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Not an Entitlement: Keep Bonuses Performance-Based

June 2, 2014 | Joanne Sammer

If an organization’s short-term incentive programs are not driving better employee performance, they are just wasting money.

HR executives should consider some startling statistics: According to Towers Watson research, 24 percent of North American companies make annual incentive payouts to employees even when those employees are identified as not meeting the organization’s performance expectations; 18 percent do not base target payout adjustments at all on employee performance.

Even that might be understating how frequently organizations undermine the incentive potential of bonuses. “I think those numbers are low,” said Paul Schwada, director of the Chicago-based management consulting firm Locomotive Solutions. “The giving of bonuses, raises and other awards to average or below-average employees is rampant.”

Even when part of the annual incentive award is shared, based on achievement of organizational goals announced at the start of the year, bonus formulas also should take into account individual performance so the award isn’t viewed as an entitlement or “lottery ticket.” When incentive payouts become disconnected from employee performance, it sends the wrong message to employees about the need to perform at a higher level. Moreover, the incentive money paid to low performers “might be better invested in needed capital equipment, new personnel, new business initiatives and so on,” said Carlos Zorea, CEO of Zorea Consulting in Chicago.

Take It to the Line

So where is incentive compensation falling down?

“It tends to occur at the end of the chain, which is with the line managers who have compensation decision-making accountability,” said Laura Sejen, global rewards practice leader for Towers Watson in New York. “They may not want to have those tough conversations, especially after telling employees that their performance did not meet expectations.”

If line managers are trying to avoid playing the bad guy, HR needs to step in to stop that practice. Although managers may be worried about hurting employee morale by withholding or limiting payouts to under-performers, failing to do so may be hurting the morale of the entire workforce. After all, when a low performer receives even a token incentive payout, it takes money away from payouts for those employees who are driving organizational performance. This is a bad message to send for employers that have emphasized their pay-for-performance philosophy.

If an organization has developed a poor process and structure for managing performance—and for setting and communicating expectations—that could spill over into incentive payout decisions. This is especially true if managers are “too distracted, busy or lazy to define performance expectations, track performance, have ongoing performance conversations (with employees) throughout the year and deliver appropriate interventions to subpar performers,” said Kimberly Abel, vice president of Employee Solutions at Maritz Motivation Solutions.

In smaller organizations, the owners and senior-most executives could be contributing to the problem. “The owner may feel loyal to an employee from years past and continue to bonus that employee, independent of recent contributions or the lack thereof,” said Zorea. In some situations, employers may worry about losing even low-performing employees and feel pressure to provide some level of incentive payout. Or the situation could simply be born from habit as organizations continue to do what they have always done.

In some organizations, inappropriate incentive payouts can be traced at least in part to the design of the incentive program itself. If there is a “poor or incomplete program design, the company simply sets financial metrics where everyone gets a bonus for the organization achieving its goals or targets,” said Abel. “While many program designers think this is a fair ‘one company/one team’ approach to sharing rewards, it can and does frequently serve to demotivate high performers who become disgruntled at receiving the same rewards as low or sub-par performers.”

Fixing the Problem

To make sure incentive payouts go to the right people, employers have a few options. They can:

Develop a clear, metric-based employee review process. Any incentive program should clearly articulate the individual performance levels required to qualify for an incentive payout, including any tiers or levels based on performance criteria. “The program design of bonus programs should be clear and in alignment with other recognition and reward programs,” said Abel.
Establish general bonus criteria before the organization begins to evaluate employee performance. Both employer and employee should come to a mutual understanding of the employee's expected goals and objectives for the coming year. Using that information, the managers can track employee performance and activities. This can provide both the basis for making decisions about employee performance incentive payouts and a paper trail to back up that decision. “Combining both the employee's achievements and an organizationally aligned scoring model helps determine the right bonus amount, if any,” said Zorea.
Ensure that employees below a certain performance level are ineligible to receive a payout. This, in effect, forces the hand of decision-makers (such as by putting in place ratings distribution guidelines and calibration sessions) so that they are unable to award incentive payouts to low performers. Instead, those funds can be automatically reallocated to higher performers, Sejen noted.
Educate managers and employees about how the incentive plan works. Everyone should be clear about what the plan is expected to achieve for the organization. “It is important to follow through with managers to make sure they have the support they need to conduct effective performance reviews, make compensation decisions and communicate those decisions,” said Sejen.
Make compensation decisions subject to higher level reviews and require line managers to defend questionable decisions. The key is to remind managers that they will be accountable for any poor incentive payout decisions before they even sit down with employees, Schwada said.

Working with Low Performers

When organizations take these types of steps to ensure that incentive payouts are closely and clearly tied to performance, they are creating something much more important than just a fair incentive plan. “Fairness, equity and feeling appropriately appreciated and rewarded are foundational building blocks to “building trust and engagement,” said Abel.

At the same time, companies should not give up on poor performers. Abel suggested that employers develop a mix of appreciation, recognition and rewards linked to the right behaviors, activities and outcomes.

“Even sub-par performers deserve appreciation for good work and recognition for the effort to improve performance,” she said. “It does not mean, however, they are entitled to the same rewards” as higher performers.

Joanne Sammer is a New Jersey-based business and financial writer.

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