Creative Compensation Strategies to Maintain Morale and Retain Talent

Presented by
Edward Rataj, CCP Managing Director, CBIZ Human Capital Services

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 Dont 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
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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

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:
Bachelors degree or above Some college or an associates degree High school graduate Less than high school diploma 4.8% 8.1% 9.8% 15.3%

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

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% 21% 6% 13% Yes, I intend to leave Maybe, so Im networking Not likely, but Ive updated my resume No, I intend to stay.

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

Compensation System Design

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

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

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

midpoint

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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

Employee 1 ( 1 ) and Employee 2 ( 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?

High Low

1
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Merit Matrix - Concept

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?

COMPENSATION Low 2 High 1

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Merit Matrix - Concept

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 High
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COMPENSATION

High

Low

1
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Merit Matrix - Example

Typical
Matrix

Performance Exceptional Exceeds Expectation Effective Development Needed Critical Need for Improvement

1 3.5% 3.0% 2.5% 2.5% 2.5%

Quartile in Range 2 3 3.5% 3.0% 3.0% 3.0% 2.5% 2.5% 2.5% 2.0% 2.0% 2.0%

4 3.0% 3.0% 2.0% 2.0% 2.0%

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Merit Matrix - Example

Best Practice
Matrix Performance Exceptional Exceeds Expectation Effective Development Needed Critical Need for Improvement 1 6.5% 6.0% 5.0% 2.0% 0.0% Quartile in Range 2 3 5.5% 5.0% 5.0% 4.0% 4.0% 3.0% 1.0% 0.0% 0.0% 0.0% 4 4.0% 3.0% 2.0% 0.0% 0.0%

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Merit Matrix - Example

Ultra-Aggressive
Matrix Performance Exceptional Exceeds Expectation Effective Development Needed Critical Need for Improvement 1 13.0% 11.0% 4.0% 0.0% 0.0% Quartile in Range 2 3 11.0% 5.0% 6.0% 3.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 4 3.0% 1.0% 0.0% 0.0% 0.0%

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Results

Typical Matrix Performance Exceptional Exceeds Expectation Effective Development Needed Critical Need for Improvement Cost Summary Payroll: $30,400,917 Merit Increases: $1,071,120.86 Percent Increase: 3.5% Cost Detail Performance First Exceptional $83,979 Exceeds Expectations $109,175 Meets Expectations $108,116 Development Needed $32,654 Critical Need for Improvement $0 Total Cost: $1,071,121 Employee Count Detail Performance Exceptional Exceeds Expectations Effective Development Needed Critical Need for Improvement Total Employees: 536 1 24 36 52 36 24 Quartile in Range 2 3 36 16 60 20 96 16 40 20 32 12 4 4 0 4 4 4 Quartile in Range Second Third $184,222 $88,669 $158,310 $58,617 $191,830 $36,698 $0 $0 $0 $0 Fourth $15,200 $0 $3,650 $0 $0 Budget $: Budget as % of Payroll: $1,064,032 3.5% 1 8.0% 6.0% 4.5% 2.0% 0.0% Quartile in Range 2 3 7.0% 6.0% 5.0% 4.0% 3.5% 3.0% 0.0% 0.0% 0.0% 0.0% 4 5.0% 2.5% 2.0% 0.0% 0.0%

Model fits within budget

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Merit Matrix - Results

Company XYZ Cost by Quartile
$600,000

$500,000

Critical Need for Improvement

$400,000

Merit Increase Cost

Meets Expectations
$300,000

Exceeds Expectations
$200,000

Exceptional
$100,000

$0 1 2 Quartile in Range 3 4

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Merit Matrix - Results Company XYZ

Costs by Performance Level
$400,000 $350,000

$300,000

Fourth

$250,000 Third $200,000

Cost

$150,000 Second $100,000

$50,000

First

$0 Exceptional Exceeds Expectations Meets Expectations Performance Development Needed Critical Need for Improvement

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Merit Matrix - Employee Analysis

Last Name Brown Phillips Pence Pratt Beals Duncan

First Name Stan Kevin Skyler Jason Susan Elizabeth

Job Title HR Generalist IT Analyst Construction Manager Controller Maintenance Manger President

Salary Grade Min Max $47,042 $53,058 $47,042 $70,169 $47,042 $153,058 $72,915 $84,892 $72,915 $112,270 $72,915 $229,587

Salary $46,000 $64,550 $76,000 $103,299 $59,000 $200,000

PerfMerit Quartile ormance Percent 1 2 4 4 2 3 4 4 5 2 3 5 6.0% 5.0% 5.0% 0.0% 3.5% 6.0%

New Salary $47,042 $64,550 $76,000 $103,299 $59,000 $200,000

Merit Increase $2,822.52 $3,227.50 $3,800.00 $0.00 $2,065.00 $12,000.00

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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Reasonable Compensation in Closely Held Businesses

The determination of reasonable compensation is particularly important when:
Arms 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.

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Reasonable Compensation Overview

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.

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Reasonable Compensation Overview

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?

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Reasonable Compensation Intent

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. 2. 3. 4. The salary history of the employee The dividend history of the corporation The formality and timing of corporate action The degree to which salary negotiations were conducted at arms length.
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1

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

Reasonable Compensation Amount

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 employees duties The employees background and experience The size of the business The employees 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
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Moran, 290-4th T.M., Reasonable Compensation. This is not an exhaustive list, but rather a listing of factors recognized as principal considerations.

Effect of Performance on Reasonable Compensation

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

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

CBIZ CompCasts

How to Set Pay Ranges that are Fair and Effective

CompCasts

Nonprofit Quick Guide to Navigating Intermediate Sanctions Creating and Using a Salary Increase Matrix Fair Pay: Maintaining Equality in Todays 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 Rataj
Managing Director 314.692.5884 erataj@cbiz.com

Thank You