Real world results should be the trigger for your incentive compensation management decisions

by on June 26, 2009 · 0 Comment POSTED IN: HR Info Center

Base your incentive compensation management on real results not on budgeted goals from last year

League tables in incentive compensation management
At Handelsbanken( leading European bank based in Sweden), their goal as a corporation is to be above average in profitability, which they define as return on equity. So, they’ve put themselves in a league table and compared themselves against 30 other banks that have a cost for risk profile measured by ROE, return on equity. The best bank is at the top down to the worst bank at the bottom.

To take that overall target of return on equity back into the organization, they break it into their 11 regions and they rank their 11 regions on that same measure, return on equity. Within each one of those regions, they break that down and rate their branches, their 54 branches in each region based on cost- to-income ratio. They moved to the surrogate of cost-income ratio because cost-income gives you a pretty good surrogate for return on equity.

They rank their branches top to bottom. And the way they based their performance evaluation is on how people do in adding income and decreasing costs.

Problems with fixed targets in incentive compensation management
Compare that to a fixed target for incentive compensation management where you’re trying to reach a set number. If at the end of the third quarter, I’m reaching that number, I can coast in the fourth quarter.

If at the end of the third quarter, I’m only 70% of the number and I know there’s no way I’m going to get there, I tend to coast .
In a situation where I’m judging myself relative, what happens if I’m number one or number two? Can I coast in the fourth quarter? No. You’ve got to keep running hard, because all those people behind you are trying to pass you.

Relative performance is a better way of keeping people motivated. It’s also a better way of adjusting to the environment.If the environment is floating up or down, the relative performance, the peers is floating up or down. The relative performance of the competition is also likewise floating up and down.

And we find that this measure is a better way of tying this reward or this evaluation factor to what the marketplace looks at. Because if you take it back to Wall Street, Wall Street cares a lot about how you perform comparable to your competitor.

So, if Wal-Mart announces a 4% same store sales growth this quarter, it sounds pretty good, but if target comes out a week later and announces a 7% growth, all of a sudden, it’s not as good.

So, it’s a way of really — automatically shifting the incentive compensation management system, so that you can eliminate the negotiation.

Edited remarks from the Rapid Learning Institute webinar: “How to Avoid Incentive Pay Plan Disasters” by Steve Player

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