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Performance Rewards and Risks

 

In a period of financial fragility the perception of many employees is that they are
working longer and harder and yet are financially worse off. Pay freezes and
reduced discretionary compensation, coupled with a 50 per cent top rate of tax and
higher National Insurance contributions mean some employees are worse off than
they were a year ago. Add to that the increase in other personal taxes and a decrease
in tax relief on pension contributions and the picture is far from rosy.
This is, however, an ideal opportunity for employers to refocus employees on the
link between performance and reward. If they perform then one would expect benefits
to the organization.
For any reward structure to be successful stakeholder engagement is critical, but in
many cases there is no such buy-in. How many employees truly appreciated and
valued the performance conditions attached to their rewards during the ‘boom times’
when payments were effectively guaranteed? In any performance-based plan, which
employees understand the relationship between their performance, that of the
company and the quantum of the reward?

The attention of both the media and shareholders is now firmly fixed on performance-
related reward. This started with bonus payments by banks, but is now filtering into
all areas of business, with companies spending more and more time on their
performance reward strategies.
It is now recognized that short-term performance targets that led to generous
bonus payments did not recognize the long-term risks of the behaviours they were
enforcing. This lesson learned by the banks, at great cost, is one that all businesses
should consider. The key word is ‘risk’ and how that can be minimized while
motivating and retaining individuals within the business.

The level of the reward should be a reflection of the performance and the associated
impact for the business. The size of bonus pools should be linked to the overall
performance of the company. Employees’ reward payments should thereafter be
linked to both the individual’s performance and the performance of the business. In
the situation where performance of the company is poor, employees should be clear
that this will reduce the value of the reward delivered, if any reward is made at all.
It is also critical to assess the level of reward payable at any one time, and how this
will impact on the business, eg. cash flow, and on the individual. Modelling a plan and
giving employees an indication of how their bonus might look given certain conditions
is one way to reinforce what you expect from them and also helps manage their expectation.

Historically the link between performance, reward and risk was largely ignored.
Reward arrangements were typically viewed as a means to attract, retain and
incentivize individuals. This in itself has elements of reducing risk because, for
example, retention gives continuity and good performance, driving the business
forward.
What we have seen recently, however, is that risk-taking behaviours to meet
performance targets and deliver rewards severely impacted the global financial
system, the ramifications of which have been widespread. As a result, companies are
becoming more thoughtful in the way they structure reward to discourage excessive
risk taking.
There are many ways to manage the risk elements; for example, making entry to
an incentive plan conditional on risk-based performance conditions. Once a person is in a plan, a business’s risk can be further reduced by combining financial targets with
Key Performance Indicators (KPIs) within the organization’s appraisal system.
Here are some examples of performance conditions linked to risk:

● If a business has cash issues, you can reduce debtor days and/or increase credit
terms.

● In order to avoid over-aggressive sales tactics, often the ‘over-promising’ of
delivery and service, client retention or satisfaction surveys may be
incorporated.

● If product defects could affect an organization’s reputation, the focus could be
on quality control and, say, the level of returns/complaints.

A further element, which again came from recommendations following the banking
crisis, is that large performance payments should be capped, with the excess being
payable over a further period and again subject to risk-based conditions.

The potential positive impact of performance-related reward arrangements on a
company can be significant, even where it may only be relevant to a small population
of key individuals. It is imperative that the performance measures used should support
the company’s strategy and be in the interests of the shareholders. Moreover, the
performance measures should be capable of being assessed on a consistent basis and
the link of performance to reward understood.

 

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