Consistency vs. Customization in Compensation Structures – Pros and Cons

Today I want to talk about a common problem faced by businesses (and by extension1. I’m actually in the process of a move. I’m sitting on the floor writing this (the furniture is all gone) and it all has me feeling vaguely whimsical. Let’s see where this takes us.compensation functions): 1

When managing its compensation structure, how should an organization account for the fact that some functions add more value to the business than others?

This is a fundamentally different question than figuring out how to reward a contributor dramatically outperforming one’s peers in the same job (higher merit increases and pay adjustments will create separation over time). It’s also different than valuating a specific job particularly highly (if a skill set is hot then the market will set the rate as a product of supply and demand).

The question I’m posing is around the challenge of addressing the fact that in a hypothetical widget sales organization, the widget salespeople may materially2. This sort of problem is a common one in many organizations, but I like using widget analogies so let’s go with this tonight. generate more value for the business than the operations people (as an example – it could just as easily be the other way around in a product-focused company).

This doesn’t mean that the skill set the salespeople have is more valuable in the overall external market than are those of the operations people in the organization (they may or may not be), nor that the skill set is harder to learn/develop. In fact, let us instead assume in this analogy that the widget salespeople only have more value than their operations counterparts internally.

Should the sales people be paid more? Depending on if you believe in internal based pay models or market based pay models your answer may vary.

…But what if an individual contributor within a function generates more money for the business than his or her manager? Should that employee have a higher base salary? If his or her commissions causes a dramatic pay disparity between he/she and the manager, should said commissions be capped at a certain percentage?

A company could choose to leave the commissions uncapped, but it might then find it can’t attract individual contributors into the management ranks because the pay hit is too significant.

…Of course, this may not be a bad thing. There is an argument to be made that the historical tool used to reward top individual contributors (moving them into management) is a deeply flawed way of selecting managers (just because one is a good doer doesn’t mean he or she is a good manager). Even if this is the case, however, the fact remains that if managers make a fraction of the pay of the employees they’re managing and aren’t selected based on their performance as individual contributors there is a real danger that said managers lack the credibility with their reports to lead them.

I don’t know what makes the most sense here – as always, it mostly depends. The topic has been on my mind lately, however, and I wanted to share some quick thoughts with you tonight.

Categories: Talent Management
Narrow Your Focus

Today was my last day in compensation. I’m stepping into a new role (internally) that will take me to both a new city and new role.

As such, this week has been unusually hard to ship for me. Crazy hours… juggling a move. It’s just been one of those weeks where its been challenging to stay in front of things.

With that said, when time gets scarce you learn what’s really important. 1 It narrows your focus. You prioritize and focus on doing the things you really need to do.

Because of the last week I am better today than I was before.

…I think that’s the lesson today.

Look to push yourself every once in a while. Narrow your focus – find out what really matters.

You’ll be better for it. You’ll understand what you need to be at your best and what you can afford to let go.

Of course, I’m just making it up as I go along.

Categories: Personal Development
A Brief Lesson in Change Management

I’m writing from my phone today. I’ve moved to another state as part of a new assignment, and my internet provider hasn’t been able to get my connection set up quite yet.

This in and of itself isn’t noteworthy (same day install seems relatively uncommon for internet and cable service), but what *is* noteworthy is that when I called today to order service the company seemed to be in chaos. Customer service reps gave conflicting information around service set up and pricing, there were systems issues, and at one point a rep said she would send confirmation of my order within 45 minutes only to never send anything or return my call.

I called the company back and spoke to two different agents before getting to the heart of the problem – they were in the middle of a merger and no one knew right from left.

This got me thinking about change management during an acquistion and the unique role HR plays in the process. Bringing two companies together involves addressing cultural issues around the way work gets done, and companies that fail to lay the proper foundation here will run into a host of integration challenges like the ones being faced by the (unamed for their benefit) cable company today.

That’s all I dare write on this subject from my phone, but I’ll look to revisit this going forward.

 

Categories: Change Management
Pay Disclosure Leads to More Efficient Markets

I had a great conversation with a mentor/friend yesterday around (non-executive) pay disclosure. It was a good exchange of ideas, so I’m writing about it here.

My thinking on the subject is that widespread accessibility to pay information leads to more efficient markets, in the same way, increased accessibility to information improves market efficiency in any other industry.

The current relationship is as follows: An employer wants an employee for as cheaply as possible, and an employee wants to provide their service for the maximum possible rate. As such, when the two parties seek an agreement there is a give and take (i.e. negotiation).

…The thing is, in the market as currently constructed the employer has a lot more leverage than the employee because the employer has greater access to information. I don’t view this as fair or unfair – it is what it is.

With that said, this creates inefficiency in the market place. Instead of the best people working for the employers most willing to pay for (and assumingly generate the most return from) their services, they instead work for the employers who happen to offer the best extrinsic/intrinsic reward package that they know of.

Increased pay disclosure in the labor market would change this dynamic.

I think the executive pay market is a good example of pay disclosure working in the labor arena. Mostly due to government disclosure rules, CEO/CFO pay rates are widely available to anyone interested (one need only make a trip to the SEC website). As such, when a company evaluates a CEO’s compensation for fairness they benchmark against the executive’s peers.

A CEO that is paid below the median of his/her peer group has an easy argument to make for being underpaid since the data on CEO pay is accurate, available in a consistent format, and easily accessible to anyone interested in it. The question of if an employer can afford a particular CEO is a matter of supply and demand – they can pay the market rate for the talent they want or they can’t. If they can’t afford the market rate for the talent they want then1. There are certainly some real issues with the executive pay structure in the United States (specifically that all employers target p50 or higher which creates a ratchet/lake Wobegon effect), but underpay for services rendered is not one of them. If similar disclosures existed for pay philosophies/market rates, we would probably see less pay disparity, and it would largely be because pay disclosure forced employers to pay competitively for positions that they’ve historically been able to underpay for.they look for someone who will work beneath it. 1

As a huge free-market guy, I certainly respect and endorse the decision of employers (typically) not to disclose pay information (it’s in their best interest not to), but I also recognize that the lack of available wage data creates an economic environment in which the overwhelming majority of employees aren’t paid a wage in line with the value they add to their respective organizations. 2 This not only creates a market inefficiency that harms the employee, but it also damages the economy as a whole. 3

Competition is good for the market (although perhaps not for any individual company). To see this is true one must only think of how almost2. There is a great article from the Economic Policy Institute that summarizes the issue well, but in short: Employers are realizing the gains of increased productivity, but most employees’ wages have held largely flat over the past several decades. any other market outside of the labor market works:

Example: If I go into a store I can see the price of every brand of gum in that store. This doesn’t disrupt the competitive balance of the market. Companies charging higher prices compete with lower-priced gums based on quality, brand, and shelf space/positioning, etc. This same reality holds true for thousands
3. Much of this is also cultural. Employees don’t discuss salaries with one another as it is considered taboo (though this is rapidly changing). Most employers insist employees disclose their current wages before extending a competitive offer (while often refusing to disclose pay range or philosophy on their end). It’s a lopsided arrangement that heavily benefits employers.
(millions?) of other products. Consumers go to gas stations and pay premiums for the products there (as opposed to going to supermarkets) because of convenience. People buy technology devices based as much on supplementary product offerings as the price of the product itself. Even in markets where there is a range/unclear market signals (like when buying a car), both parties are on relatively equal footing since a car customer can choose not to disclose the most he is willing to pay (and has dozens of easily accessible online resources that show what competitors are offering for similar vehicles, etc.). Only the labor market (and a few others) is fundamentally different here because the value of labor is such a closely held secret.

If starting tomorrow employees knew more about the value of their labor, in the short term there would probably be a rise in market turnover. Afterward, however, I think the markets would stabilize; employers would both pay more competitively *and* draw more lines in the sand (there would be fewer counter offers) I also think you would see wages as a whole rise… and employers who couldn’t compete on wages would start to compete on fringe benefits / intrinsic rewards instead.

Of course, pay disclosure on any wide scale level is unlikely to ever happen. Employers paying below p50 (and perhaps even p75) would lose far too much talent to competitors if wage info were to become widely available in the way that executive compensation is.

I will say that I think there will be a shift to the center here going forward (with employees gaining more leverage). Gen Y is much more open to sharing salaries with one another. We typically don’t share salary info internally (there is an implicit understanding that there is blowback if the employer finds out), but we share much of this info freely amongst friends outside of our organizations. Much of my social circle is in HR/Marketing/Finance, and we all know one another’s salaries (and the salaries of friends of friends in some cases as well). If someone in my peer group is unhappy with pay it isn’t hard for him/her to learn the names of 10 companies that pay better for similar work. A decade ago those same people would have just had a sneaking suspicion they were below the market average.

Between informal social networks and sites like Glassdoor / Payscale (which are getting cleaner in their data collecting methodology), employees are becoming more educated around pay. Whether that creates any leverage or not remains to be seen.

Categories: Compensation
Perception of Pay is More Important Than Level of Pay

The idea that one’s perception of pay is a core component of pay satisfaction is a simple – perhaps even intuitive – concept.

If someone perceives they are being compensated at an appropriate rate then the actualities of the market are almost besides the point.

In point of fact, however, this principle is not in wide use. Companies routinely spend significant sums of money raising pay (base and at risk) to drive performance. What they should be doing is looking at how employees perceive the plan design and tinkering with it in more cost effective ways.

Anna Krasniewska Shahidi has an interesting spotlight on World at Work TV that touches on just this idea.

She goes on to expound on sales compensation best practice (individual performance incentives, team based incentives, the role of compensation1. It really is a good video (and it’s less than 7 minutes long). I’d recommend watching the whole thing. functions in administering sales comp etc. 1), but what I want to focus on are three core elements of pay perception that she says drive performance:

1. Fairness – Is effort aligned with returns?
2. Complexity – Is the plan design easy to understand?
3. Risk Component – Is the employee population / individual employee comfortable with the level of pay at risk?

If the answer to all three of these questions is yes then one is well on the way to achieving the most difficult – and important – component of effective plan design:

The sense that the employer has the employee’s best interests in mind. 

If a company’s employees believe they are being taken care of, the details of the compensation plan just become a series of affirmations supporting that belief.

Or do I have it wrong?

Categories: Compensation
CEO Pay Ratio Legislation Up For Repeal

The Dodd–Frank Wall Street Reform and Consumer Protection Act has1. I love the requirements around disclosure of pay versus performancehave mixed feelings on the clawback policy, and think the say on pay vote provision causes more problems than it solves. both positive and negative components 1, but one thing I definitely hate about the act is the pay ratio mandate.

The HR Policy Association does a fantastic job of explaining what the pay ratio mandate is, so rather than bloviate about the concept I’ll share its simple(r) explanation below:

The pay ratio provision requires publicly held companies to annually calculate the median total compensation for all employees globally, as defined under the SEC’s executive compensation disclosure rules, and disclose a ratio of the median employee’s compensation to the CEO’s compensation.

I want to point out that I get the public outrage around executive pay (although I don’t agree with it). I also want to say that contrary to the claims on many large-cap companies, I don’t think that it would be that difficult for2. To get an employee population median, a company need only pull a listing of their population’s salaries, sort by country, and do a currency conversion to USD. From there, it’s just a matter of querying the median salary from the data set. Any company with a half-decent HRIS could get a reasonable approximation of this number in under a day or so. most organizations to calculate the ratio.

A gambler counts out cash while making a proposition bet on Super Bowl XLV at the Las Vegas Hilton in Las Vegas, Nevada January 27, 2011. The Pittsburgh Steelers and the Green Bay Packers will compete in Super Bowl XLV in Arlington, Texas on February 6. REUTERS/Las Vegas Sun/Steve Marcus (UNITED STATES – Tags: SPORT FOOTBALL)

Yet I am still against the pay ratio mandate for two reasons:

1. I don’t think investors really care about the number

2. The number literally doesn’t matter as it concerns the health of an organization

The 2nd point isn’t an exaggeration. In a May 23rd testimonial before a House Subcommittee, in response to an AFL-CIO claim that “[the bill to abolish the Dodd-Frank pay ratio mandate] is designed to hide material information from investors, encourage runaway CEO pay and increase economic inequality,” Center On Executive Compensation CEO Charlie Tharp pointed out that there is no correlation between company performance and the CEO Pay Ratio. Tharp drew attention to the fact that based on data on the AFL-CIO’s own website, companies it considers to be “great” have a 412.5 average pay ratio compared against a 354 average pay ratio of all S&P 500 companies.

If anything, the evidence points the other way here.

Further, CEO pay represents only a few basis points for most large-cap companies. Ergo, the cost isn’t a concern either.

The only point of the ratio at this point is to satiate a small slice of the public that is (pointlessly) upset about what executives makeIn my opinion, that isn’t a good enough reason to enforce the mandate.

…With all that said, this is going to be a hot button issue for some time to come. I’d ultimately like to see the pay ratio issue put to bed so that companies (and the consultants they employ to advise around this stuff), investors, the media, and analysts can focus on more important things.

Categories: Compensation
Building Great Benches Starts With Helping Your People Understand Themselves

Throughout life, as human beings our goals and priorities have a tendency to shift.

We don’t want children, and then we do. We’re mobile and then we’re not. We care about promotional opportunities, and then we find the job we really want and settle down. We’re hungry to maximize earnings, and then we make “enough” and begin to focus on other things.

In this way life is much like a river’s current. It is always changing, and will never be exactly the same across any two moments in time.

This makes talent management difficult. When doing succession planning there is no way to really know just how well our best laid plans are going to work out. As HR professionals we encourage the business to invest time and resources to develop the people identified as future leaders… but there is still so much about those people that we just can’t predict.

Human beings are volatile… unpredictable. This reality doesn’t mesh too well with talent management, however, because succession planning is really all about molding future leaders via exposure to critical experiences. The idea that those experiences may not produce the desired effect from a developmental standpoint turns much of the succession planning process on its head.

I don’t really know how much of talent management is art and how much is science… I have a sneaking suspicion that neither component is the most important piece of the puzzle, though.

Instead, the focus should be on developing a well defined company culture that provides employees with the flexibility to identify their strength, weaknesses, likes, dislikes etc. This is how an organization stocks its benches with the right talent.

A company that gives its employees a firm sense of what it means to work there – and provides them with the opportunities to identify where they can make the biggest impact – is an organization that will always have the right people in the right jobs at the right time.

Categories: Talent Management

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