Driving Productivity and Profitability Through Deferred Compensation
"To Be or Not to Be"...Strategic, That is the Question
Deferred compensation plans have been around for a long time. Most companies have heard of them even if they haven't instituted one. Plans under this umbrella range from pure deferral plans (funded solely by employee contributions) to supplemental executive retirement plans or SERPs (funded solely by employer contributions).
Regardless of their shape or scope, most of these arrangements have been set up as conventional, executive benefit plans with little or no ties to the threefold mission that all rewards strategies should help fulfill:
- Win the talent wars - help recruit and retain the right people
- Improve productivity - get key people focused on key performance factors
- Increase profits - generate results that will improve (rather than be a drain on) the bottom line
In short, the problem with turnkey or traditional deferral plans in the market is that none of them drive productivity and profitability.
When effectively engineered, deferred compensation can be a strategic tool that addresses each of the components of an effective rewards program. However, accomplishing this requires that a company have a clear purpose in mind in setting up such a plan - and that it knows what behavior it wants to promote. With that established, a simple deferral plan can be transformed into a dynamic incentive.
Incentives that Drive Productivity and Profitability
Companies that want to see improvement in productivity and profitability need to be able to identify the key factors that drive that result - and then execute them. Improved productivity and profitability are largely a function of execution, success and confidence within and organization. As individuals (particularly leadership and other key people) execute the core drivers of results, success is realized and confidence is ignited. That confidence, when reinforced, breeds further success and has a multiplying affect throughout the company.
As a result, if you wish to develop incentives that will reinforce this pattern you must first address the following:
- Identify core drivers of business growth (key performance indicators)
- Determine the (increased) value to be earned by shareholders if the drivers are executed and the associated results achieved
- Establish how much of the increased value should be shared with the employees in the form of incentives
- Define what form the incentives should take
- Determine the execution and success behavior that should be rewarded by the incentive
In creating this focus, it should be remembered that incentives need to not only make sense for the company - they must also be motivating for employees. Generally, rewards should achieve one or all of three needs that employees look to fulfill through their association with your organization: cash needs, security needs and wealth accumulation needs.
Deferred Compensation as an Incentive Tool
When evaluated in the context just mentioned, far too often deferred compensation plans are set up as plans of "convenience." They are commonly instituted to satisfy the needs of highly compensated employees - to offset the restrictions associated with qualified retirement plan arrangements, provide tax savings, and help them more effectively plan for retirement. Such plans aren't "bad" per se - and they can carry some retention value.
However, much more can be done to have these programs become a more compelling way to promote performance and to improve the bottom line of the company. Here are just a couple of examples.
Example #1 - Strategic Deferred Compensation
One arrangement that incorporates a more strategic approach is to build a plan that combines employee elective deferrals, company contributions or matches, incentive matches and creative vesting schedules. Such a plan would have the following characteristics:
- Voluntary employee deferrals that go into a fully vested account.
- A company match that goes into a partially vested account.
- An incentive-based contribution (by the company) that also gets placed in a partially vested account.
- The value of the fully vested account is tied to 401(k) like investment options.
- The value of the partially vested contributions are linked to a phantom stock account
Let's examine how a plan organized like this helps us fulfill the threefold mission mentioned earlier.
Win the Talent Wars
- Voluntary contributions (providing both an attraction and retention component)
- Company match (when tied to a vesting schedule, creates retention capability)
- Incentive based contribution (ditto)
- Incentive based contributions (which are tied directly to the fulfillment of specific performance criteria)
- Employer phantom stock account (the value of which is tied in part to an increase in the profits of the company - or at least the achievement of certain profit thresholds)
Example #2 - Balanced Rewards Plan
This plan employs the structure of a supplemental executive retirement plan typically funded by the company. However, it is designed to lessen the guarantee commonly associated with SERP plans and incorporate and "earned" award approach - where the payout will be more or less based on performance. Here's how it would work:
- A guaranteed payout income award is established for a plan participant at 50-60% of a traditional SERP payout level
- Performance "tiers" are established for the "balanced rewards" portion of the plan (usually not more than two or three)
- Performance criteria/thresholds are set for each tier - with the first Tier targeted to bring the payout value to the level of a traditional SERP if "Target" performance is achieved
- Performance thresholds can then be set for the other tiers that will allow the payout to exceed the Target level if superior performance is realized
These illustrations show how a great plan can produce a positive economic return for the company. It occurs when motivational components of the plan produce an otherwise unachieved result - creating new economic value to share. In this sense, plans that are designed like these are essentially "self-financed." If no superior value is created, then awards aren't paid.
If You Have A Plan...
Those that currently have deferral or SERP programs in place will want to evaluate what they are doing in the present climate of recruiting and retention, driving profitability and creating greater economic value. The following questions can help with that assessment.
- Has the plan been structured with an eye towards executive retention?
- Has the financing/funding arrangement been contrasted with viable options to insure optimal financial results?
- Does the communication of plan values reinforce corporate strategy and promote the employee value proposition?
- Is the plan up-to-date with all legal requirements?
- Does the plan have a purpose that is aligned with corporate strategy?
For the right company, there really is no better time to capitalize on the flexibility and financial viability of a well-designed deferred compensation plan. However, new plans should only be adopted if they fulfill a strategic and economic objective. "Convenience" plans should be reviewed and updated to create greater strategic and economic alignment.