How_to_Create_an_Effective_Incentive_Compensation_Plan

There are many ways companies can reward their employees for going above and beyond and performing exceptional work. One of the most effective, to borrow a line from a popular movie, is to "show them the money" by creating an employee bonus plan or incentive compensation plan.

But structuring an effective plan requires careful thought and strategy. Specifically, what do you hope to achieve with your bonus or incentive compensation plan? Why are you creating the plan in the first place? Ideally, your plan should motivate employees to focus their efforts on activities that are directed toward achieving specific company goals.

An incentive is structured so that employees perform measurable tasks that lead directly to the accomplishment of company goals - increased sales or profitability, improved customer retention or acquisition, or the achievement of key performance indicators (KPIs), for example.

Employees' goals can be focused at the company, departmental or individual level. Structuring incentives around the achievement of departmental or individual goals may help employees feel like they have more control over their accomplishment - and thus be stronger motivators than broad company-wide goals.

Key Factors to Include in Your Incentive Compensation Plan

Among the challenges in creating an effective incentive plan are: 1) aligning the employees' tasks (or goals) with overall company goals; 2) making sure the employees' goals are measurable and; 3) setting goals that are achievable, but not too easy.

Use these guidelines to help create an incentive compensation plan that rewards employees for achieving personal goals and contributes to the progress of the company.

Explain the Plan Clearly to Your Employees

Make sure all your employees understand how the plan works and what they must do to realize their incentives. Formalize the plan in writing to help avoid confusion, and so you have a document you can reference if there are any misunderstandings.

Tie Incentives to Performance Standards and Goals that are Finite and Measurable

Goals shouldn't be open-ended, but should have a finite end date - usually the end of a quarter or year. And rewards should be tied to achieving performance standards that are specific and measurable, and over which employees have some degree of influence.

Make Sure There is Enough "Stretch" in the Goals

Employees shouldn't be rewarded just for doing their jobs — this is what their salary is for. Their goals should stretch them to go above and beyond average performance, but not be so difficult that they aren't realistically achievable.

Design the Plan so it's Adaptable

Your company's strategies and goals will change over time, so your incentive plan should be dynamic enough to change with them.

Slant the Plan toward Your Top Performers

The employees who perform at the highest levels, and whose individual performance has the greatest potential impact on the company as a whole, should have the opportunity to earn the biggest rewards.

Establishing Parameters to Protect the Integrity of the Incentive

When structuring your incentive compensation plan, it's important to ensure that employees are not overly focused on the incentive to the detriment of other important aspects of their job. You don't want to have employees engaging in unwise actions in the pursuit of the incentive award. There are a few strategies that may enable you to avoid this scenario, including the following:

  • Establish a cap or maximum on incentive payments (e.g., two times the target or no more than 100 percent of salary).
  • Have payment contingent upon company and/or division (not just individual) performance to goals (e.g., company performance must be at least 60 percent in order to fund incentive payments).
  • Require that a portion of the incentive payment be deferred for one or two years, with future payout contingent upon continued employment or continued employment and performance.
  • Reserve the right of executive management to make downward adjustments to payments based on such factors as financial and individual performance or other behaviors inconsistent with company expectations.
  • Include a "claw back" provision whereby all or a portion of the payments must be repaid based on factors like inappropriate financials.
  • Adopt strong corporate governance, including active and effective oversight by executive management and the board of directors.
  • Ensure that your company's leadership and culture support and reinforce the appropriate and desired results and behaviors.

A well-structured incentive compensation plan presents a win-win scenario for your company and your employees. Enabling employees to reap financial rewards based on their performance will motivate many of them to work harder and smarter and make better decisions that are not only in their best interest, but are also in the long-term best interests of your company.