Some of the progressive companies we work with both in India and Sri Lanka have in the last few days spent quality time looking at their profit estimates for 2008 and forecasts for 2009 to work out their cash flows to structure a robust bonus plan to boost the morale of performing staff battered by many rounds of job cuts and financial turmoil and also to be sure that most performing executives won’t have to look for a second job as a result of these developments. Many companies despite the setback in 2008 and the overall prediction that the outlook for the global economy is likely to worsen say it would be very hard to motivate staff without giving them any Bonuses in January or April 2009. This is true, because as a boss we surely have seen how effective money is in lighting a motivational fire. However, for many companies there is less money to go around in 2009 therefore, many of them want to spend what ever they have wisely and make sure that they give a disproportionate share to employees who have contributed to whatever success the company has achieved in 2008. Then those companies that do not have the cash to pay a bonus want to quickly let the top executives know that they will not be receiving bonuses this year, but wish to work out predetermined goals for 2009 so that staff will know in advance what they can get as bonuses at the end of 2009. It seems only fair that top executives should shoulder their fair share of these difficult economic times. If not, it would send exactly the wrong message to a company’s top brass to collect bonuses while their investors, taxpayers and minor employees suffer due to weak economic conditions and flat business results. In a recent Watson Wyatt survey Roughly half of 264 companies surveyed say they will reduce the size of their executive bonus pool from last year. Among the 49 percent that plan such reductions, 30 percent expect a cut of up to 20 percent, 35 percent say they’ll drop bonuses 20 percent to 50 percent, and 23 percent will cut 50 percent or more. Eleven percent do not plan to pay any annual bonuses.

The other challenge for companies is to determine the wage pool for 2009. The once popular Merit-pay increases are underperforming as a pay-delivery system, and a growing number of companies are moving to variable pay as a better way to attract, retain, and motivate employees. Under the merit-based pay for performance system, often there are too many "top performers" and too few "low performers." At the same time, merit-increase budgets have declined so that it has become like spreading peanut butter on bread. In the merit-increase system our experience is that there is too little money to truly differentiate good vs. poor performance. In our view bonuses are far more effective to manage out all the low-end performers. Often the good performer in a merit pay system would get 1 percent more than the average employee. More often everyone receives the same increase no matter how well the employee performs and often-good performers ask why they need to work harder just for a 1 percent additional increase? Research has shown that the limited success of the merit-increase system has resulted in a growing number of companies turning to variable pay. The importance of variable pay is that it has a variable component that is delivered contingent upon pre agreed results. Types of variable pay include business incentives, stock-option plans, individual performance plans, team awards, cash profit sharing, gain sharing/productivity plans, and special recognition plans. Some companies that have good variable pay plans have even tied their bonus scheme entirely to the company’s bottom line. At the end of the year the results are analyzed and based on individual performance and predetermined bonus payout plans, the bonuses are paid. That ensures that company keeps employees focused on overall profitability. Especially, now that companies have to cope with the vagaries of shorter business cycles there should be a conscious effort/commitment to align executive compensation to the success of the company and therefore companies should set a large proportion of total target pay as variable compensation (risk pay). However, a pay for performance variable reward system to work effectively needs a valid results based performance appraisal system.

In most of the Fortune 500 companies the portion of employers offering at least one variable pay plan has increased from 51 percent in 1991 to 78 percent in 2005 and over 85% in 2007. Companies are offering variable pay plans to a broad spectrum of employees. Companies, investors, and employees see the benefits of variable pay. Many companies view variable pay as a competitive necessity, a driver of desired behaviour among employees, and a better way to manage expenses by lowering fixed costs. Investors would see companies that have variable pay as a more attractive investment because variable pay links business results with pay and rewards. Employees look at variable pay as giving them more earning potential and greater control over total compensation. Companies are spending more on variable pay while merit-increase budgets have decreased in recent years and with the current economic conditions the trend is very likely to continue. For salaried employees, the salary budgets have increased from around 9 percent of payroll in 2005 to 13 percent of payroll in 2007, many companies would be hard pressed to maintain a 10 percent payroll pool in 2009. Therefore, companies with a low base pay and large variable pay plans offer greater incentive opportunity, have greater emphasis on communication, develop more accurate goal setting, and can maintain realistic goals and targets. In conclusion, Directors on Boards in 2009 would therefore need to take a hard look in the mirror when determining the right thing to do on executive salary increases and bonus payouts during these very difficult economic conditions and move towards a more flexible wage system and basing executive compensation on risk adjusted performance to cope with the vagaries of shorter business cycles and also to stay afloat in this depression.