3 Insights from the Compensation Games – How to stop a 21 percent net income loss from turning into a $1.6M Bonus

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“Despite 20 years of trying, we have still failed to come up with an objective performance metric that can’t be gamed.”

Lynn Stout, Professor, Cornell Law School from this article that sparked a connection to compensation.

UPDATE: Part 2 of this Article Here, What they don’t like about compensation software.

Performance in business is like performance in any profession; people seek an edge. Today performance and compensation are deeply connected; how you measure performance and reward it is at the core of the new, Compensation Games, where competition meets employee rewards.

compensation game

 

Performance management and compensation software are intricately intertwined, what you do in one affects the other. Take the case of a CEO who earned a bonus while the company was experiencing a large quarterly income loss.

The stock price went down, and influenced by the stock repurchase, moved up enough to trigger the bonus.

If you set up a plan that rewards a performance increase in EPS (earnings per share), but allows a decrease in income at the same time, you likely have a flawed compensation plan. Performance in this case isn’t a review, it’s a measure that was overlooked.

In the compensation game that is being played today, a flawed plan often leads to much more than a momentary loss of revenue.

The game is not just played at billion dollar CEO levels, compensation gaming goes on in traditional companies, even smaller ones.

What a CEO  does is based on the plan; the important lesson here is how the gaming was set up by the company’s compensation plan that affects much more than executives.

While we aren’t here to recommend your EPS strategy, here’s a few insights from a compensation management perspective on how executive, and all employee levels, are involved in a new game linking compensation and performance:

 

  1. Wisely Set, and Regularly Evaluate, the Rules of Your Compensation Game

The compensation plan sets the ground rules; executives, managers, and even employees may game the system by focusing on outcomes that create short term, and long term, rewards.   What scenarios will arise from this plan – not just financial goals but all productivity measures?

In the CEO example above, where a 21 percent loss in income reduced the stock price, while a stock repurchase increased the price enough to trigger a CEO bonus, it’s not actually hard to understand why CEOs do it.

It’s in the rules, and it benefits the CEO and arguably the company, in terms of the value of its stock. Yet to reward a CEO for a poor performing year is the result of a compensation plan, not some negative CEO stereotype. Because the measure is based on stock price, not on income.

The solution here is usually a longer term, 5 or more years, for EPS share bonuses, and avoidance of short term perks that aren’t aligned with company income. Or at least weigh the value of the increased EPS to the reduction (long and short term) for income.

Compensation is just one part of the game; performance and its measures are the other.

  1. Blend compensation reviews with  performance reviews, which are also a source of gaming.

In some companies, performance reviews carry more influence. In others, merit pay influences reviews. Either way, these mutual influences create behaviors which become habits that should bring an individual, and long term company, reward.

Communication is a key factor in all reviews; poorly communicated compensation, and performance, reviews are lethal on morale. This is often an unknown part of the game for companies, who don’t know how this information is shared, and received.

Performance reviews are known for bias; compensation plans are often known for being rigid. Together these help paint a more accurate picture of where a company is going now and in the upcoming years, then simply looking backward to validate old activity.

While this shift will take time, the move from reactive compensation plans to real time compensation plans, with software that adapts, is already happening.

This is done by measuring whether the current employee actions, and the incentives driving those actions deliver the desired results. Checking to see if those measures stay valid is key; like a garden, a good business grows when it’s watched, and watered regularly.

The real question is, will your plan adapt in the face of

changing economic, executive activity, and/or market conditions?

  1. Compensation games happen in a competitive business environment. Build around them.

    Good gaming is ultimately good execution, where the rewards, and competitiveness within a company helps more benefit than poor gaming, which rewards a few and possibly de-incentivizes many employees along the way.

Good compensation is also good execution.

In a way, it’s the new HR Compensation Game – where social, performance, and compensation layers mesh, each one affects the other. These dependencies are key to understanding the long term success of your compensation plan.

It’s no longer about writing a plan down and do it, it’s about communicating this continually in a way that generates individual and business growth.

How to Get Everyone to Win Your Compensation Game

We’re not here to judge a business’s executive pay, or compensation games; management should create an atmosphere where every day, there is focus on the game at hand.

Today this combines more frequent performance reviews with compensation plans that balance short term recognition with the long term growth of the company, and its employees.

Finding the right compensation plan and software helps you play the game as well, because even if you don’t consider it, the compensation game is played every day in, and around, your company.

Because compensation is not only  about what you pay and reward people for, it’s about creating a business which is driven by compensation games, and people. The best companies are ones where people enjoy the game, and play it daily.

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