As Goes The Economy – So Goes Compensation???

By Robert Furge
Compensation Practice Leader

As far as formal Compensation is concerned, we are a relatively new profession. It was only in the early 1960s that engineers conducting time and motion studies handed the reins to us and we began to focus on the science of how best to structure pay programs to attract, retain and motivate employees.

We have learned a lot since our beginnings in the 1960s. What we have not learned is how to handle and manage economic cycles. We have historically reacted to economic cycles after the fact, which results in our pay programs being whipsawed back and forth and causes them to be out of sync with reality.

Looking in the Rear View Mirror

In our first 50 years as Compensation professionals, we have experienced almost every type of business condition because of the never-ending economic cycles. We have adjusted our pay programs to take into account runaway inflation with wage and price controls, then recessions with massive downsizing and then again, an economic expansion of unprecedented proportion. However, in each of these economic situations, we developed our compensation programs looking in the rear view. The result has been compensation reward cycles of boom and bust with little correlation to actual employee and corporate performance.

Lets face the facts - we have always had trouble tying pay to performance. This is because our programs are developed in one part of an economic cycle and end up measuring performance and paying out in a different part of the cycle. We develop programs that seem to expect that whatever part of the economic cycle we are in, it will continue indefinitely. Consequently, our employees, and especially our executives, end up with feasts as the economy improves and famine as the economy contracts. Thus, differentiation for true performance is lost in the process.

The Day of Reckoning

Well friends, the exaggerated up and down economic cycle of the last 10 years has completely exposed this weakness and we are now being forced to change our ways. Stockholders are screaming because executives were paid millions and immediately thereafter, they lost their shirts. Lower level employees are disgruntled because they are working harder and smarter for much less share of the pie and questionable retirement at the end of the rainbow. All of this is causing the SEC, FASB, PBGC and other groups to start changing the rules under the logic that if we cannot police ourselves, they will do it for us. (As a side note, history shows that government intervention only makes thing worse).

Where to From Here?

So here we are. We now have to work ourselves out of this dilemma under new rules that will only make things more difficult. How do we start and what do we look at?

Here are five things to consider in program design:

  1. Economic Cycles – we need to recognize that whatever part of the cycle we are in, it may differ in a year or two.
  2. Normalized Pay Levels - what is an appropriate target / band of pay for positions given our industry and size if we normalize the economic swings?
  3. Eliminate Cycle Effects - how do we subtract out the effect of the economic cycle so we can give decent rewards for decent performance in hard times and lesser rewards for lesser performance in good times?
  4. Value Added and Peer Performance - How do we design plans that consistently measure and reward performance based on creating true corporate wealth and corporate improvement against competitors in all parts of the economic cycle?
  5. Stockholder & Employee / Management Buy In – How do we effectively communicate that rewards will be based on true growth and value added regardless of the economic cycle?

As a first step, we need to help management realize that views of the economy a year or two out are just speculation and no better than looking into a crystal ball. The economy could continue to improve, go sideways or even be in a recession two years hence. Consequently, true measures of corporate performance need to be based on factors that eliminate or subtract out the effect of the economic cycles.

The next steps involve tying employee rewards to the true value employees have added to the company, the real wealth that has been created on the company’s behalf and overall financial progress of the company compared to industry peers.

The Mandate

We are well past our professional beginnings of Compensation as a science and there is no question that we now understand the problem. The world is demanding we begin ending the poor correlation that exists between pay and performance. To do so, it is imperative we shift our thinking and plan design to remove the effect of economic cycles on our pay programs.

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Bob Furge
Worldwide Consulting Group LLC
(01) (303) 581-9700

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