UNDERSTANDING OF A VARIABLE PAY PROGRAM

Christian Laniel et David D. Burke

Most businesses offer variable pay programs to their management staff. However, they can vary a lot from one business to the next and their complexity can make them difficult to understand. Applicants who consider a job offer are not always aware of the nature of the compensation offered to them, nor do they pay enough attention to the related terms and conditions. Their disappointment and frustration then replace the expected amounts.

DEFINITION

“Variable” pay can be described as any compensation that is paid on the basis of annual performance. This category includes annual bonuses, profit-sharing programs and commissions. For the senior managers and executives, this category also includes long-term profit-sharing plans and performance-related pension plans.

Future employees who analyze the variable pay offered to them must consider three things: 

  1. the target amount that will be paid for a satisfactory performance; 
  2. the amount that may be paid for an outstanding performance; 
  3. the probability of achieving both of these pay levels.

EXAMPLE

Three companies offer identical total cash compensation targets that are structured differently. Company A offers a $110,000 salary and a fixed bonus of $5,000, while companies B and C both offer salaries that are less than $100,000 but which have an additional target bonus of 15% of the base salary.

At first sight, the three offers seem to be the same ($115,000). But what about the bonus? How likely is it that it will be paid?

Applicants must also find out the conditions for the payment of the bonus, the performance level required for the employee to earn a given bonus level and the corporate performance necessary for the bonuses provided in the program to be paid. Furthermore, they must find out if the performance criteria are determined in advance or are partially or entirely discretionary. Obviously, a discretionary bonus makes the offer a lot harder to judge.

Finally, applicants should ask themselves whether it is possible to exceed the target bonus value and, where applicable, by what amount and method? Suppose in our example that an applicant achieves a better or outstanding performance. Company A would pay its fixed bonus of $5,000, which would maintain the total compensation at $115,000. Company B would pay a bonus of $20,000, which would come to a total of $120,000, while Company C would grant a $30,000 bonus, which would bring the total cash compensation to $130,000. Because Company C’s variable pay program provides bonuses that may double the target bonus, the compensation offered by its program would be considerably higher than that of its competition for the same level of performance.

CONCLUSION

This example demonstrates just how important it is to analyze not only the amounts but also the way the variable pay program is structured in order to determine its full potential. To complete their analysis, applicants would be wise to find out about the kind of bonuses the company has paid in the last three to five years before drawing conclusions about the value of the offer they are considering.

Source: Our translation of “Comprendre, c’est payant!” by Christian Laniel and David R. Burke, CRIA, La Presse, on January 6, 2007, Carrières et professions section, page 5. Original French version is reproduced with the authorization of the ORHRI. All rights reserved.

Christian Laniel is Senior Consultant, Executive Compensation, and David D. Burke, CRIA, is Retirement Practice Director at Watson Wyatt Canada.