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Is Incentive Compensation Viable in an Uncertain Economy? (Part One)

September 02, 2020 • By Ken Gibson

Chances are, the COVID economy brought you face to face with flaws in your pay strategy. When the lockdown hit, compensation became the enemy of cash flow and (perhaps) the cause of layoffs. Its “expensiveness” became a serious problem virtually overnight. Now you are likely wondering what should happen going forward—and specifically whether incentive plans should play a larger or a smaller role in your rewards approach. Should you even offer incentives in an economy as uncertain as this one?

The short answer is yes. In fact, incentive compensation must become a larger part of your offering if your pay strategy is going to meet the demands of our current environment. The reason your compensation plan was problematic when the pandemic hit is because it lacked flexibility and was heavily weighted to guarantees (salaries). So, going forward, incentives need to make up a bigger (potential) portion of employee earnings.

Flexible but Enduring

What you need your rewards strategy to be in any economy is agile—especially in an uncertain one. This means it must give you options for how to pay your people based on what’s happening in your business, your industry or the economy right now. This does not imply you should reinvent your compensation offering every time there is a significant change in any of those categories. That would be financially impractical, strategically problematic and lead to chaos. However, you do need to create enough flexibility in your pay structure to accommodate change as occurs. Here’s how.

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Think about your company’s compensation offering as you would an investment portfolio. In building the latter, any reliable expert would have your start by creating an investment philosophy statement. This essentially becomes your portfolio “constitution” stating the purpose your investments will serve and for what period. Your philosophy will identify the types of asset classes that will be considered for the portfolio and how they will be evaluated over time.

When you have established a clear objective for your investment portfolio and articulated your philosophy about the types of investments it should include, it becomes easier to select the specific assets you should acquire within the asset classes you have selected. Then, once you have secured and allocated your investments, you have flexibility in how you manage them based on the ebb and flow of economic conditions that occur. And you will do that by periodically rebalancing the assets in your portfolio, not by pulling out the ones you have and replacing them with new ones every time the economy shifts.

This is the ideal way to approach your rewards portfolio as well. Consider each compensation and benefits plan to be an asset class that should only be included if it is consistent with the purpose and philosophy of your pay strategy. And as the economy changes, you shouldn’t stop some pay plans and put other in. Instead, you should shift the “weight” (emphasis or volume of investment) you will give one set of programs over others. You will “rebalance” you pay portfolio. This will be difficult to do if you have limited the number of compensation “asset classes” in your portfolio. It is this kind of lack of diversity that caused you felt stuck when the COVID economy hit. You had no way to rebalance your rewards offering because it was largely “invested” in one or two types of pay plans (typically salaries and bonuses) and some group benefits (commonly medical insurance and a 401k plan).

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This is why incentive compensation will be so important to you going forward. Companies who adopt a balanced approach between guaranteed and incentive compensation will find room to adjust how they pay their people when challenging times require a different emphasis. For example, companies who have both a long and a short-term incentive plan can reduce or eliminate contributions to their STIP in a sour economy but offset that change with additional contributions to the long-term plan. While this reduces an employee’s current earnings, it creates a potential long-term payoff for people who can help them company survive then thrive in the future. And it also reduces the cash flow impact of the compensation you are paying. You can actually increase performance rewards (long-term incentive plan contributions) but lower current compensation expense at the same time.

In part two of this series on the viability of incentive compensation in the current environment, we will address this concept further and offer specific examples of how a balanced pay strategy can create the flexibility you need.

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When it comes to building a compensation strategy, you can trust that VisionLink knows what works and what doesn’t. We are ready to share that knowledge with you.

Ken Gibson

Ken is Senior Vice-President of The VisionLink Advisory Group. He is a frequent speaker and author on rewards strategies and has advised companies for over 30 years regarding executive compensation and benefit issues.