Managers and employees alike have long had an uneasy relationship with Incentive Compensation (IC). The custom of “remembering the workers” began at the end of the 19th century, with employers giving employees candy, turkeys, or watches for the year-end holidays. The F.J. Woolworth company was the first to institute cash bonuses of $5 for each year of service. Investment banks picked up on the idea and ushered in massive Wall Street year end bonuses that might equal or exceed annual salary. It’s now commonplace in tech companies to build IC into employee compensation packages.
At the start of the year, a manager and employee agree upon the criteria that must be met to qualify for an IC payout at the end of the year. In determining IC criteria, a manager must imagine accomplishments outside of an employee’s ordinary job responsibilities that are so stellar that the company is willing to fork over this extra money. The promise of this potential windfall may lure prospective employees to join the company and handcuff existing employees into sticking around at least until the payout.
IC is a relatively simple proposition when it’s quantifiable. That is, if a metric is associated with the goal, it’s easy to determine success of failure. For example, if a salesperson closes more than five deals in a quarter, there’s a payout for each additional deal. If it’s difficult to determine a metric to measure a goal, it’s a squishy goal. The focus of this post is on the squishy IC goals, and doesn’t suggest changing the bonus structure for quantifiable goals, like those for salespeople.
When determining the IC payout at the end of the year, a manager evaluates an employee’s level of success in reaching the vaunted, agreed-upon goals. Complete success results in 100% payout, no success results in 0% payout, and most receive something in between. Often there’s an additional caveat including overall company performance in the computation of the bonus. That is, if the company has a bad year, IC payout percentage may be reduced or eliminated.
Much has been written about the pitfalls of IC plans. Any of us who have been on the front lines as either managers or employees with IC plans have witnessed the problems firsthand.
- Goals reflected in an IC plan may be incredibly important at the time of origination, but irrelevant at payout time. Unless an IC plan is revisited periodically throughout the year, employees may be incentivized to perform work on things that oppose the current direction of the business.
- If a changed business climate prevents an employee from completing an IC task, it places fair-minded managers in a bind. Should an employee be penalized for not completing a task under these circumstances? This results in a good amount of managerial fudging.
- Incentivizing employees to succeed in endeavors beyond their ordinary job responsibilities often has unintended consequences. For example, an employee may focus on IC goals to the detriment of day-to-day responsibilities.
- IC is misleading. Many companies never pay the full amount or even close to it. Still, employees tend to include bonus potential into their perceived salary.
- IC is demotivational. Great employees may utterly fail in meeting IC criteria because their day-to-day responsibilities are all-consuming. That is, they missed their IC goals because they were busy doing a great job.
Should a new company build an IC plan into its compensation packages? Hell, no! But, in the absence of IC, is a company at a recruiting disadvantage against competitors promising richer compensation plans that include IC? Maybe. A company may choose to scrap IC entirely and provide competitive base salaries that account for the loss of IC.
For companies that believe extraordinary innovation should be coaxed and rewarded, here’s a better approach to IC. Create a culture of recognition where any employee, or a customer, is encouraged to call out a colleague’s stellar work. An independent committee of employees, not necessarily management, is provided a pool of money and authorized to award it to nominated workers. Employees who are awarded a bonus are celebrated and their superb work is outlined in a company communication. These are some benefits of this type of bonus plan:
- It’s democratic – anyone in the company is eligible and it’s not controlled by management
- It’s enriching – publicly recognizing co-workers’ accomplishments engenders a motivated and high-achieving workforce
- It’s immediate – we humans are wired for immediate gratification. Providing an award at the time of an achievement is more valuable than an end of year payout.
- It’s educational – by publicly explaining the work that warranted this recognition, employees from other teams gain an understanding of what’s considered above-and-beyond work in another discipline.
- It’s honest – a company could tout this plan when recruiting employees without making implicit promises about potential compensation.