Case Study: Leadership Incentive Plan

Situation:
A fairly large, well-established company had a long-standing annual leadership incentive plan that did not meet its needs.

The bonus pool for the plan was determined by the company’s performance against three financial goals. That pool was distributed based on the recommendations of the participants’ managers, but ultimately at the discretion of the CEO.

The Board of Directors was satisfied with the plan as it was based upon goals with which they were comfortable, chief among them net profitability. However, since the bonuses were largely discretionary, most participants had little or no understanding of how their payouts had been determined. Participants understood that their awards signified how their managers perceived their performance generally, but since it was not tied to any specific achievement it was not effective in influencing their behavior.

Solution:
The Board required that any new plan be sensitive to profitability, so that management would not profit in years when shareholders were feeling the pain. Senior leadership desired a plan that would align the efforts of management with the strategic direction of the company. The CEO wished to retain some measure of discretion to address circumstances unforeseen at the beginning of the plan year.

We develop and implemented a plan that met all of these requirements.

Under the new plan, the bonus pool is fully funded only if the company meets net profitability goals. If profitability falls below goal, the bonus pool is funded to a corresponding level (i.e. if actual profitability is 90% of goal, the pool is funded at 90%). This satisfied the Board’s concerns.

A participant’s share of the pool is determined in two ways. First, 75% of the bonus is based upon performance against department-specific goals. These goals provide good “line of sight”. That is, participants easily understand how they can affect performance against these goals, which provides the alignment that senior leadership desired. Second, 25% of the bonus continues to be at the discretion of the CEO, thereby meeting his needs.

Perhaps most importantly, we developed a robust communications effort to support the plan. Each participant receives a thorough introduction to ensure that they understand how the plan works, how it could benefit them personally, and how they can influence their bonus potential. To keep participants focused on their goals, they now receive regular reports detailing how their departments are performing YTD, giving them plenty of time to make corrections and adjustments and improve both their own bonus potential and the company’s achievement of key objectives.