By TONY PILEGGE
Special to Business and Legal Reports

As the economy continues to rebound and job growth accelerates, the leverage pendulum that swings between employer and employee is returning to center. While this news is encouraging for the overall economy, labor market improvements are presenting new challenges for corporate management, among the most important of which will be the creation of meaningful, cost-effective reward systems for employees.

Amidst new, attractive job opportunities, workforce mobility is likely to rise. So will the cost of human capital. How can companies mitigate instability caused by employee turnover? How can they keep their best performers? How can they attract new talent to fuel growth in an increasingly competitive environment? And, how can they do this without significantly increasing labor costs?

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The first step in the process is to take a talent inventory. Who will be central to the company's success? The answers will vary. For strong, highly successful companies, it could be the management of a key growth division. For underperforming businesses looking to reverse a slump, it could be the top salespeople. The overarching goal is to align a company's people strategy with its business strategy.

The right mix and level of compensation

The next step involves identifying the appropriate mix and level of compensation- i.e., the pay package that will enable the company to retain valuable employees as well as attract necessary talent to build and enhance the business going forward. Benchmarking can be an important tool in the process. How does the company's pay compare with competitors? Employees generally are aware of how their salaries compare to others in the industry because recruiters regularly provide that type of information. For better or worse, recruiters create an expectation that must be managed.

All companies, regardless of how successful, typically look to keep base salaries low, as this is a fixed and generally substantial cost. As a result, more and more businesses have begun to adopt compensation strategies that tie pay to performance. Performance can be defined as individual, group or business unit, the company as a whole, or a combination of the aforementioned, depending on the specific goals of the business.

One approach involves developing variable compensation programs. In addition to a base salary, employees are eligible to receive bonuses based on performance. The size of the payments will vary depending on the degree of success and the influence an individual had on that success. In most cases, not every employee will receive a bonus, allowing the company to direct compensation dollars to those individuals contributing the most. The best variable compensation programs pay for themselves.

Another solution calls for eliminating across-the-board base salary increases, and instead, focusing more attention on high performers. For example, instead of offering all employees an annual base pay increase of 4 percent, an alternative approach would be to leverage those base pay dollars towards the high performing employees. The strongest performing employees receive much larger increases-perhaps 8 percent to 9 percent-and the weakest performers receive little or nothing. This approach helps to hold down overall base salaries (fixed costs) while rewarding and helping to retain your top performing employees.

Stock options and nonfinancial rewards

Another area of compensation receiving heightened attention is stock options. After skyrocketing in popularity in the 1990s, options have become much less attractive for both companies and employees. Proposed accounting rules would require companies to recognize options as an expense on their income statements. And employees, some of whom were previously granted options that were ultimately worthless, are far less enticed by them.

Rather than abandoning stock options all together, employers should consider simply changing their approach. Instead of focusing strictly on options, employers may wish to diversify their long-term incentive granting practices by including shares of restricted stock and cash-based, long-term incentive programs. Shares of restricted stock require no investment on the part of the employee and can be sold only after a vesting period of several years. Typically these awards are forfeited if the employee leaves the company prior to the awards vesting. Cash-based, long-term incentive programs allow the company to focus employees' efforts on goals other than stock price appreciation.

Beyond traditional financial incentives, employers should look to other nonfinancial rewards to retain and motivate their workforce. Studies have shown that financial incentives such as pay raises, on average, have a motivational impact of less than 2 weeks. No matter how much money a company might give, employees will soon become "habituated" to it. Such nonfinancial intrinsic rewards can include personal and professional development opportunities, promotional opportunities, employee trips, flex time, and other special-recognition programs. Combined with a reasonable financial compensation program, nonfinancial programs can contribute significantly to employees' overall job satisfaction.

After experiencing years of a stagnant economy and a protracted employers' market, an economic recovery is taking shape and companies across industry sectors are being forced to reevaluate their compensation strategies. Holding the line on costs, while staying competitive in a changing marketplace, has become a top priority. Whether the company is excelling or struggling, a market leader or an emerging growth company, implementing strategies that motivate employees and reward performance, while keeping fixed expenses low, can enable management to protect and enhance human capital and position the company for long-term success.

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