'Me Too' Bonus Plans

February 26 2002 - Company annual incentive or bonus plans are increasingly converging on a few features, based on supposed "best practices. In other words, businesses are copying each other in the design of the bonus plans that play a key role in the efforts of most Fortune 500 companies to drive executive performance.

This is one of the main findings of the 2001 Towers Perrin Annual Incentive Plan Design Survey, based on information about annual executive bonus plans at 237 companies. Many of these are large, global companies which also have non-U.S. employees.

"The move toward widespread similarity among bonus plans at a broad cross-section of companies raises a significant executive compensation issue," said Doug Friske, a Towers Perrin principal. "Are these companies, each with arguably different executive compensation needs, getting maximum value and competitive advantage from taking a 'me too' approach in designing this essential component of pay?

"Our experience dictates that one size doesn't fit all," Friske continued. "A real difference exists between the blind application of so-called 'best practices' and a careful determination of 'best fit' in the design and calibration of annual incentive plans."

Key findings of the survey:

- 62% of respondents said they used three or more measures to determine their bonus payouts. Earnings per share was the most commonly used performance measure (34%), followed by revenue measures (25%), measures of net income or profit (22%), and earnings before interest and taxes or EBIT (14%).

- Over half the companies surveyed adopt corporate nonfinancial measures or individual performance measures to determine awards. Most frequently used corporate nonfinancial measures include customer satisfaction, employee satisfaction, quality and new product development.

- Almost 70% of respondents reported using just one criterion to determine plan eligibility - position in the company being most common (44%), followed by salary grade (38%).

- Over half the companies incorporated cost of capital into their incentive plans.

- About 66% of the respondents used at least two different methods to determine performance expectations, or standards, for their main performance measure. Budgeted performance is most commonly used (60%), but increasing numbers of companies also consider business conditions (49%), year-to-year growth (48%) and/or investor expectations (27%).

"Most companies review their incentive plan designs fairly regularly and modify them as needed in order to ensure effectiveness," said Annalisa Barrett, a Towers Perrin Executive Compensation consultant who conducted the study. "Nearly 60% of the companies have reviewed their plan at least three times in the last three years, and 55% of them have made significant modifications at least once. Companies are also placing more emphasis on the performance-expectation setting process and are considering a variety of factors to determine performance standards."

Copies of the survey are available in the U.S. by calling (800) 525-6741, or outside the United States by contacting the nearest Towers Perrin office.