Most employers in North America don’t think so, according to CFO.com,reporting on a new survey by the compensation consulting firm, Willis Towers Watson. The survey, conducted in the last quarter of 2015, was directed at 150 large and midsize U.S. and Canadian employers. The survey reached a somewhat stunning conclusion — that only 20% of those employers surveyed “find merit pay to be effective at driving higher levels of individual performance at their organization and only 32% said their merit pay program is effective at differentiating pay based on individual performance.”
Wait, isn’t pay for performance the centerpiece, the focal point, the very heart and key goal of today’s compensation programs, especially executive compensation? Haven’t employers fully embraced pay-for-performance, often at the behest of proxy advisory firms and institutional investors? According to WTW’s global practice leader for rewards, notwithstanding all the time and money invested by employers “in their traditional pay-for-performance programs, primarily annual merit pay increases and annual incentives,…[u]nfortunately, these reward programs are falling short in the eyes of many employers. It appears that organizations are either trapped in a business-as-usual approach or suffer from a me-too mentality when it comes to their programs.” WTW also reports that “employers give their short-term annual incentive programs low marks. Only half say these programs are effective at boosting individual performance levels, and even fewer (47%) say annual incentives effectively differentiate pay based on how well employees perform.”
However, another WTW representative suggested, in many cases, the problem may be that employers fail to construct their programs as true merit pay programs: “In many cases, merit pay is a standard adjustment disguised as a pay-for-performance program. All too often, there is either a breakdown in delivery or managers feel compelled to give some type of increase to everyone instead of differentiating performance and rewarding employees accordingly.” The survey showed that 71% of employers “use wage increases in local markets as the basis for determining merit increase budgets, while 54% use their organization’s financial performance in the most recent year as the basis. And when it comes to annual incentives, just over half (51%) report using organization-wide performance measures to determine the funding pool, while individual performance measures are used to determine award payouts.”
Fortunately, according to WTW, employers may be on the road to implementing some of the necessary changes, as managers begin to take matters into their own hands, by adopting “a broader, more forward-looking view of performance when making decisions about merit pay [and] giving more weight to certain performance indicators than is called for in their program’s design. Nearly two-thirds (64%) of respondents say managers at their organization consider demonstration of knowledge and skills required in an employee’s current role when making merit increase decisions. That compares to less than half (46%) who say their programs are designed to take these performance indicators into consideration.”
WTW’s global practice leader averred that pay-for-performance programs can be useful tools when they are properly designed and implemented effectively: “However, conventional thinking on pay for performance is no longer appropriate. Companies need to define what performance means for their organization and how managers can ensure they are driving the right performance, and reevaluate the objectives of their reward programs to ensure they are aligned with that definition.”
While the survey appears to address the effectiveness of merit pay programs across the organization, you have to wonder if the same structural issues plague executive pay-for-performance programs. Would 80% of companies conclude that executive pay-for-performance programs are likewise ineffective at driving individual performance?