5
Compensation
How Should Employees Be Paid?

IF YOU WANT TO ELICIT STRONG EMOTIONS from a group of workers, ask them about compensation. Everyone has an opinion about the subject, most of the time relating to something they believe their organization could be doing better. Yet certain aspects of compensation are shrouded in secrecy and discomfort. Employees often fear requesting raises or are reluctant to ask questions about pay. Similarly, many managers hate responding to requests for raises or cannot answer even the most basic compensation inquiries. When compensation issues are not addressed head-on, they lurk behind the scenes and become sources of rumors, misinformation, and discontent.

The problems organizations and individuals face when communicating information about pay stem from the very personal nature of compensation and the complexity of wage and hour laws. Some companies face additional challenges because they do not have, or fail to inform employees about, an organizational compensation philosophy or policy. In this chapter, we will discuss the relevant wage and hour laws and other considerations involved in developing, implementing, and disseminating a total compensation strategy.

WAGE AND HOUR LAWS

Compliance with federal wage and hour laws begins with your obligation to prominently post the federal wage and hour compliance poster in your workplace. Many companies sell wage and hour posters, but you can get them for free by calling your local Wage and Hour Division of the Department of Labor or by downloading them directly from their Web site.

The next step is to make certain that you, or the company that completes your payroll, keep proper employee payroll records that include:

• Name and Social Security number

• Address (including Zip code)

• Date of birth (if under eighteen)

• Gender and occupation

• Time and day of work and when work begins

• Hours worked each day

• Total hours worked each workweek

• Basis upon which wages are paid (e.g., hourly or weekly rate of pay)

• Regular hourly rate of pay

• Total daily or weekly straight time earnings

• Total overtime earned for the workweek

• All additions or deductions from employee’s wages

• Total wages paid each pay period

• Dates of payment and pay period covered

If an outside vendor completes your payroll, it maintains this information and can provide it to you in an easy-to-understand format.

“What do the minimum wage laws mean for my business?”

The wages you pay your employees are not determined by legislation, but there are laws that establish minimum hourly rates. The Fair Labor Standards Act of 1938 (FLSA) sets a federal standard for the lowest rate of pay per hour of work for most jobs. Many states also have their own minimum wage laws. In situations where federal and state laws are different, you must comply with the law that is most generous to the employee.

There are some very narrow exceptions to the federal minimum wage requirements. You do not have to pay minimum wage to tipped employees who earn at least the minimum wage when their tips are added to their direct wages, or to workers under twenty years old during their first ninety days of employment. You can get information about these and other exemptions from the U.S. Department of Labor.

No more than 5 percent of all U.S. employees receive the federal minimum wage, because in most locations it is not a competitive rate of pay. There are states and localities that require that area standards or prevailing wages be paid to contractors performing work for municipal agencies. Some municipalities have also adopted a minimum wage called a “living wage.” Living wage campaigns are generally driven by coalitions of community groups, religious leaders, and unions with the aim of requiring private employers that benefit from government contracts or funding to pay their workers at rates at least at the local poverty level. There are more than a hundred living wage ordinances with varying requirements in locations throughout the United States.

“When do I have to pay my employees overtime?”

Under the FLSA, employees working more than forty hours a week are entitled to overtime unless they qualify for certain specified exemptions. Employees who are legally eligible for overtime are often referred to as “nonexempt,” as opposed to “exempt” workers, who fit into one of the excepted categories. Exempt workers receive their full salaries for each workweek regardless of the number of hours they work. However, you cannot avoid your overtime obligations merely by classifying workers as exempt and paying them salaries. The FLSA sets strict guidelines for determining whether a position qualifies for an exemption.

In August 2005, the Department of Labor issued revised regulations governing overtime eligibility for executive, administrative, professional, outside sales, and computer employees. These regulations describe what are commonly called “white-collar exemptions.” As an employer, you are responsible for determining which positions in your organization are exempt and for defending your reasoning if challenged.

Executive Exemption

To qualify for the executive exemption, individuals must:

• Regularly direct the work of two or more full-time employees or the equivalent

• Have the authority to hire, fire, and promote employees, or such individuals’ suggestions about the employment status of others must be given particular weight

• Regularly exercise a high degree of independent judgment in their work

• Receive a salary of at least $455 per week

• Have as their primary duty the management of the enterprise, or management of a customarily recognized department or division

Administrative Exemption

This category is often overused, but should be limited to those who:

• Have the primary duty of performing office or nonmanual work that is directly related to the management or general business operations of the employer or its customers

• Have a primary duty that includes exercise of discretion and judgment with respect to matters of significance

• Receive a salary of at least $455 per week

Professional Exemption

The professional exemption recognizes those positions requiring special skill and training. Employees in this category of exemption must:

• Have the primary duty of performing work that requires advanced knowledge (defined as work that is primarily intellectual in character and requires consistent exercise of discretion and judgment)

• Have advanced knowledge in a field of science or learning

• Have advanced knowledge that is customarily acquired by a prolonged course of specialized intellectual instruction

• Receive a salary of at least $455 per week

Outside Sales Exemption

The outside sales exemption applies to employees who:

• Have the primary duty of making sales or obtaining orders or contracts for services or for the use of facilities for which payment will be received from a client or customer

• Are customarily and regularly engaged in making sales or obtaining orders away from their employer’s place of business

Computer-Related Occupations Exemption

In order to qualify for the exemption for computer-related occupations, employees must:

• Receive a salary of at least $455 a week or, if compensated on an hourly basis, a rate of at least $27.63 an hour

• Be employed as a computer systems analyst, computer programmer, software engineer, or other similarly skilled worker whose primary duty includes:

• The application of systems analysis techniques and procedures, including consulting with users to determine hardware, software, or other system functional specifications

• The design, development, documentation, analysis, creation, testing, or modification of computer systems or programs, including prototypes, based on and related to user or system design specifications

• The design, documentation, testing, creating, or modification of computer programs related to machine operating systems; or

• A combination of the duties listed above, the performance of which requires the same level of skills

“How can I avoid mistakes in classifying positions?”

You can minimize your risk by carefully reviewing your current wage and hour practices. In your analysis, pay attention not only to job descriptions of exempt employees, but also to the way each job is actually performed, to ensure that only those employees who are legitimately exempt are classified and paid that way. A position is not automatically exempt just because the job has a managerial-sounding title or because the employee has a professional degree that is not applicable to the job. It is the actual primary duties of the worker, not the occasional responsibilities, and the level of judgment and discretion required by the position that matter.

Pay exempt employees strictly on a salary basis. Generally, you must pay exempt workers their salary for each week they perform work, regardless of the quantity of work performed or availability of work. With limited exceptions, you cannot take deductions from their pay because of sickness, partial day absences, or jury service. If you take deductions from the salary pay of exempt employees, they may lose exempt status and you may be obligated to pay them for back overtime.

“How do I calculate overtime payments?”

The FLSA-mandated overtime rate is 1.5 times the nonexempt employee’s “regular” hourly rate of pay for all hours worked over forty hours during the week. Employers frequently make the error of calculating the amount based on the worker’s “base” hourly rate of pay. When workers earn a flat hourly rate, the regular and base rates will be the same. When employees work at two or more different rates or earn commission, bonuses, payments for good attendance, or other forms of compensation during the week, you must include these variables when determining the regular hourly rate.

Here is an example of this calculation:An employee works forty-five hours in one workweek—thirty hours at $15 per hour and fifteen hours at $20 per hour—and also earns a $40 commission for the week.

Step 1. Multiply the hours worked by the hourly rate for those hours:
30 hours X $15 per hour - $450
15 hours X $20 per hour - $300

Step 2. Add the totals from step 1, plus the $40 commission, to get $790 total base pay.

Step 3. Determine the regular rate by dividing the total base pay by the total hours worked (i.e., $790 / 45 hours − $17.55).This is then the regular rate for this week. So for forty hours of work, this employee would earn $702.

Step 4. The overtime rate of time and a half is calculated on the rate determined in step 3 (i.e., $17.55 X 1.5 − $26.33). Five hours of overtime equals $131.65.

Step 5. Add the forty hours at the regular rate plus the overtime: $702 + $131.65 − $833.65

Had there been no commission involved, you could have avoided the calculations by paying all the overtime based on the higher rate of pay, because this rate will always be higher than any regular rate that was calculated as a weighted average. In any week where the employee has earned a commission or other extra payment, always do the calculation, since the regular rate may be higher than the highest of multiple hourly rates.

You are obligated to pay nonexempt employees for time worked, whether or not the work was on the clock and whether or not any off-the-clock work was voluntary. It is not enough to have a policy stating that managers must approve all overtime—if your employees were working, with or without manager permission, they are entitled to pay. Wage and hour claims related to off-the-clock work have skyrocketed. Be sure you do not pressure employees to record only regularly scheduled hours on their time sheets, or work additional unpaid time early or late. Company-sponsored meetings and training sessions also count as hours worked for overtime purposes. It is critical to develop accurate methods to keep records of actual time worked by your nonexempt workforce and to ensure compliance with company overtime policy.

You may be subject to additional state or local laws regarding the payment of overtime or setting working hours or break times. There is no federal requirement to pay overtime for hours worked on Saturday, Sunday, or holidays, but some state or local governments require employers to pay premiums to those who work on these days. In some jurisdictions, you must pay overtime to nonexempt employees if they work more than eight hours in one workday, regardless of the number of hours they work in a week.

Wage and hour investigations are most often triggered by a complaint from a disgruntled current or former employee, or one who hears about the success of a claim filed by a friend, or reads about high-profile class actions. Once state or federal investigators begin an audit, they are likely to continue their work until they find a violation, and the number of claimants is likely to grow in the process. Because audits are time-consuming, and penalties for violation can be significant, it is best to be proactive in understanding and complying with the laws. If you have questions regarding interpretation of any of the wage and hour regulations, seek the advice of an experienced professional. Your local department of labor can be helpful in answering inquiries and will not use the information you provide to seek out potential violations.

THE COMPENSATION SYSTEM

Since it is unlikely that you will be paying your entire workforce the minimum wage, you will need to determine what to pay them. You will make better decisions if you take the time to determine your compensation philosophy. Compensation decisions guided by a sound framework or philosophy will result in practices that make sense for your business.

“How do I figure out my compensation philosophy?”

Start by answering the following questions:

• What can you afford to pay and continue to earn the profit margins you expect?

• How should pay compare to similar positions in relevant markets?

• Will you offer bonuses or incentives?

• How much will you spend on benefits, and how will this influence pay rates?

• Will you follow the same philosophy in different parts of the business or different geographic locations?

• Who will make decisions regarding pay and raises?

• How and when will raises be given?

• How often will you review your compensation philosophy?

• How will you communicate this philosophy to employees?

There is no right or wrong answer to any of these questions. If you are a small company with limited opportunity for growth and promotion, you may believe you should pay higher wages than other companies in your area or industry. Alternatively, you could decide that your wage rates will be average but you will offer an incentive plan linked closely to company financial performance.

Whatever decisions you make, put them in a written format you can share with employees. This may take the form of a policy, a statement in an employee handbook, or notes or minutes of a senior management or owners’ meeting. Be prepared to review this philosophy or policy at least annually. Changes in your business, including growth, acquisitions, new products, economic conditions, available talent pool, and competition, can trigger revisions.

Now that you’ve laid the foundation, it’s time to build the framework!

Armed with your compensation philosophy, the next step is to implement a system to help you make decisions and resolve problems about pay. The most effective compensation systems are those that are relatively easy to understand and administer.

Unless both internal equity and external competitiveness are present in your compensation practices, you will have a difficult time attracting and retaining employees and keeping up morale. Internal equity relates to whether the compensation structure reflects the relative value of jobs and people within the organization. External competitiveness ranks compensation alongside competitors or comparable positions in different industries.

Setting Rates of Pay

“What are pay grades and how do I use them?”

Pay grades, sometimes called rate ranges or steps, are the basic element underlying the majority of formal compensation structures. Under these systems, organizations group jobs of similar values into grades. Each rate range reflects a distinguishable pay difference from others and will include a variety of jobs. Within every grade, there is a salary minimum, a midpoint, and a maximum, with the minimum and maximum salaries generally about 15 to 20 percent lower or higher than the midpoint. People with little or no experience typically begin at the bottom of the rate range. The midpoint of the range is generally the “going rate” for the position.

Structuring a wide salary spread within each grade allows businesses the flexibility to recognize differences in individual performance and accommodate salary growth. However, if the salary spread is too wide you will have less control over your pay rates. Usually, the higher the level of position, the broader the salary range. There are no set rules regarding how many grades an organization should have. It depends on the size of the company, the complexity of the reporting structure, and the range of jobs.

Some organizations use a variant of pay grades called “broad banding,” a concept that employs fewer grades and much wider salary spreads.

There are several approaches to slotting positions into grades. Some companies perform job analyses using such factors as the level of skill, education, and experience required; responsibilities such as number of reports and fiscal oversight; and market wages. Some will use a formal job points system that assigns a point value to each component of a job description. The point total for each position determines its place in the grade system. Job points systems are very time-consuming and expensive when done correctly. It is easier to use labor market comparisons to set rates and ranges.

Review your rate ranges at least every two years. There is no need to adjust your entire grade structure just because the relative values of one or two jobs have changed. You can always regrade a position or make changes to salary spreads within individual ranges. Competitive pressures, area wage fluctuations, or changes in job requirements may trigger range adjustments.

“We don’t have formal job descriptions. Do we need them?”

While it is not necessary to have job descriptions for your employees, these documents are helpful. Job descriptions can be used to inform employees about their responsibilities, guide supervisors when evaluating work distribution and departmental organization, and help determine appropriate pay grades and classifications. They can also be an important part of the process of identifying overtime-exempt positions by providing clear identification of actual primary duties. However, too many companies spend inordinate amounts of time writing job descriptions, only to put them away on a shelf, never to be seen again. The most helpful job descriptions are living documents that are short and easy to understand, tied to company goals, reviewed regularly by both the employee and the company, and modified as needed.

When you write job descriptions, do not focus on the history of the job. Instead, think about the position as you want it to be and how it is actually performed, related to the current needs of the organization. Describe the position’s duties and not the individual in the position. Include:

• The job title

• A short, general summary of the job

• The title of the person the position reports to

• The departments the position interacts with

• The primary responsibilities and job functions

• The minimum education, experience, and training needed for the position

“How do I set rates of pay?”

While pay grades promote internal equity, pay rates establish external competitiveness. The amount you pay employees will be an important factor in determining whether they work for you or for someone else. Businesses commonly start developing their rates of pay by looking at market rates or at what competitors pay for the same job. This is easiest to do for hourly, nonexempt positions. If you wish to hire a clerk and know that the other companies in your area or industry pay clerks between $12.00 and $13.00 per hour, you can decide to match that average or pay more or less, based on your compensation philosophy.

Using market rates for salaried, exempt positions is more complicated. It is often difficult to identify a “going rate” or even a narrow range of pay for key positions. If you are hiring a sales manager, you cannot accurately conclude that “sales managers earn $80,000 a year because that is what XYZ Company pays.” You will usually factor individual experience, education, compensation history, and industry expertise into your analysis.

Include geographic differences in your market rate analysis, especially for salaried positions. According to the 2009 Culpepper Geographic Pay Differential Practice Survey, more than 70 percent of employers with workers in more than one location provide geographic differentials or adjust pay based on location. Geographic differences may not be as striking at higher salary levels. If you have multiple locations where the market rate varies greatly, allow for these differences and make adjustments either in base salary or otherwise when you move employees between locations. In a move from a lower to a higher market rate, there are creative ways to pay the employee more without raising base salary. For example, you can add a separate “cost-of-living allowance” to the worker’s paycheck. If this person subsequently moves back to the lower market rate area, you can discontinue the allowance without having to reduce salary. If the move is to a city where the rate is significantly lower, it is difficult to ask someone to take a pay cut, but you will want to achieve greater equity between this employee and new coworkers. You can attain this goal by taking away a benefit or perk to which other workers are entitled.

You can get wage market data from a number of sources. The federal Bureau of Labor Statistics (BLS) compiles this information in a number of different formats. The Occupational Employment Statistics division of the BLS releases statistics broken down in a number of ways, including by state and metropolitan area. When looking at information for specific positions you may see reference to the “SOC” code. This is the Standard Occupational Classification System that the BLS uses to identify jobs.

Chambers of commerce and trade organizations produce market data through wage surveys, which they generally provide free or for a reasonable fee to members or companies that participate. You can also buy compensation surveys from a number of large national consulting firms. Web-based salary search tools such as www.salary.com and www.payscale.com post free survey information, with more detailed data available for purchase. The big job posting boards publish salary information that is designed for use by the job seeker but can be used by anyone. The Web-based tools are generally not as comprehensive as the surveys produced by large consulting firms.

Pay Increases

“When should I give employees raises?”

Companies give raises on set dates in the year, on anniversary dates, and for employment milestones. The best timing for your company will depend on your philosophy, your budgeting process, your compensation system, and what your competitors in your geographic area are doing.

“What criteria should I use to determine raises?”

Merit Increases. Merit increases are the most common form of pay raise. Many organizations tie the raise directly to performance evaluations, with a set percentage pegged to each performance rating. You may also choose to allocate a specific dollar amount or percentage for raises in each department and allow managers to determine the amount for each employee based on performance and contribution. This gives individual managers the discretion to give greater rewards to star performers as long as the total of all raises does not exceed the department’s budget. Competitive forces have caused a sharp decline in the amount paid for merit increases. From the 1980s to the 1990s, average salary increases dropped from between 7 and 10 percent to between 3 and 4 percent. Since the beginning of the new millennium, average increases have continued to decline. According to the 2009 U.S. Salary Increase Survey conducted by the consulting company Hewitt Associates, the average merit increase for salaried exempt employees dropped below 3 percent for the first time since the survey was initiated in 1976. Employees sometimes incorrectly refer to these low increases as cost-of-living increases. Cost-of-living increases actually reflect the changes in the consumer price index compiled by the BLS and are more popular during periods of high inflation.

“Does this mean that more employers are skipping raises altogether?”

Due to the challenging economic environment of recent years, many employers have announced salary freezes, and some have even required employees to take pay cuts. Employees are never happy to hear this type of bad news, but they are rarely surprised. Before making the announcement, clearly identify the reasons for the decision and analyze whether such a move is appropriate across the board. Certain positions in the organization may be in high demand and may therefore require increases to allow you to remain competitive in the market to retain these employees. However, a pay action that affects all employees, including senior management, will send a message to employees that “we are all in it together for the good of the company.”

When you lift the salary freeze or reinstate pay after a pay cut, you are not required to do this retroactively or make employees whole for amounts not paid during the salary action. Never promise that a pay freeze is a temporary or one-time event, as you will lose credibility if you find you must take similar, or more drastic, steps in the future.

“How do merit increases work within the structure of my pay grade system?”

You have substantial flexibility with individuals who are at lower points in the pay grade. People who start out at the minimum for the rate range usually do so because they were promoted into the job or otherwise had little experience in the area. Good workers will improve rapidly as they gain experience, allowing you to move them up quickly within the range toward and eventually beyond the midpoint.

When an employee reaches or exceeds the maximum pay point of the grade, your choices become more difficult. You can opt to “cap” or “red circle” this person’s pay and not award further raises until you increase the salaries within the range or until the employee changes positions. Some companies that do not want to risk losing solid performers by freezing salaries will instead give them token raises or bump them to the next pay grade, if appropriate. The decision is entirely up to you and should be based on the individual circumstances involved. You can apply the same principles when a restructuring results in position changes and salaries are above the maximum for the new grades.

“Does a promotion always involve a huge raise?”

Not unless the job is a true promotion and not a lateral move. A true promotion involves significant additional responsibilities and the elevation to a new pay grade, in which case you should increase the employee’s salary to fall within the new range. If the promotion is such that it justifies a very large increase, you can split or stagger the increase over the subsequent months. Since a new position is probably a stretch for many people, they will have the time to get their feet wet and grow into their responsibilities. Giving a very large increase all at once can set unrealistic expectations for future increases.

“Are merit increases the only way to give raises?”

Pay for Performance. A pay-for-performance system directly rewards individual productivity. Employees are given a specific set of objectives, with certain tasks to complete or certain outputs to achieve, and pay increases are based on how well they meet their objectives. While some people claim that pay for performance aptly rewards the best employees and fosters competition that improves performance standards, others say the emphasis on individual efforts hurts teamwork and overall productivity. Pay for performance has also been criticized because it does not take into account the influence of process, materials, or machinery or other factors beyond an employee’s control that may impact attainment of goals. Since pay for performance can involve subjective standards, the system has also raised questions of bias.

Before implementing pay-for-performance raises, thoroughly research the parameters and communicate the ground rules to affected employees and their managers to avoid misunderstandings. As with any pay structure, there should be no mysteries.

Raises for Single-Rate Jobs. If you have a few “single-rate jobs,” where you are paying a number of people the same wage, it is often effective to give the same flat dollar amount of increase to all people in these positions on a set schedule. However, if you have a number of single-rate jobs, it may serve you better in the long term to give increases as a percentage of the hourly rate, so that you don’t compress the differences between rates of pay and overtime. If you decide to implement merit increases for single-rate job employees, the criteria for individual increases should be very clear, communicated well to employees, and applied consistently.

Across-the-Board Increases. Across-the-board increases are raises given to all employees to deal with nontypical economic factors. You may, for instance, award this type of increase if you discover that your rates of pay are significantly lower than those of your competitors.

“What happens when employees complain about the system?”

No matter what pay and increase structure you choose, some people will be unhappy. But remember that there is no perfect method of compensation, and any approach may create problems. It is more important that you are comfortable that your approach fits in with your overall philosophy and that you communicate your system to the workforce.

In a common scenario, an employee will march into the manager’s office, announce that she was offered a new job, and request a substantial raise or ask that the employer make a counteroffer to get her to stay. Before automatically succumbing to this ploy, consider the entire situation. If she is at the low end of the rate range or the competitive rate has changed significantly, it may be reasonable to grant the increase. Sometimes it is better to refuse. Remember that she has already interviewed elsewhere and received a job offer. She may already have “emotionally resigned” and be more interested in the new position. Once you grant the raise, she may continue to use this tactic into the future.

Never let your salary structure drive a decision that does not seem to make sense. You can create a “special case” to meet market demand for a position or to acknowledge an individual’s unique or desirable background. Document these exceptions to show that the differences were not the result of any discriminatory motives.

“Why can’t we ever seem to keep salaries confidential?”

Despite publicized rules about the confidentiality of salary information and the general reluctance to share information, salary details inevitably seem to leak. Predictably, salary leaks create disgruntled employees, especially in circumstances where workers discover that a new employee performing the same or a similar job is being paid more than they are. When employees ask questions about perceived salary disparities, it is best to answer honestly. Without discussing specifics, you should explain that you are paying the higher rate because of market forces or the individual’s different work experience or educational background.

Often employees may realize significant increases only by changing jobs. But job changes can entail a loss of job security, seniority benefits, and general comfort level that comes with knowing your employer. Some of your employees will take that risk and others will not; it is inappropriate to adjust everyone’s salary every time you hire a new employee for more money.

“What about those perks?”

Auto leasing, country club memberships, or clothing allowances may fit into your compensation philosophy and policy—that is your decision. Perks should be considered part of the total compensation package. Before instituting any perks, survey eligible employees to determine whether they perceive value in what you plan to offer. Also consider that when you offer perks to only a selected group of employees, others may be resentful and morale may suffer.

VARIABLE PAY: BONUSES AND INCENTIVES

Variable pay is different from base pay in that employees are not entitled to these payments but must continually earn them anew. Incentive structures are divided into two categories: short-term programs that reward behavior or performance over periods of a year or less, and long-term programs that foster attainment of goals over a number of years. Short-term programs are usually based on cash payments, while long-term incentives typically involve stock or other equity arrangements.

Tailor your organization’s incentive program to your individual financial situation, business objectives, and employee demographics. Calculate the potential total cost before implementation, and if there is a possibility that you will be unable or unwilling to pay the bonuses earned, change the plan or do not implement it at all. A plan with a bad payment history is not a motivational tool. If you already have a plan with a poor reputation and you want to continue to pay bonuses or incentives, discontinue it and create a new one.

“What are some of my bonus and incentive options?”

Flat-Rate Bonuses. The simplest and most common bonus is the flat dollar amount paid out once a year. This could be a holiday bonus, a special payment to recognize a company milestone or achievement above financial goals, or a payment under an annual bonus plan. Bonuses are generally given across the board or to specific categories of employees; they can include variable amounts based on criteria such as level of position or length of service, or payments as a percentage of the employee’s base salary.

Short-Term Bonuses. Short-term bonuses are effective tools to recognize performance or spur improvement. Companies give these bonuses to reward achievements such as upselling, outstanding customer comments, measurable increases in production, quality improvements, or safety suggestions. These incentives have the biggest impact when you set a specific, short (usually one to three months) measurement window and tie awards to a publicized, company-wide promotion. Continuing these plans indefinitely dulls their effectiveness, can result in poor monitoring, and may create the misimpression that the bonuses are a regular part of pay.

Sales Incentives. Sales incentives can range from payments of flat percentages of sales to more complex systems comprising factors such as lead generation and performance against a specific sales target or plan. Commissions are payments made as a percentage of sales and are usually paid out on a regular schedule shortly after the completion of the sale. Choose a schedule that best fits your particular type of sales. If you sell a product with a high potential for returns or significant changes in the order before delivery, you may choose to “hold back” a portion of commissions until product acceptance. If you pay your salespeople on a commission-only basis, you may provide them a “draw” against a commission or incentive. Under this structure, you will deduct the amount of the draw from earned commissions or incentives prior to payout.

While your sales incentive structure should be driven by the results desired by the company rather than copied from a competitor, it is important to consider competitive factors as well. Give ample notice of any changes you make to payout or target amounts. Items to consider when designing a sales incentive plan include:

• How often will the plan pay out? Each pay period? Monthly? Quarterly?

• Who will maintain and review data concerning payout entitlements?

• Is the plan based on sales targets or total sales?

• If a plan is based on targets, what happens when employees exceed their targets?

• What incentives, if any, are paid if an employee leaves?

• Will there be holdbacks (payments that are delayed to enable the business to reconcile amounts due with cancelled sales or reduced customer payments)?

• How does the competition pay their salespeople?

• Will this plan reward individual performance, team sales, or both?

• What kind of records are salespeople required to keep?

• What time period does the plan cover?

Goal-Based Bonus Plans. Goal-based programs reward the achievement of company objectives, team performance, individual results, or a combination of the three. You can use individual payments as an award for successful completion of a project or for coming up with an outstanding cost-cutting suggestion. Company and team bonuses are typically paid for meeting financial, productivity, or cost-cutting objectives. Payouts under the plan can be a flat sum or based on a percentage of the profit made or the gain attained. When designing your program, carefully select those goals that are most important to your business, since eligible employees will naturally focus on performance that will help them earn the bonus. If your program provides annual payouts, enable eligible employees to track progress toward the goals throughout the year.

Sign-On Bonuses. The subject of sign-on bonuses is covered in Chapter 1 on recruitment.

Retention Bonuses. When a company goes through a merger, acquisition, or downsizing, employees begin to get nervous, lose focus, and leave for other employment, especially if they know that their jobs will be eliminated. Retention bonuses are predetermined amounts paid to those employees who continue in their jobs to a set date. They are valuable tools for keeping key employees during transition periods and other times of change and uncertainty.

“Should we issue stock options?”

Stock options are a long-term incentive that gives the employee the right to purchase company stock in the future at the stock price on the date the options were granted. To exercise the right to purchase options, individuals must usually remain employed by the company for a specified period of time. Stock option plans are based on the theory that having options will encourage employees to produce more, so that share prices will increase and they can realize greater profits when they exercise their options and subsequently sell their stock. Options have traditionally been the compensation form of choice for start-up companies that were short on cash but projected huge earnings.

Volatility in the stock market and the scandals surrounding accounting procedures and corporate accountability have caused many organizations to rethink their stock option plans or to turn to other forms of equity-based compensation altogether. Although you may elect to grant equity incentives across the board, it is not fair to make them a major part of the compensation of all workers. These, and most other long-term schemes, should be geared toward executives and other key employees with greater control over the future direction of the company.

Stock-based incentives have significant tax consequences and complex legal requirements. Do not attempt to structure and implement such a plan without professional assistance.

“Now that I have decided which incentives to offer, how can I make the plans effective?”

How you administer the plan is just as important as the type of plan you choose. Employees must perceive that the plan is fair and provides value and incentive, and that the bonuses and incentives are paid as promised. These guidelines will help you:

Document the plan in writing and distribute it to employees eligible to participate. The document should include the reasons the organization is offering the incentive; details such as timing, eligibility, and criteria for payouts; reasons for any variation in payouts; and whether amounts of payments will be capped. If the plan does not provide a specific end date, include a provision that the organization has the right to modify or terminate the plan at any time. The simpler the language, the better.

Train the people responsible for administering the plan so that there is a single understanding of payment eligibilities and calculations. Also train the managers who will be making decisions about who will receive payouts and how much they will receive.

Make payouts when promised under the plan, and plan your payouts to occur as soon as possible after the rewarded performance occurs.

Evaluate the effectiveness of the plan on an ongoing basis. Analyze whether the incentive produced the intended results or improvements. Did it cause employee confusion or resentment? Were employees continually motivated or did they lose interest? Be prepared to change the programs to make them more effective, or develop new ones to help the organization attain new goals.

“Didn’t you forget executive compensation?”

No, we left it out on purpose! Executive compensation is a term used to describe the special pay packages given to CEOs and senior management. These are limitless in variety, ever-changing, and have been subject to intense scrutiny, particularly in publicly held companies. Executive compensation should be structured by compensation experts, with assistance and administration by highly trusted investment professionals.