The Ups and Downs of Variable Pay
Although a growing percentage of U.S. companies have adopted variable pay systems over the years, the budgets for such pay have dropped recently, a trend expected to continue at least through 2002. It's unlikely, however, that the use of variable pay will decline anytime soon, given studies showing its positive impact on the bottom line.
The use of variable pay plans continues to grow among U.S. firms. A 2001 Hewitt Associates survey of 953 organizations shows that 81% of surveyed companies had at least one type of variable compensation in place, up from 78% in 2000 and 51% in 1991. Other studies indicate that many companies that aren't already using a variable pay program are considering implementing one in the near future. Even not-for-profit organizations are turning to such plans. Survey data from Aon Consulting shows that 50%-60% of not-for-profits offer some form of variable pay, compared with 70% of for-profits.
Nonetheless, between 2000 and 2001, variable pay budgets were in decline, according to WorldatWork's October 2001 survey. Based on the responses of 1,000 companies, variable pay budgets for exempt employees dropped from 10.1% in 2000 to 5.9% in 2001, largely due to the economic downturn. Nonexempt employees experienced similar decreases, and variable pay budgets are expected to continue their decline this year.
A recent survey from Watson Wyatt Worldwide indicates that underwater stock options are a particular problem for many companies. "Many companies believe they have to tackle this problem for options to be viewed as a valuable tool for attraction and retention," says Rick Beal, a senior consultant at Watson Wyatt Worldwide, as quoted in Compensation & Benefits Review. Among companies considering overhauling their programs, about half plan to issue more options at a lower strike price, while the other half plan to cancel existing options and reissue them at a lower price.
Are variable pay programs worth the headaches? Some studies suggest they are, as long as they're designed well. Research from Frank H. Lyons and Dan Ben-Ora of Arthur Andersen shows that companies with variable pay plans using measures tied to individual and employee performance are positively correlated with improved financial performance over a three- and five-year period.
And Watson Wyatt's Human Capital Index (HCI) study found that some types of variable pay seem to boost shareholder value. For example, the fact that a company has a relatively high percentage of employee-owned stock is correlated with a 1.3% increase in shareholder value. If pay is linked to a firm's business strategy, there's a 1.1% increase in value, and if a high percentage of employees participate in incentive/profitsharing plans, there's a .9% increase.
Employers can't, however, assume that all variable pay plans are created equal. The same stock-option plan that was effective in the 1990s may do more harm than good in today's environment. A good, holistic design that suits the corporate environment is key. Anything less may wind up as a disincentive to people whose hard work and positive attitudes are sorely needed.
The use of variable pay plans continues to grow among U.S. firms. A 2001 Hewitt Associates survey of 953 organizations shows that 81% of surveyed companies had at least one type of variable compensation in place, up from 78% in 2000 and 51% in 1991. Other studies indicate that many companies that aren't already using a variable pay program are considering implementing one in the near future. Even not-for-profit organizations are turning to such plans. Survey data from Aon Consulting shows that 50%-60% of not-for-profits offer some form of variable pay, compared with 70% of for-profits.
Nonetheless, between 2000 and 2001, variable pay budgets were in decline, according to WorldatWork's October 2001 survey. Based on the responses of 1,000 companies, variable pay budgets for exempt employees dropped from 10.1% in 2000 to 5.9% in 2001, largely due to the economic downturn. Nonexempt employees experienced similar decreases, and variable pay budgets are expected to continue their decline this year.
A recent survey from Watson Wyatt Worldwide indicates that underwater stock options are a particular problem for many companies. "Many companies believe they have to tackle this problem for options to be viewed as a valuable tool for attraction and retention," says Rick Beal, a senior consultant at Watson Wyatt Worldwide, as quoted in Compensation & Benefits Review. Among companies considering overhauling their programs, about half plan to issue more options at a lower strike price, while the other half plan to cancel existing options and reissue them at a lower price.
Are variable pay programs worth the headaches? Some studies suggest they are, as long as they're designed well. Research from Frank H. Lyons and Dan Ben-Ora of Arthur Andersen shows that companies with variable pay plans using measures tied to individual and employee performance are positively correlated with improved financial performance over a three- and five-year period.
And Watson Wyatt's Human Capital Index (HCI) study found that some types of variable pay seem to boost shareholder value. For example, the fact that a company has a relatively high percentage of employee-owned stock is correlated with a 1.3% increase in shareholder value. If pay is linked to a firm's business strategy, there's a 1.1% increase in value, and if a high percentage of employees participate in incentive/profitsharing plans, there's a .9% increase.
Employers can't, however, assume that all variable pay plans are created equal. The same stock-option plan that was effective in the 1990s may do more harm than good in today's environment. A good, holistic design that suits the corporate environment is key. Anything less may wind up as a disincentive to people whose hard work and positive attitudes are sorely needed.