The tumultuous 2020 is edging to a close and it is time to think about incentive plans for 2021. A somewhat more predictable year and one more amenable we hope to setting annual incentive objectives! Many businesses will continue to be cautious and point to uncertainties which of course should influence design.
Criticism was leveled at companies that amended 2020 incentive targets to make it easier for managers to earn incentives but organizations were no doubt concerned about executive retention as well as performance, through what was a very uncertain period. Senior recruitment continued during 2020 and is now back to full steam as organizations recognize new workforce dynamics and leadership requirements as well as business opportunities created by the pandemic.
Things to keep in mind when setting objectives for 2021:
A good incentive target should be both realistic and achievable. When the business climate is unpredictable these can be more elusive which means uncertainty and perhaps a range of achievement may be preferable to a pinpoint target.
- In uncertain climates organizations tend to reduce the amount of incentive including the maximum payable, to mitigate the impact of unintended outcomes.
- Lower thresholds are also more common in order to widen the range of performance opportunity that will trigger a payment;
- An easier to hit target accompanied by a reduced threshold and lower maximum reduces “leverage” or risk by flattening the payout curve; and
- Consider whether new targets are temporary or represent a longer-term market shift that supports a revised business strategy.
2021 is likely to see less business activity than 2019 and possibly, even 2020. Maintaining ratios of incentive plan costs to net income will mean lower incentive payments. When growth is anticipated to be low more emphasis typically is placed on business goals rather than revenue. For example, incentive goals might include completion of an acquisition, or sale of a business unit, transferring assets between business units, accelerating technology, or even cost reduction i.e. achievement of an event rather than achieving a financial measure.
In the post-pandemic world, this may also be the case where the business model has significantly changed because of new markets or customers.
During periods of recovery or transition companies often want to make sure that they outperform their peers by having a peer relative performance incentive and thus avoid the challenge of setting alternative, more complex goals in an uncertain world.
These considerations relate only to short term incentives; long term incentives tend not to have specific performance objectives, instead of rewarding value added to the business over three to five years to motivate retention. The 2020 experience should not normally result in a change to objectives or design unless an annual grant is determined by reference to short term achievement measured by internal metrics, in which case, mitigate the impact by averaging the performance determinant over a longer period or vest awards over time to continue to motivate retention.