Corporate Compensation Plans and the Federal Tax Code are Brothers from Different Bureaucracies

—They both reward the elite and the wealthy. It’s time for reform.

Most corporate pay plans are to effective compensation policy what the Federal tax code is to fair tax policy. Which is to say, they are needlessly bloated, convoluted, confusing, inequitable and highly inefficient.

What was once a simple process to raise revenue to run the government, has over time, become contaminated by peripheral objectives and motives that have made the tax system an opaque morass of unintelligible rules and loopholes. In the same way, business pay plans – which should motivate and reward exceptional effort and results – have become tainted with increasing needless complexity resulting in the same sort of inefficiency and unfairness that plagues the Federal tax code.

A Little Background . . .

Corporate pay plans were initially developed as a simple process to provide fair pay and incentive for the performance of defined tasks. Over time, however, the system has evolved, like tax policy, as a way to achieve other objectives and satisfy CompensationPlanspersonal motives. This has caused most corporate compensation plans to take on the complexity of a formula for analyzing human DNA; as a result, corporate pay plans have become highly ineffective as a motivator of superior performance at all levels of the organization. But even worse, unlike the tax code that everyone agrees needs to be fixed, corporate pay plans continue to become more and more complicated and less and less effective. And there’s no agreement that wholesale change is needed. But it is.

In the political world, adopting real reform and fixing bad tax policy is difficult because everyone is protecting their own sacred cows. Not so in the world of corporate compensation. Here, plans continue to become more complicated and inefficient primarily because management has abdicated one of its most significant responsibilities and powerful management tools to outside “compensation consultants.” These outside consultants have only one objective: to keep the fat fees rolling in. They know the only way to do that is by cobbling together plans that give the appearance of creativity and sophistication, but that are in reality nothing more than a warmed-over mishmash of peer-group comparisons.

What Smart Compensation Plans Can Achieve

A compensation plan can be one of the most powerful tools a leader has to motivate and reward those employees who have the ability to add value to the company. Such a plan can:

  • Set the cultural tone of the organization
  • Create a sense of equity
  • Identify what is most important to the success of the company
  • Motivate specific performance, and
  • Reward those who do the most to help the company achieve the most.

Admittedly it can be challenging to design a plan that offers these benefits, but making the effort is worth it. Difficult as that effort may be, opting out and abdicating this responsibility to an outside consultant shows a complete lack of understanding that borders on incompetence.

But there is a darker reason why management opts to use outside consultants to develop compensation plans. It is a way to provide cover for management when the real intent of the plan – as is often the case – is to pay out even more to the highest paid in the company.

Compensation plans can be a lot of things, but one thing they should never be is an attempt to find pay-parity with competing peer group companies. The truth is that compensation is the simplest, easiest and most effective tool in the hands of a strong leader. Simple, well-designed pay plans can be a constant, consistent communication that marshals the attention and efforts of the employees in a way that joins them in parallel with the leader to achieve the vision of the organization.

How Management can Create an Intelligent Compensation Policy

A corporate compensation plan starts with fair remuneration for the employee’s performance of clearly defined tasks. But it should be much more than that. “Compensation” is a broad term that includes all forms of recognition and reward for the efforts of the employee. The point is that a properly designed compensation plan permeates the entire culture of the organization in a way that unites line employees and management in the parallel pursuit of the betterment of all. And that kind of relationship simply cannot be developed by an outside consultant.

An efficient and effective compensation plan is the sum of three parts:

  1. Pay for the performance of a specific task.
  2. Increased reward for adding value to the performance of a specific task.
  3. The opportunity for employees to share in the value their efforts create.

It is always argued that if the cost of labor is higher than that of the competitor, then the company is at a disadvantage; but that does not have to be the case. If the pay is fair and is part of a balanced total compensation system, it can become an advantage. A recognized equitable pay system for the performance of the basic elements of a job attracts higher quality workers, reduces turnover and motivates employees to reciprocate by working harder to preserve their jobs. In the end, so long as it is reasonable, the increase in labor costs can actually become an investment in increased profits.

There are at least two other embedded policy errors in the structure of basic pay plans. The first of which is that these plans establish a rigid level of pay – entry, mid-range and top level – within a specific job description. Pay levels are more often PayScalethan not determined by time-in-grade and once the employee reaches the top level, they are not eligible for any further increases. This attitude is accepted and traditional in business, but it is counter-intuitive to logic. If the employee has been in the position long enough to reach the top pay-grade they are probably the most experienced and efficient at that job. Yet, no matter how long they stay or how well they do, they are locked into an intractable wage scale because pay is defined by the task, not the performance. Even if the employee loves their job and is good at it, to receive any increase in pay, they are forced to move to another job. What sense does that make?

The other miscalculation with this structure is that every employee in the same pay-grade is paid at the same level—regardless of productivity. This means that no matter how hard or smart employees work, they receive exactly the same pay as those who “go through the motions” or slough off. How fair is that? What type of incentive does this offer for those who do more? If the standard of measurement is how many files are processed and one employee produces at twice that level, shouldn’t they be paid more? In theory, if one does not measure up the minimum standards, they are fired. Yet, when one produces well above the standard, the pay is the same. Explain that logic to me.

The most important element of a successful compensation plan is a structure that allows those who use their talents to add value to an organization – at any level – to share in the value they create. There are two key elements needed for this type of plan to work:

  1. It must include everyone in the organization – not just senior management – and it must be structured from the bottom up – not top down.
  2. Rewards must be based on specific activities that create value and they must be based on results the employees feel they can control and profit from.

It does not unify the organization or motivate all employees when only the top people are allowed to participate in the real rewards for the success of a total company effort. To be motivating and effective, the rewards for creating increased value should trickle up from the bottom, not trickle down from the top. Trust me, when management receives their rewards based on the rewards earned by those below them, they become stronger, more involved leaders.

Probably the most glaring deficiency of most corporate compensation plans is that rewards are based on results that most employees feel they cannot impact. If they don’t feel they can make a difference, there is no motivation to make a difference. When rewards are based on macro items such as – increase in profits, reduced expenses, higher sales and even a rise in stock price, virtually the entire organization feels powerless to have an impact and, as a result, the compensation plan becomes powerless to impact their performance. Instead, it becomes largess for the already highly compensated executives of the company.

And the Moral of the Story …

If your company has a compensation plan designed by an outside “compensation consultant,” it is in all likelihood a bad plan. Chances are it is as complicated and as ineffective as the Federal tax code. Sure, just like the tax code is structured to protect and take care of those with money, because Congress knows how its bread gets buttered; the consultant-designed compensation plan is structured to reward the highest paid, because the consultant knows who contracts them and writes the checks.

A well-designed compensation plan can be an effective tool to gain the support of all members of the organization and motivate them to be concerned about and committed to the success of the organization. To abdicate the development of such an important part of leadership to an outside consultant is nothing less than squandering opportunity and an abdication of leadership.

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