By Sean Dean, Associate Editor
Goal-setting for incentive programs is more art than science, but companies should take steps to ensure they avoid the "sandbagging" phenomenon, said Mike Halloran, worldwide partner at Mercer Human Resource Consulting, during WorldatWork's Total Rewards Conference & Exhibition in Anaheim, California.
Halloran started his presentation by defining sandbagging as the downplay of one's ability in order to deceive. In compensation, sandbagging occurs when goals for incentive programs are set so low that individuals can make good money without working too hard, he said.
Halloran said setting goals for annual incentives is a growing challenge for companies. Setting the goals too high or too low is ineffective, he noted. He told audience members that they must ensure that their incentive programs have rigor and credibility.
He said one possible sign of sandbagging is that a business unit is qualifying for the maximum bonus or close to it every year. Another "telltale" sign of sandbagging is that the business unit is receiving above average to maximum bonuses consistently, but there are indications that the business unit isn't a high performer within the industry nor is it improving within the industry.
He offered an example of one of Mercer's clients, specifically a global consumer products company. When the company began to look at data, the company found some interesting trends. The company discovered wide variations in the incentive payouts among different business units around the world. In Russia, the company paid an average of 161 percent of the target over a five-year period, but in France, the company paid an average of 22 percent of the target over the same period.
He said that the data raised a few questions, including:
He said it's important for incentives to challenge people to grow the business. He said there a three primary approaches to setting performance targets:
- Did the business units have goal-setting problems?
- Did they have planning issues?
- Did they have management issues?
- Were they using the right metrics?
- Did the outcomes really reflect performance?
He said Mercer's research has found that 40 percent of companies use the absolute (internal) approach in short-term incentive plans and 45 percent use it in long-term plans. Half of companies use the absolute (externally informed) approach in short-term incentive plans and 30 percent use it in long-term plans, Halloran said. He said each of these two approaches have their strengths and weaknesses.
- Absolute (Internal). In this approach, companies measure performance versus internal factors like the budget. This approach requires strong internal budgeting and the ability to set meaningful, fair targets. He said some companies pre-set standards related to earnings growth or return on invested capital.
- Absolute (Externally Informed). In this approach, performance is measured against historical performance, prospective performance, and shareholder and analyst expectations. This approach requires alignment between several external inputs and alignment between external inputs and internal forecasts, he said.
- Relative. In this approach, performance is measured versus a customized peer group of companies and versus a public index of companies. This approach requires a peer group with a strong competitive bond and easily identifiable peer group of companies, he said.
He said many people argue that the relative approach is the best way to counter sandbagging because it captures true performance using information from other companies with the same internal business economics, with the same macro economics, and competing in the same products and/or markets.
However, he said, the relative measurement is no "cure-all" and involves conditions that companies must consider. For example, there is a potential to pay for negative performance of the business unit because the performance of other companies in that peer group was worse. In addition, industry consolidation and sudden changes in the availability and comparability of data are two other factors companies face, he said.
He concluded his presentation by saying the art of goal setting will continue to evolve and that the use of the budget without a direct outside perspective will become less common.