After many years of designing and implementing performance based pay arrangements, Executive Pay Systems has identified a number of plan design and process attributes that determine whether a company's reward system will be successful when assessed as a strategic performance improvement device. When remuneration systems are re-designed to incorporate these attributes, a correlation between plan implementation and profit/share price improvement begins to emerge:

In the example shown in Illustration 1, a national financial institution, the correlation is best described by referring to the facts:

• The new plan was introduced for application to the year ending June 03
• The first iteration was paid 9/04, the 2nd iteration paid 9/05
• Profits doubled over the two iterations. Share price trebled
• There was no inorganic growth over that period they didn't buy anything of consequence to improve revenue or profit
• Employee numbers grew by less than 5% over the two iterations
• Employee turnover (non-call centre) dropped by 6 percentage points
• Fixed pay remained static but reduced as a proportion of profit over the two iterations.

Please note that, in such a circumstance, the top line improvements in profit and share price should not be considered solely attributable to performance based pay. A company that embraces the design attributes referred to above and discussed later in this paper, as this company did, is a company which is more likely to have embarked on a change program incorporating many performance improvement components.

What are these attributes?

Our experience shows that performance based rewards succeed only if:

• The plan is fully funded - the amount of money available is provided by an overall performance measure or set of measures which demonstrate that the shareholder is better off before the employees begin to participate;
• Performance requirements are communicated, measured and rewarded differentially - employees have to know that superior performance will be rewarded and inferior performance will not;
• The plan operates in unison with tight control over fixed pay - companies need to make a decision to stop responding directly to salary surveys on the basis that the overall incentive spend will increase if the performance targets are met; and
• The plan needs to progressively shift accountability for remuneration decision making to management and away from either a centralised body (usually HR) or a formula. Managers thereby become responsible for both fixed and variable pay decisions (within a performance driven budget) and have to communicate the reasons for those decisions to recipients.

Our experience also shows that performance based rewards succeed only when:

• Individuals can see that their activity is connected, however remotely, to the corporate strategy;
• Individuals have to understand precisely what they have to do and how it will be assessed. This communication must be received as well as sent and the understanding of it must be tested in the performance management and/or development sessions between the Manager and the employee;
• The process put in place to manage pay outcomes is efficient, rigorous and has integrity; and
• There are robust systems in place to support remuneration decision making.

Finally, we have found that these success factors are inter-connected:

• To successfully communicate a performance objective it must be connected to the strategy;
• To implement the communicated performance differentiation there must be a process; and
• The implementation of an adequate process depends on using robust systems.

There are many other operational imperatives: Timeliness; Accuracy; Co-ordination across the company; Business/Management involvement, Pre-planning and scheduling, etc.

But the ones mentioned in detail above are the challenging ones most commonly neglected in the planning and design of remuneration plans.  For example, in relation to processes and systems, most companies rely on a plethora of spreadsheets, collated centrally.

If you would like an assessment of the effectiveness of your annual remuneration review process, and its effect on company performance, contact Executive Pay Systems for a Performance and Remuneration Assessment.