The design plan for your employee incentive program

by on June 17, 2009 · 0 Comment POSTED IN: HR Info Center

Use industry benchmark as the start for your employee incentive program design

An organization can certainly look at a list of peer organizations and run different performance metrics whether it be profitability growth, revenue growth, cash flow, whatever the metrics are that we talked about previously. And look at what do our peer organizations do or what is the market doing in terms of performance at the 25th, 50th and 75th percentiles.

You can formulaically combine those two. We’re going to pay at the same percentile as our performance and design your employee incentive program from there.

Long term employee incentive program design
When we get into the long-term component – again, defined as over a full year, there are a number of other considerations that come into play. Things like overhang, burn rate, fair value transfer. All of these things would go into the long-term incentive plan design. So as an example, things like dilution on an annual basis also known as the burn rate.

This is data that was pulled for a high-tech company. And what that says is that in the market, the companies are granting 1% to 1.5% of the value of a company to the executive team as an incentive to align the executive goals with the corporate goals. So on an annual basis, the company is giving 1% to 1.5% to the executive team.

Translate overhang into a spreadsheet
The first column is median. That second column is 75th percentile. We looked at both peer data, pulling a list of publicly traded peers but then there’s also some published data available from different survey sources.

Overhang is the total amount of shares outstanding, not what’s granted on an annual basis but the total amount that is granted to executives again, to align their interests with corporate interests.

Here, we see a median, meaning half of the organizations are above this half or below it, of 12% to 18% of the value of a company is essentially tied up in the executive team’s incentives. In high tech, if we take this further and look at the 75th percentile, the point at which only 25% of organizations are above it, nearly 30% of the ownership of a company is granted to executives for incentive.

The cost of employee incentive program
We also in this case looked at fair value transfer, which is similar to dilution. This confirms our 1% to 1.5%. So what that means in a nutshell is as we look at this – at the median level – and again, this data applies to high-tech companies. You’d have to run your own analysis for your own industry and those types of considerations. But for every dollar of profit, somewhere between $0.12 and $0.18 is going to the executive team.

Major factors in an employee incentive program
You need to take that information based on the overhang, burn rate and those factors. Again, that’s looking at the combination or the allocation of profit between ownership and the executives. But then also, combine that with what is market competitive pay for our executives.

In some cases, you end up with almost exactly the same answer. In other cases, you end up with a bit of a disconnect and it’s really bridging that gap to look at the balance between what’s market competitive, what do we have to offer in order to attract and retain a quality CEO for example versus what is going on in the market in terms of the offerings for long-term incentives.

Edited remarks from the Rapid Learning Institute webinar: Incentive Pay Plan Blunders That Can Cost You a Fortune by Ed Rataj

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