Top 5 Mistakes in Structuring Employee Compensation

Time and time again, we see companies make serious mistakes when it comes to linking employee compensation to results. Let’s talk about the top 5 mistakes.

No Clear Connection Between Compensation and Performance

First, the biggest mistake is that often bonuses and raises are arbitrary with no clear connection between compensation and performance. This creates an ongoing problem. An employee gets a 10% raise this year and they expect at least the same next year. The problem worsens as employee tenure lengthens because the business has to pay more and more money every year with little to no direct correlation to performance.

In many cases we find that employees are grossly overpaid with little to no regard to the market replacement value, which in many cases is significantly lower. We see the results of this most often in a business sale, where after acquiring a company the new buyer will choose to, in some cases, replace overpaid employees with employees at market wages.


Not Penalizing

Second, generally employees love well structured incentives and like being recognized for their efforts. But on the flip side, no one likes to penalize employees or hold back compensation. As a result, the business owners and their executive team will rationalize and sugar coat things in order not to penalize. In some cases, we have seen leadership create new roles for people who had sub-par performance in the first place, all to avoid confrontation.


Paying On Numbers Only

Third, it is a mistake to pay employees incentives on numbers only. Employees should be paid for financial as well as non-financial targets to get the right behavior and the desired result. If you only pay for financial results, it can encourage bad behavior. For example, your sales team may hard-sell your customers with no regard for your company’s reputation, or your customer service team may cut corners to lower costs, risking customer loss for your company.


Not Segmenting Employees

Fourth, in our experience employees should be internally segmented into groups of A, B and C players. C players are marginal in their performance and do not make any material impact in your company. B players are good employees and care deeply about your company, but generally are not the driving force behind your company. That’s where the A players come in. These are folks that have many of the key attributes of B players, but also have the desire as well as the ability to grow professionally and move your company forward effectively.


Not Differentiating Compensation

And lastly, employee compensation should be differentiated. It’s critical to show that you treat your top performers differently versus the average performers. And that top performers are rewarded and recognized differently.  

If you look closely at how value is created in a company, you will come to the conclusion that value is primarily created by incremental gains in something. An employee must create a gain in something otherwise they should not get incentive compensation. If your incentive compensation plan does not connect employee performance and its resulting gain to the right compensation, you may simply be wasting your money.

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