Dear Workforce What’s The Thinking About Quarterly Payouts For Executives
Most executive incentive plans are annual in both design and payout. They are designed to align with the fiscal year of the organization, and are built to reinforce the needed goals of the company for that year. As a result, goals will change from year to year based upon the strategy of the company and current economic conditions. While it is not uncommon to have all employee, or broad-based, incentive plans or sales incentive plans pay out more frequently--quarterly or even monthly--it is very uncommon to have executive incentive plans pay out more than once a year.
When one considers paying out any incentive plan more frequently than on an annual basis, there are a number of complexities that emerge. The biggest is the fact that the full incentive for a quarter's performance cannot be paid out and a portion must be "banked" to cover the variations in performance between quarters. That is, a great first quarter could lead to payouts significantly above plan, only to find quarters two and three were below plan. This would lead to the potential of paying out too much during the first quarter and an inability to pay anything (or worse, having overpaid) for the second and third quarters. These plans also require a "truing up" at the close of the year to make sure that the correct total incentive paid aligns with the actual performance delivered.
Additionally, since there is considerable scrutiny regarding executive plans today, most annual plans pay out only after the final external audit of the company's performance. This is to assure shareholders and other interested parties that the actual performance was achieved, and that payouts are in line with the performance achieved and the covenants of the plan. Thus more frequent payouts complicate this need for total transparency, which shareholders and others are demanding even more in today's environment.
If you are considering going to more frequent payouts, there are five critical conditions that must be in place before such a plan will work.
1) Company performance should be relatively constant throughout each quarter of the year. There should be no big quarters or small quarters that cause considerable variance in revenues. Your company should not be in a cyclical industry or one in which external factors significantly affect performance.
2) Planning for company performance should be at a high level and the plans should be both accurate and believable to the participants. The plans must be achievable and reflect what an executive can actually influence during the quarter.
3) There should be an appropriate "hold back" percentage to assure that total year performance is accurately captured and that there are no overpayments. This percentage will be significant, usually in the 20 percent to 25 percent range.
4) There should be an appropriate "true up" process at the end of the year to reflect the total year's performance and the variance between quarters.
5) Clearly communicate with participants regarding the structure of the plan. Executives need to understand the entire process and the record-keeping, as well as the quarterly communications challenge, will be significantly increased.
What will be gained by more frequent payouts? The answer must be reflected in higher corporate performance: higher sales, earnings, growth and a realistic probability that executives' effort could make each quarter a winner. Quarterly payouts for executive plans is uncharted territory, and for a good reason. I would suggest that you move slowly and deliberately, especially in today's environment in which the governance of all executive compensation is questioned--and an appropriate return on compensation paid out is demanded.
SOURCE: Dr. David A. Hofrichter, principal & national practice leader,Buck Consultants Inc., Chicago, Illinois, Dec. 24, 2002.
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The information contained in this article is intended to provide useful information on the topic covered, but should not be construed as legal advice or a legal opinion. Also remember that state laws may differ from the federal law.