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Performance-Reward Connection
Has the plan been designed to provide an appropriate performance-reward connection? Does the plan motivate and engage eligible plan participants? Is eligibility fair and consistent among employee groups? Does it target and motivate the right audience to attain the desired results? Will the plan cause friction among ineligible employees?
Business Risk vs. Reward
What is the business risk versus the reward generated? Some organizations will assess compensation risk and apply a risk review. A risk review is intended to identify items of potential risk versus reward that is used in discussions with top management. Items such as a key risk indicator (KRI) can provide a valuable review of the risk versus reward balance.
On a rare occasion, unexpected events (such as the 2020 global pandemic) take place during a variable compensation plan’s performance period. Management may elect to reassess the plan during mid-year and redefine the performance goals to better manage the event and ensure the plan design takes into consideration the changing business environment. Ideally, a plan design should be stable throughout a performance period. This is for significant, unexpected events affecting the variable compensation plan.
An unstable business with very unstable results may be difficult to manage under a variable compensation plan. Do the employees really have the ability to influence these results?
Design of Plan Document
Every variable compensation plan should have a formal plan document outlining the plan design. It should include:
- Purpose of the Plan
- Plan’s Goals and Objectives
- Performance Period
- Eligibility
- Requirements to Fund the Plan
- Metrics, Scope, Weights
- Design Features including Threshold, Target, and Maximum Payouts
- Performance Period and Payout Provisions
- Definitions of Key Terms
- Plan Rules
- Sample Calculation
- Plan Administration
- Legal Statement for Plan Interpretation of Results and Resolution of Issues and Authority to Alter, Amend, or Terminate the Plan
A legal review of the recommended plan document is necessary as well.
Administrative Details
Administrative details of the variable compensation plan should also be established. These typically include who is responsible for plan design and administration, who calculates and approves the plan results and earned payouts, the timing for payouts, the process for doing payroll, and any required overtime payments for plan payouts to nonexempt employees. Expanded details of plan administration should be provided to payroll, finance, human resources, and management as needed.
Throughout the performance period, financial accruals will typically be required to plan for payouts under a variable compensation plan. Plan administrators should communicate regularly with finance to determine their responsibilities and requirements for budgeting for accruals under the variable compensation plan to ensure any required accruals take place on time and within budget.
System Support
Depending on the design of the variable compensation plan, system support will need to be evaluated and managed to ensure the plan can be effective operationally.
- Will the plan’s metrics require financial or non-financial system support for measurement?
- Will the plan require design of management by objectives or other individual performance criteria?
- How will the eligible employees and variable compensation plan’s targets be captured in the Human Resources System?
- What reports will be necessary to effectively maintain and manage the variable compensation program?
- How will recommendations for payout for eligible employees be managed and transmitted to payroll?