Compensation budgeting to retain your best talent…

Compensation budget is an organization’s financial commitment towards compensation awards for its workforce. It’s a lifeline for compensation management process.  A performance linked compensation budget for your managers to work upon will help you to retain your best as top talent always have more options and  you may always run into a risk of losing talented workforce to your competitors.

If your compensation allocation objective is to attract, retain and motivate best talent than performance linked budgeting is the key.  Adoption of merit linked budget over the fixed budget will provide that required extra room for distributing compensation to your best talent, to achieve your organizational goals.

Be it a fixed number or a number based on some prorated value (such as on base salary), a manager with more talented people should have more budget in his disposal to allocate workforce appropriately. Use of organization or division wide performance linked budgeting guidelines will ensure consistency as allowing discretion beyond a point may result in derailment from original purpose. To enforce consistency, variation beyond an accepted threshold should not be permitted.

Choosing performance linked budgeting over the fixed budgeting gives an extra boost to your pay for performance system.

Be Careful with Averages (Especially with Compensation)

The Department of Labor put together this chart that compares the average amount spent on compensation and benefits between private and public sector employees.  At first glance, you might think that those interested in high paying jobs should look to public sector employment, or that public sector employees are overpaid.  However, drawing such conclusions from a simple average is premature.  In this case, the problem is that we aren’t looking at pay for the “average employee” across these two dimensions; we’re looking at averages calculated from entire groups of very diverse people.  Nancy Folbre, an economics professor at University of Massachusetts breaks these numbers down into a distribution of earnings in an effort to discredit initial interpretations of these averages, and to come up with some meaningful takeaways from the data.   

Comp is much more polarized in the private sector, where private sector employees are over-represented in lower and higher income brackets, while most public sector employees fall in the middle ranges.  43% of private sector workers earned less than $25k per year and more of them are part time (26%).  More public sector employees are college educated (45% of public sector workers have a college degree v.s. 29% of private sector workers).  The data suggests that employees performing similar jobs in the upper end are paid significantly more in the private sector than they are in the public sector.  And if you’ve got a lower skilled job, then it’s probably better for you to work for your local municipality.

Averages often offer poor and sometimes misleading insight when it comes to compensation reporting.  Too much is lost when data is aggregated.  The fact that the average salary for a US subsidiary is lower than a Mexican one may or may not be a problem; if they are the same, it may or may not be a problem; or, a problem may exist when the average salary in the US is higher than it is in Mexico.  Then you ask yourself, who cares about salary averages broken out by country, or business unit, etc..  I see too many compensation reports that just offer these higher end aggregates and don’t allow someone to look deeper into the numbers to draw meaning.  If you’re going to show an average, then be sure to allow someone to cut that average across multiple dimensions to get to some level of granularity; otherwise, an average is just a tease.

Merit pay at the Vatican and practicing Correctitude

It’s been about a year since the Vatican announced it’s new merit pay system.  I have to admit, the initial announcement slipped by my radar.  But now that it’s been brought to my attention, I’m fascinated.  I took a look at this article, describing the changes.

“The system will take effect January 1.  But, characteristically for an institution that “thinks in centuries”, it will be introduced only gradually.”

 So, ten months have gone by.  They’ve probably started down the path, I assume.   I’m curious to know how that’s going, how they are handling the change.

Some of the things they are measuring:  Dedication, professionalism, productivity, politeness.  Politeness?   Uh oh, I know some people at my company that are going to be in trouble if that one catches on as a goal.

Other articles have, instead of politeness, listed this goal as “correctitude”.  Maybe “politeness” is just a bad translation from Italian ?  Whew, let’s go with that.  Then what exactly is correctitude, and do we need that in our workplace?  Well I found this:

Correctitude: Appropriate manners and behavior; propriety.

….which is probably sufficiently vague to serve as a good performance goal. (I’m kidding, Justin!).  

I’m still having trouble figuring out the proper behavior to achieve this goal.  But what about this:

Political correctitude: avoidance of expressions or actions that can be perceived to exclude or marginalize or insult people who are socially disadvantaged or discriminated against.

And a synonym to this is “political correctness”.  That’s more like it.  I think I have sufficiently translated this to English.

One small problem for me.  Earlier in this post I may have insulted or marginalized people who are socially disadvantaged in terms of not having the ‘politeness’ skill.  Which means I have demonstrated a lack of political correctitude.  I clearly have some work to do in this area.

An Economist’s View of Compensation and Honesty

I always liked the field of economics because it allows us to model complex situations (given simplifying assumptions) which then give us insight into the relationships between variables and how they might react given some kind of change. The analysis becomes even more intriguing when we try and model human behavior. So let’s take a walk down memory lane for those of you took a microeconomics class in college as we apply some of what we learned to ‘ourselves’ and the failure of a rewards system.

Economists often refer to the concept of utility – it’s basically a measurement of value or happiness someone derives from a transaction. We can apply this concept to the amount of value a worker derives from their employment. After a bit of research into a worker’s preferences, we can start to build a utility function where overall value of employment is dependent on a number of factors; e.g. U = (1/2 Compensation + 1/2 Flexible hours). As you can see, the function expresses how utility is affected as each factor is adjusted, and it also shows the tradeoffs someone must make if they want to keep a constant level of utility when factors are adjusted up or down. The tradeoffs a person is willing to make at a constant level of utility is expressed in graphical form as an Indifference Curve; a person is willing to be on any point of the indifference curve since the amount of utility they derive will be the same no matter where they are on the curve.

Now that we have a function that captures preferences, we also need one that captures the constraints on those preferences – we all would like as much compensation and flexible hours as possible, but there are practical limits to these amounts and they must be recognized in tandem with individual preferences as we try and use this model to predict behavior. In order to maximize utility, an individual will make a choice where their indifference curve is tangent to the constraints they face (see graph below).

 

The graph explains a situation where an employee’s utility is a function of money and honesty. Based on the slope of their indifference curve at various levels, they are willing to compromise honesty for more money.

An example of this situation could be where Jim, who works for a bond rating agency, is paid an annual bonus based on the revenue generated by his company. If Jim is honest and gives a poor rating for a mortgage backed security, the investment bank who paid the rating agency to rate the security may take their business somewhere else and the resulting revenue loss for the agency would impact the Jim’s bonus. This constraint placed on Jim by the incentive plan is represented by the line titled “Incentive Plan 1”. If we match this constraint with Jim’s preferences for money and honesty, Jim would choose HA amount of honesty in the report he produces and $A amount of bonus. If Jim isn’t too worried about his personal reputation (and more about his income), such an incentive plan would consistently produce inaccurate ratings and could damage the long term revenues for the firm. A company can adjust the constraints they place on employees by adjusting their incentive systems – this will impact the choices people make. If the agency changes its bonus formula for Jim so that less of it is dependent on short term revenue, it will cause the constraint curve to shift downward – this yields a higher level of honesty for Jim (HA->HB) and greater long term profits for the rating agency via stronger brand/reputation for the analysis they produce.

It’s hard to measure the preferences of individuals. We will all have different indifference curves; Al Capone’s indifference curve in the model above will look quite different to Mother Teresa’s. But measuring preferences at an aggregate level is a more realistic exercise. As compensation professionals design incentive plans, it’s important for them to recognize that, on average, employees will reach a point where they will be willing to ‘game the system’, manipulate performance measures or make some other compromise in their interests of maximizing utility. Therefore, it’s not enough to hire ‘honest people’ – you need to look at your rewards structure.

– Alex Capone