Survey Shows Continued Importance of Incentive Plans

The economic downturn posed unprecedented challenges in managing reward programs and costs. And continuing economic uncertainty has prompted a sharp focus on cost management in companies' decisions regarding annual incentive plan funding.

Towers Watson’s most recent survey of annual incentive plan practices provides new insights into the continuing evolution of bonus plan design. Following are some of the highlights.

Plan Eligibility

Over the past decade, incentive plan designs have become more consistent within organizations. As more companies offer a single annual plan for both executives and other employees:

• More companies are altering their eligibility requirements.
• Executive-only incentive plans are now in the minority.
• The most common eligibility factor is salary grade or band — not position title, reporting relationship or officer status as in the past.

Plan Funding

Our latest survey shows continued growth in the use of funding formulas based on financial results to determine aggregate spending. Trends include the following:

• Although the sum-of-targets approach to plan funding remains the most prevalent method, results-based funding now runs a close second.
• The most prevalent results-based funding measures are cash flow and operating income; by contrast, in our 2005 survey, net income was the most common results-based funding method.

Performance Measurement

In the drive to improve measurement and make compensation practices more effective, organizations continue to adjust their annual incentive plans by altering design features, usually in ways that don’t involve a wholesale redesign. Trends include:

• While nearly nine out of 10 companies responding to our survey rely on two or more performance measures, two-thirds now report using three or more measures.
• While sales or revenue is the single most common financial performance measure, four of the next five most common measures are earnings- or profit-based, and cash flow is now tied for second most prevalent performance measure.
• Performance measures showing the largest increases, compared to our 2005 survey, are cash flow and EBIT/EBITDA.

Finally, there appears to be a shift in how companies are setting performance expectations: A majority of companies now base goals on “expected business conditions.” Formerly, this practice was less common than goal setting based on budgeted performance and year-over-year improvement. Whether this is a temporary reaction to a difficult economic environment or a more lasting trend remains to be seen.