Key Issues to Consider when Determining Rewards
As we head into the year-end bonus review period, it is worth reflecting on the fundamental issues facing Non-Executives and Senior Managers responsible for determining rewards. MCR has helped Boards and Senior Executives through many difficult periods of business performance, and this year is shaping up to be among the most controversial.
Consideration of results in a tumultuous post-Covid performance year presents a variety of challenges. Perhaps more than any year in recent memory, external factors have impacted performance and results – both positively and negatively. Supply chain issues, spiking interest rates and inflation, energy price volatility and downturns in consumer sentiment have had significant impact on companies this year and it is the job of Senior Managers and Non-Executives to balance these factors in interpreting actual results. To assess how these external factors should impact year-end compensation decisions, we at MCR suggest considering the impact of ‘externals’ on three key remuneration levers.
1. Firstly, we would consider how company results overall were impacted by external factors . Starting with Revenue, consider how factors such as interest rates, energy expense, supply chain delays and other factors impacted the results of the overall plan. While the tendency of executives is to focus on negative impact, it is important to consider where ‘windfalls’ may have given a boost to results. After considering the overall impact, it is possible to assess the amount that this variable should have on bonus payments. If actual performance was better than that caused by the external impact, there is an argument for improved bonuses. It is possible, however, that in the case of a positive external variance, actual results could be lower than expected. So, while results were perhaps better than budgeted, performance didn’t keep pace with the positive external results, and should result in lower bonuses. Bonus pool funding should reflect how performance results mitigated or surpassed the impact of external factors.
2. Consider business portfolio effects . In larger companies, it is possible that one or more parts of the business have a negative result due to externals while another area could benefit. While overall funding must reflect the economic business results achieved, the available bonus funds should be directed to those parts of the business best taking advantage of positive externals or most mitigating the impact of negatives. This impact may not be fully accounted for in bonus pool calculations; some rebalancing may be required.
3. Don’t restate, interpret . There is a tendency among some managers to restate performance targets reflecting uncontrollable factors. For example, lowering revenue targets if supply lines were disrupted or ‘adjusting’ profit goals based on higher costs than budget. These cause two problems from an incentive plan perspective. Firstly, they imply that performance goals were unreasonable, and require adjustment to understand results and secondly, they risk lowering expectations into the future for what could have been a one-off, or otherwise, temporary, factor. Be clear about missing targets, but also on what results were actually achieved. “Given energy cost increases of 50%, our results indicate that we were able to recover most of this unexpected variance and still end only 10% below target.” Likewise, limit consideration of ‘future performance’ when interpreting this year’s results. While it is tempting to say “Q4 was so bad, we better cut the pool as next year looks like a bloodbath” it is better to leave that issue to the objective-setting process for next year. Discounting actual results based on future fears lacks credibility and will undermine acceptance of future targets.
Here is a simple list of discussion points for your bonus determination meetings this year:
1. What external factors impacted the economic results for the year that were not known at time of objective setting?
- Were these impacts positive, negative or offsetting?
- What was the overall economic impact at the enterprise level?
2. How were the various sub-groups (divisions, countries, etc) impacted and how did these impacts vary?
- Did bonus plans adequately capture the impact of these differences?
- What should be done to ensure the positive and negative impact of external factors flows through to divisions appropriately?
3. How much did the contribution of divisions/teams add to or mitigate the externally impacted results?
- Did a ‘whale’ land on the beach or did extraordinary efforts prevent even greater negative impact?
- Adjust payouts given these factors, don’t revise targets.
Any adjustments to bonus pools ‘post hoc’ are generally frowned upon in normal circumstances. Good incentive design requires targets with consequences for being attained or missed. Management teams that regularly adjust incentive plans to reverse-engineer desired payout levels quickly find they lose credibility with participants. Likewise, executive decision-makers who refuse to consider extraordinary impacts can be seen as unrealistic and out of touch with the businesses.
All indications are that for many businesses, this is indeed an extraordinary year. MCR’s team of Senior Financial Services Reward professionals have experience in navigating this balance to keep motivation high and payouts appropriate and understandable.
Reach out to our Financial Services Reward Practice Lead randal.tajer@mcr.consulting
to discuss your year-end issues and learn how we can ensure you get to the right conclusions.
Copyright © 2022 Randal Tajer
