by Deborah Marshall
As human resource consultants, we see more frustration among our clients over performance management and compensation decisions than any other HR issue. Linking them together requires foresight, planning, and a strong sense of what you want to accomplish.
Communicating the significant differences between base pay and incentive compensation is critical to the success of an aligned system of rewards and recognition. When done well, aligning performance and pay can enhance employee understanding of expectations and improve your bottom line results.
Most importantly, have a strategic plan in place so you know what your financial institution wants to accomplish over the next several years (services, markets, growth opportunities, etc.). A well-thought-out plan for the future and a clear understanding of your mission make it possible to determine the actions necessary to achieve desired results.
Strategic goals help to determine action plans. Action plans show us what competencies our employees need to have to succeed in today's markets. Competencies help us to define job responsibilities, training needs, and performance management systems.
Establishing and maintaining an effective performance management system positively affects the performance of individuals and the entire financial institution. Regular review of progress on goals (the appraisal process) can improve employee performance by defining expectations in alignment with strategic goals and action plans. A clearly defined, well-written, and effectively communicated process is critical.
If it is not crystal clear what employees should be doing to achieve goals, it will be very difficult to fairly assess their progress, and therefore institutionwide progress. This is a management function that cannot be left to chance or assumption.
Sharing progress on goals with employees shows a commitment to their importance and to the future. Individual appraisals also offer the opportunity to provide (and receive) employee feedback. Senior leaders should be meeting with managers, and managers with their employees at least quarterly (if not monthly), to share results and update goals.
Good compensation plans have five basic components:
- Reliable, competitive market data (targeted total compensation)
- A well-designed base pay system
- Reliable individual and business performance information
- Incentive plans tailored to specific individuals and/or groups
- Thorough communication with managers and employees
It is helpful to understand and communicate that base pay is mostly a function of budget and labor market forces. Trying to divide up a 3.5% "merit" base pay budget and thinking it will be motivational is not very realistic. Employees need to know that the market mid-point for their position is a competitive rate of pay for doing a good job. The top end of the pay range is reserved for truly outstanding performance, typically achieved by only about 5% to 15% of your workforce. The differentiator is incentive pay.
Although there is certainly some "science" in determining equitable pay arrangements, the emotional aspect of pay causes the most problems. When emotion takes over, it is usually because of lack of information and less-than-ideal communications with employees about performance expectations, the compensation system design, and economic realities. We should be congratulating employees for getting a 2% increase if they are already over the market rate for their job, not apologizing for it.
For incentive compensation programs, a well-written document outlining eligibility, formulas, targets, timing, administrative features, and payouts is critical. We see bonus/incentive pay anywhere from 5% of base for lower-level positions up to 50% of base pay for CEOs. Keeping each plan flexible and updating them at least annually are also important. We see too many "legacy" plans in place that haven't changed in years.
If you aren't getting the results you want, it's a management problem. Aligning pay with performance and holding people accountable for results must happen. Managers need to have those "high, medium, low" discussions with their employees so they know where they stand. If the low performers can't or won't improve, no amount of compensation will help.
Aligning performance management and compensation systems relies on accurate job descriptions, clear communication of expectations with employees, current external market information, and your strategy and philosophy as it relates to pay for performance.
Understand there are no "perfect plans." Keeping the intent and purpose of your systems in your line of sight will help you stay the course and manage performance and compensation effectively.