Creative Compensation Strategies to Maintain Morale and Retain Talent

Presented by

Edward Rataj, CCPManaging Director, CBIZ Human Capital Services

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Strategic Edge Series

• Seven Core Principles to Maximize the Value of Your Business During Its Life and Upon its Sale – May 18th

• Creative Compensation Strategies to Maintain Morale and Retain Talent – June 22nd

• Don’t Be Held Captive: Go Captive to Manage Your Risk and Expenses – July 20th

• Federal Incentives That Can Show You the Money – August 17th • Protecting Your Legacy with Succession Planning – September 21st

• State Tax Nexus: No Physical Presence Required – October 26th

All these webinars are from 2:00 – 3:00 ET. Here is the link for registration for any of these webinars - www.cbiz.com/strategicedge

Agenda

• Explore turnover in the rebounding economy• Review steps for designing a market-based

compensation system• Recognition and sustaining high performance through a

merit matrix• Discuss compensation in closely held businesses• Answer your questions

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Unemployment in Improving Economy

• Common perception, supported by monthly reports from the U.S. Bureau of Labor Statistics:

• 10% unemployment• In reality, a strong negative correlation exists between

unemployment percentage and education:

Bureau of Labor Statistics Table A4: Employment status of the civilian population 25 years and over by educational attainment

Bachelor’s degree or above

Some college or an associate’s degree

High school graduate

Less than high school diploma

4.8%

9.8%

8.1%

15.3%

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Projected Turnover as Economy Improves

• According to a recent WorldatWork survey, more than half of employees intend to leave their current job as the economy improves.

• The survey asked: Do you plan to pursue new job opportunities as the economy improves? – 60% — Yes, I intend to leave – 21% — Maybe, so I’m networking – 6% — Not likely, but I’ve updated my resume – 13% — No, I intend to stay.

www.worldatwork.org/waw/adimComment?id=35633 5

Compensation System Design

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Designing a Market-Based Compensation System

• Plan and collect data• Ensure job documentation accuracy• Complete market analysis• Design pay structures• Model implementation costs• Assess internal equity• Create procedure manual• Report results

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Purpose of a Compensation System

• Implement compensation philosophy• Ensure efficient allocation of resources• Provide rational basis for pay decisions• Assist supervisors in evaluating and rewarding

performance

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Job Documentation

Job Documentation

Market Matches

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Market Pricing Methodology

• What is market pricing?• Valuation of pay for jobs in the external labor markets• Key considerations when determining labor markets:

– Location

• Local• Region• Nation

– Industry

• Industry specific• Broad spectrum of employers

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Market Pricing Methodology

• Reliable Data– Published survey data

• Major consulting and surveying firms• Statistically validated• Standard deviation analysis of data

• Unreliable data examples:– Self-reported data– DOL– Data from one or two competitors

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Designing Salary Structures

Range Spread

Midpoint Differential

minimum

midpo

int

maximum

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Assessing Current State of Compensation Program

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Merit Matrix Approach

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Compensation Strategy – Merit Matrix Approach

• Affects pay increases, not pay structure• Rewards performance• Focuses dollars on employees that are most likely to

leave because of pay

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Merit Matrix - Concept

Hig

hL

ow

2

1

• Employee 1 ( ) and Employee 2 ( ) are both accountants with exactly the same tenure, experience, education and pay. Only performance differentiates them. To whom would you provide a higher pay increase, low-performing Employee 1 or high-performing Employee 2?

1 2

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Merit Matrix - Concept

2 1

• In this example, all other factors are equal except current base salary. To whom would you provide a higher pay increase, high-paid Employee 1 or low-paid Employee 2?

Low High

COMPENSATION

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Merit Matrix - Concept

2

1

• Finally, all other factors being equal, to whom would you provide a higher pay increase, high-paid/low-performing Employee 1 or low-paid/high-performing Employee 2?

Low HighCOMPENSATION

Hig

hL

ow

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Merit Matrix - Example

Typical

Matrix

Performance 1 2 3 4Exceptional 3.5% 3.5% 3.0% 3.0%

Exceeds Expectation 3.0% 3.0% 3.0% 3.0%Effective 2.5% 2.5% 2.5% 2.0%

Development Needed 2.5% 2.5% 2.0% 2.0%Critical Need for Improvement 2.5% 2.0% 2.0% 2.0%

Quartile in Range

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Merit Matrix - Example

Best Practice

Matrix

Performance 1 2 3 4Exceptional 6.5% 5.5% 5.0% 4.0%

Exceeds Expectation 6.0% 5.0% 4.0% 3.0%Effective 5.0% 4.0% 3.0% 2.0%

Development Needed 2.0% 1.0% 0.0% 0.0%Critical Need for Improvement 0.0% 0.0% 0.0% 0.0%

Quartile in Range

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Merit Matrix - Example

Ultra-Aggressive

Matrix

Performance 1 2 3 4Exceptional 13.0% 11.0% 5.0% 3.0%

Exceeds Expectation 11.0% 6.0% 3.0% 1.0%Effective 4.0% 0.0% 0.0% 0.0%

Development Needed 0.0% 0.0% 0.0% 0.0%Critical Need for Improvement 0.0% 0.0% 0.0% 0.0%

Quartile in Range

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Results

Model fits within budget

Typical

Matrix

Performance 1 2 3 4Exceptional 8.0% 7.0% 6.0% 5.0%

Exceeds Expectation 6.0% 5.0% 4.0% 2.5%Effective 4.5% 3.5% 3.0% 2.0%

Development Needed 2.0% 0.0% 0.0% 0.0%Critical Need for Improvement 0.0% 0.0% 0.0% 0.0%

Cost SummaryPayroll: $30,400,917 Budget $: $1,064,032

Merit Increases: $1,071,120.86 Budget as % of Payroll: 3.5%

Percent Increase: 3.5%

Cost Detail

Performance First Second Third FourthExceptional $83,979 $184,222 $88,669 $15,200

Exceeds Expectations $109,175 $158,310 $58,617 $0Meets Expectations $108,116 $191,830 $36,698 $3,650

Development Needed $32,654 $0 $0 $0Critical Need for Improvement $0 $0 $0 $0

Total Cost: $1,071,121

Employee Count Detail

Performance 1 2 3 4Exceptional 24 36 16 4

Exceeds Expectations 36 60 20 0Effective 52 96 16 4

Development Needed 36 40 20 4Critical Need for Improvement 24 32 12 4

Total Employees: 536

Quartile in Range

Quartile in Range

Quartile in Range

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Merit Matrix - ResultsCompany XYZ

Cost by Quartile

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

1 2 3 4

Quartile in Range

Mer

it In

crea

se C

ost

Critical NeedforImprovement

MeetsExpectations

ExceedsExpectations

Exceptional

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Merit Matrix - ResultsCompany XYZ

Costs by Performance Level

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

Exceptional Exceeds Expectations Meets Expectations Development Needed Critical Need forImprovement

Performance

Co

st

Fourth

Third

Second

First

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Merit Matrix - Employee Analysis

Perf- Merit New Merit

Last NameFirst Name Job Title Min Max Salary Quartile ormance Percent Salary Increase

Brown Stan HR Generalist $47,042 $72,915 $46,000 1 4 6.0% $47,042 $2,822.52Phillips Kevin IT Analyst $53,058 $84,892 $64,550 2 4 5.0% $64,550 $3,227.50Pence Skyler Construction Manager $47,042 $72,915 $76,000 4 5 5.0% $76,000 $3,800.00Pratt Jason Controller $70,169 $112,270 $103,299 4 2 0.0% $103,299 $0.00Beals Susan Maintenance Manger $47,042 $72,915 $59,000 2 3 3.5% $59,000 $2,065.00Duncan Elizabeth President $153,058 $229,587 $200,000 3 5 6.0% $200,000 $12,000.00

Salary Grade

Adjustment due to employee being below salary range

Lump sum increase due to employee being at top of salary range

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Merit Matrix

• Cost neutral• Rewards performance• “Targeted” turnover• Fair and efficient method for administering pay• Accelerates employees to market competitive pay levels

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Merit Matrix – Common Pitfalls

• Structures out of alignment with market– Garbage in, garbage out– May improperly allocate limited salary increase dollars based

upon the current competitiveness of pay

• Performance scores not calibrated– Supervisors can learn to game the system– Cheating is rewarded– Top performers may not be properly rewarded

• Matrix results outside of budget

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Assessing “Reasonable” Executive Compensation in

Closely Held Businesses

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• The determination of reasonable compensation is particularly important when:– Arm’s length transactions are less likely, – Large amounts of compensation are provided to a visible

position and – The boundaries between owners and employees are blurred.

• Examples include divorce cases, S and C corporations and executive holdings of a significant number of company shares.

Reasonable Compensation in Closely Held Businesses

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• There is no single recognized definition of reasonable compensation.

• This is one of the key reasons that compensation frequently comes under scrutiny – without a clear approach to establishing what is reasonable, subjectivity bears heavy influence.

Reasonable Compensation Overview

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• According to the IRS, there are two key elements of determining reasonable compensation:1. Intent

Is the payment in exchange for services provided?

2. Amount

Is the payment reasonable given the services rendered?

Reasonable Compensation Overview

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• Compensation is reasonable only if the amount provided was both intended to be and treated as compensation at the time of payment.

• Intent is typically questioned when there is an appearance of “disguised dividends.”

• Considerations used in measuring intent include:1

1. The salary history of the employee

2. The dividend history of the corporation

3. The formality and timing of corporate action

4. The degree to which salary negotiations were conducted at arm’s length.

Reasonable Compensation – Intent

1 Moran, 290-4th T.M., Reasonable Compensation.

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• “It is, in general, just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances.” Regs. § 1.162-7(b)(3)

• The Internal Revenue Manual identifies several factors that IRS personnel should consider in determining the reasonableness of compensation, including:1

– The nature of the employee’s duties– The employee’s background and experience– The size of the business– The employee’s contribution to the success of the business– The amount paid by similar size business in the same area to equally

qualified employees for similar services

Reasonable Compensation – Amount

1 Moran, 290-4th T.M., Reasonable Compensation. This is not an exhaustive list, but rather a listing of factors recognized as principal considerations.

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• Measuring Performance– The courts have recognized significant profitability as

rationalization of seemingly high executive compensation. This is particularly true for personal service organizations.

– Other financial ratios that may be considered as indicators of corporate success include revenue growth, return on shareholders’ equity, return on assets, return on sales, earnings per share and return on capital.1

Effect of Performance on Reasonable Compensation

1 This list is not necessarily comprehensive. Rather, it is a representative list of financial performance metrics cited by the courts as factors that may suggest superior performance.

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Additional Considerations

• Nonprofit compensation• Fair pay based on race and gender• Online performance management• Sales compensation

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Summary/Key Takeaways

• Market-based compensation system• Merit matrix• Compensation in closely held businesses

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CBIZ CompCasts

CompCasts Nonprofit Quick Guide to Navigating Intermediate Sanctions

How to Set Pay Ranges that are Fair and Effective

Creating and Using a Salary Increase Matrix

Fair Pay: Maintaining Equality in Today’s Litigious Society

In development at: www.cbiz.com/hr/compcasts

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QUESTIONS?

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CBIZ Human Capital Services Contact

Edward RatajManaging Director 314.692.5884   erataj@cbiz.com

Thank You