Incentive compensation plan formulas include multiple variables like performance incentives, market demand, and the economy

Incentive compensation plan design starts with trying to figure out what the incentive targets are for each job. Then, try to figure out the total target compensation that is competitive in the marketplace for a specific job or a group of jobs, what’s the mix? Or how does that vary between salaries and incentives?

And look at the market. But there are some internal decisions you’re going to have to make, even if you have good market today. And, a lot of what goes into the incentive compensation plan may depend on the type of job that you’re looking at.

You have their salary. From the survey, you have the actual incentive at the 50th percentile which is a median rate half paid below, half paid above that rate.

And, then you have something called the target incentive at the 50th percentile. The base salary plus the actual incentive at the 50th percentile will equal, the second from the right hand column in this table, actual total cash.

Now, that’s actually what’s paid. Actual incentives means that was actually paid to the survey participants, based on how well they’ve performed against whatever incentive compensation plan they were in.

The target cash is actually the target incentive. Then we focus on the actual total target cash of the 50th percentile. And, there’s a reason I do. I pretty much ignore the actual total cash 50th percentile. The reason to focus on the total target cash is because that number, as far as the target incentive for a particular job, does not vary from year to year that much. It’s pretty much a standard kind of a target incentive.

The actual result of the incentive compensation plan will vary a lot from year to year based on lots of things. Primarily, how well the company is doing on a year-to-year basis and just as importantly, how the economy is performing on a year-to-year basis.

Once somebody sets a target incentive and it’s generally expressed as a percent of salary. It doesn’t really vary for any company. That’s the target the actual incentive varies.

To give you an idea how it does vary, in 2005, the actual incentives paid against targets were approximately 125%. Meaning the actual payments were 125% of the target incentives for the average job out there. In 2006, they were about 80%.

So, you can see a wide swing in what’s actual. You want to figure out what’s the target incentive.

Edited Remarks from “Incentive Talk: How to Design an Incentive Plan that Works for – Not Against – Your Company’s Goal” by Rick Olivieri

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