus system to correlate in a timely fashion with employee behavior is more effective but more complicated (see Gain Sharing, John G. Belcher, Jr., Gulf Publishing Company, 1991). It also runs the risk of not influencing those who are not particularly motivated by cash tomorrow in return for performance today. Bonuses also run the risk of creating high expectations and a sense of dependence, resulting in serious disappointment when times are tough.
Equity can be true ownership in the form of actual shares (or options to purchase shares), or virtual ownership in the form of phantom stock. CEOs posit, "If our employees are treated as owners, they will behave as owners and dedicate themselves to the long-term success of the company." Sometimes true. Not everyone has the characteristics of an owner. Owners are entrepreneurs. They take risks. They are willing to sacrifice today for the payoff tomorrow. However, a good many employees prefer steady and predictable compensation today over a potentially greater but less certain payoff in the future. Phantom stock or equity will not materially change their behavior.
Some final thoughts on motivation: Different people are motivated by different things, and not everyone is motivated my money. Sure, everyone needs money and wants more of it. Time and again, however, employee surveys indicate that compensation is around fourth on the list of satisfiers in the workplace. Daniel Goleman, in his groundbreaking work on emotional intelligence (Working with Emotional Intelligence, Bantam Books, 1998), notes that motivation comes from within; from the sense of a job well done. Satisfied needs do not motivate; only unsatisfied needs motivate, according to Stephen R. Covey (The 7 Habits of Highly Effective People, Simon & Shuster, 1990). The lesson? Find out what your employees need — what truly motivates them — before embarking on a new compensation strategy. And then design the compensation system to achieve your long-term business objectives.
Louis Allegra is president of Allegra Management Consulting, Inc. He chairs CEO advisory boards in affiliation with Vistage, the world's largest CEO membership organization, to help Lexington-area executives improve their performance and enhance their lives. Lou can be reached at Louis@AllegraManagement.com.