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The Handbook of Incentive Compensation

by Rich Armstrong, Brad Hams, Cathy Ivancic, Loren Rodgers, and Corey Rosen

$25.00 for NCEO members; $35.00 for nonmembers

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Incentive plans are common in companies, but satisfaction with them is not. Surveys of human resource executives consistently show that incentive plans often do not live up to results. Still, too many companies report too much success with incentive compensation to just give up on the concept. In the decades of work the NCEO has done on employee ownership plans, one of the most powerful incentive tools, we have also learned a great deal about non-employee ownership models that work consistently well. In this book, we have drawn that experience together. The first chapter offers an overview of why incentive plans do not always succeed. It is followed by chapters describing general principles in designing incentive plans and making them work; how to structure an effective profit sharing plan; how short-term incentives can work alongside longer-term employee ownership plans; how bonus plans and open-book management work in the Great Game of Business; and finally what the various equity incentive plans are, from ESOPs to stock options to phantom stock.

Publication Details

Format: PDF, 116 pages
Dimensions: 6 x 9 inches
Edition: 1st (December 2009)
Status: Available for electronic delivery

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1. Why Incentive Pay Plans Fail
2. Designing and Supporting Effective Incentive Systems
3. Creating Ownership Thinking with Incentive Pay
4. Beyond Bribery: Short-Term Incentives That Grow an Ownership Culture
5. Bonus Plans and the Great Game of Business
6. A Primer on Sharing Equity with Employees


From Chapter 1, "Why Incentive Pay Plans Fail"

The excessive undervaluing of long-term rewards is one of the most frustrating things to companies that share ownership, but even those with annual profit sharing may find that employees are focused on the very short now. Part of the solution has to be education and involvement. The more people understand the numbers and use them at work, the more they will identify with the company and its long-term possibilities. Another partial solution can be combining short- and long-term rewards, as described above. A third way have an annual profit sharing formula, but it is paid out quarterly. To avoid paying profits early that later losses may force them to rescind, a "10-20-30-40" formula is used in which 10% of the potential future profit pool projected for the year is paid out in the first quarter, 20% in the second, and so on.

From Chapter 3, "Creating Ownership Thinking with Incentive Pay"

I generally suggest that incentive plans be tied to projected annual profit performance. Further, I suggest that they be divided into quarterly opportunities, a good practice that makes the incentive more immediate and flexible. Once designed, the plan should be communicated to your employees along with key areas of focus to ensure the plan will be funded. I suggest that you reevaluate your incentive plan every year as you go through your budgeting process, and it is likely that you will tweak it from year to year. The design may stay fundamentally the same, but the numbers will change based on revenue growth, improvements in operational efficiencies, changes in product or client strategy, etc. When you introduce the plan each year, reiterate to employees that this is the plan for the upcoming year but there is no guarantee that it will remain unchanged for subsequent years. Having said this, I strongly advise you not to mess with the plan during the year for which it has been designed.

From Chapter 5, "Bonus Plans and the Great Game of Business"

You begin by setting up the game around a critical number—a performance target that represents what's most important to the organization and critical to success. It's important to involve everybody in defining the critical number. When goals are created with broad participation—that is the minds of the people who are closest to the action and who understand the realities—it creates a level of commitment and alignment that just can't be matched. When the critical number is correctly identified, targeted, and tied to a performance incentive, the rules of The Game have been set. The critical number becomes the focus of the game. Critical numbers can be many things—sales growth, profit, overhead absorption, billable hours, EBITDA, value added—whatever is essential to defining business success. There may be critical weaknesses you want to address by adding another critical number to the mix, such as quality problems, delayed shipments, accounts receivable days, etc. Critical numbers can exist for the entire company or for parts of the company. You might also change the numbers as problems get resolved or new key drivers emerge.

Next, you do everything you can to educate people about the critical number—what it is, why it's important—so everyone can contribute to achieving it. This may seem like a daunting task, but it doesn't have to be. Critical numbers are straightforward; they are much less complicated than income statements or balance sheets. They are simple scores that can be charted and reported regularly. In sports, most baseball fans understand why earned run average or slugging percentages are critical numbers. Critical numbers in business are no harder to explain.