06 - WorldatWork · 2018-04-02 · Karen Ickes, CBP Director Sara McAuley, CCP, WLCP Director Alan Gardner WorldatWork () is a global human resources asso-ciation focused on compensation,

3Q | 2015

Goal Setting: Meeting Stakeholder Expectations in an Increasingly Dynamic and Complex WorldBy Seymour Burchman and Mark Emanuel, Semler Brossy

Consulting Group

Incentive Compensation: Measures MatterBy Robert J. Greene, Ph.D., CCP, CBP, GRP, SPHR,

GPHR, CPHRC, Reward Systems Inc

Is the Safelite Auto Glass Case Study All It’s Cracked Up to Be?By Frank Giancola

Driving Compensation Strategy Alignment: Using Analytics to Benchmark Practices from European Normative DataBy Brian Levine, Ph.D., Min Park and Tom Jacob, Mercer

Cost-of-Living Adjustments By John Kilgour, Ph.D., California State University,

East Bay

Published Research in Total Rewards

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Mission

WorldatWork Journal strives to:

❙ Advance the theory, knowledge and practice of total rewards management.

❙ Contribute to business-strategy development that leads to superior organizational performance.

❙ Provide an outlet for scholarly total rewards writing and research.

Editorial

Publisher Anne C. Ruddy, CCP, CPCU

Executive Editor Andrea Ozias

Managing Editor Jean Christofferson

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Design

Art Director Jamie Hernandez

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WorldatWork Management Team

President and CEO Anne C. Ruddy, CCP, CPCU

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Vice President, Human Resources Kip Kipley, CBP, SPHR

Circulation

Circulation Manager Barbara Krebaum

2015 WorldatWork Association Board

Lead Director David Smith, CCP, CBP, CECP

Secretary/Treasurer Jeff Chambers, WLCP

Director Bruce Clark, J.D.

Director Nathalie Parent, CCP, CBP, GRP, CECP, CSCP

Director Karen Ickes, CBP

Director Sara McAuley, CCP, WLCP

Director Alan Gardner

WorldatWork (www.worldatwork.org) is a global human resources asso-ciation focused on compensation, benefits, work-life and integrated

total rewards to attract, motivate and retain a talented work-force. Founded in 1955, WorldatWork provides a network of nearly 30,000 members in more than 100 countries with training, certification, research, conferences and community. It has offices in Scottsdale, Ariz., and Washington, D.C.

The WorldatWork group of registered marks includes: WorldatWork®, Wor ldatWork Society of Cer t i f ied Profess iona ls®, A l l iance for Work-Life Progress® or AWLP®, Cer tif ied Compensation Professional® or CCP®, Certified Benefits Professional® or CBP, Global Remuneration Professional or GRP®, Work-Life Certified Profess iona l™ or WLCP ®, Cer t i f ied Sa les Compensat ion Professional™ or CSCP™, Certif ied Executive Compensation Professional or CECP™, workspan®, WorldatWork® Journal and

Compensation Conundrum®.

This publication is a special benefit of membership.

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WorldatWork Journal (ISSN 1529-9457) is published quarterly by WorldatWork, 14040 N. Northsight Blvd., Scottsdale, AZ 85260, as a benefit to members, who receive an annual subscription with their membership. POSTMASTER: Send address changes to WorldatWork Journal, 14040 N. Northsight Blvd., Scottsdale, AZ 85260; 480-951-9191. Canada Post (CPC) publication #40823004.

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Copyright © 2015. WorldatWork. All r ights reserved. WorldatWork: Registered Trademark ® Marca Registrada. Printed in U.S.A. No portion of this publication may be reproduced in any form without express written permission from WorldatWork.

Rejection rate: In the second half of 2015, the rejection rate for papers submitted to WorldatWork Journal was 40%.

Reprints: For bulk reprints contact: Gail Hallman at 800-352-2210, Ext. 8175, or [email protected].

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2015 WorldatWork Society of Certified Professionals Board

Lead Director Tracy J O Kofski, CCP, CBP, GRP

Secretary Kevin Hallock, Ph.D.

Director Trevor Blackman

Director Carrolyn Bostick

Directo Robin Colman

Director Guillermo Villa

Director Karen Ickes, CBP

Director Kumar Kymal

Director Steve Pennacchio

Director Brit Wittman, CCP, CECP

Director J Ritchie, CCP

Director Robin Colman

Reviewers

WorldatWork Journal thanks the following individuals for reviewing manuscripts during the editorial cycle for the Third Quarter 2015 issue. Subject-matter experts, including members of WorldatWork’s advisory boards, review all manuscripts.

Wendy Criswell, CCP, CBP, WLCP, PHR I Alexandria Renew Enterprises

Andreas Spurlock, CCP I City of Las Vegas

Chris Ratajczyk, CCP, ACCP, SPHR

Melissa Shulman, CCP I Takeda Pharmaceuticals

Brad Worley, CCP, CBP I Animato

Brandon Conkle, CBP, CCP, GRP I Georgia Institute of Technology

Jan Rauk, CCP, CBP, GRP, SPHR I University of Idaho

Mark Day, CCP, GRP

Kelly Muechler

Wayne Camp, CCP, CBP, SPHR, CCCG

Susan Eichen, Mercer

John England, Pay Governance LLC

Daniel Purushotham, Ph.D., CCP, CBP I Central Connecticut State University

Mark Bussin, Ph.D., CCP, GRP I 21st Century Pay Solutions Group Pty

Stephanie Emhoff, CCP, CSCP I Cox Media Group

Dianne Auld, CCP, GRP, CSCP, WLCP I Auld Compensation Consulting

Dario Kosarac, CCP

Angela Keller, CCP, CSCP, SPHR

Jerry Colletti, CSCP

Fiona Heywood

Mike Ryan

Colin Jarvis

Executive SummariesThird Quarter 2015 | Volume 24 | Number 3

4 WorldatWork Journal

Goal Setting: Meeting Stakeholder Expectations in an Increasingly Dynamic and Complex WorldSeymour Burchman and Mark Emanuel | Semler Brossy Consulting Group

The challenge of setting meaningful, yet realistic, incentive plan goals has become

more difficult in an increasingly complex world. The authors provide three sets of

criteria to help guide companies in establishing meaningful goals that serve to meet

key stakeholder expectations.

Incentive Compensation: Measures MatterRobert J. Greene, Ph.D, CCP, CBP, GRP, SPHR, GPHR, CPHRC, Rewards Systems Inc

Getting measurement right is not easy but mandatory for incentive plans to accomplish

an organization’s goals. The right measures must be selected and the information

necessary to measure results accurately must be available. It may be necessary to

employ measures that are subjectively determined but all interested parties must accept

that they are appropriate. The article provides guidance in setting effective incentive-

plan measures under various business situations.

Is the Safelite Auto Glass Case Study All It’s Cracked Up to Be?By Frank Giancola

The Safelite Auto Glass case study is arguably the most prominent academic research

article that describes how financial incentives motivate employees to higher levels of

performance. Safelite is the largest provider of automotive replacement and repair

services in the United States. The article explains how the productivity of Safelite’s

auto windshield installers improved by 44%, after its pay plan was switched from an

hourly plan to a piece rate plan. This article examines the case, which was written by

a labor economist, from a HR management perspective and uses outside sources of

information to shed new light on what might have been behind the productivity gain.

As it turns out, evidence suggests that most employees improved their performance

primarily to save their jobs, as much as to increase their earnings by installing more

windshields under the new piece rate plan.

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Third Quarter 2015

© 2015 WorldatWork. All Rights Reserved. For information about reprints/re-use, email [email protected] | www.worldatwork.org | 877-951-9191

Executive SummariesThird Quarter 2015 | Volume 24 | Number 3

5 Third Quarter | 2015

Driving Compensation Strategy Alignment: Using Analytics to Benchmark Practices from European Normative DataBy Brian Levine, Ph.D., Min Park and Tom Jacob, Mercer

Rewards constitute a significant investment for all organizations. Thus, it is important

to strategically leverage this key investment most effectively. This includes formalizing

rewards programs to help drive employee attraction, retention and behavior — all of

which, in turn, drive business objectives. This article offers an objective approach to

both investigate differences in practice from norms and inform areas of focus. It uses a

unique application of predictive analytics to measure strategies for employee rewards

at a country level, taking advantage of incumbent-level data collected for pricing

jobs. Key differences are shared across a set of European countries examined, and

a blinded example illustrates the value of looking to company-specific differences.

The analysis presented in this article is based on extensive incumbent-level data for

seven European countries and encompasses approximately 640,000 employees across

1,750 organizations.

Cost-of-Living AdjustmentsBy John Kilgour, Ph.D., California State University, East Bay

This paper examines cost-of-living allowances or adjustments (COLA) for Social Secu-

rity, private-sector pension plans and various public-sector pension plans. While COLA

arrangements have largely been replaced by specified annual increases in private-

sector collective bargaining, the concept of indexing wages and salaries to inflation

has been adopted by Social Security and defined benefit pension plans in the public

sector. Inflation will cause income disparity between the public and private sectors and

create pressure to curtail public-employee pensions.

Published Research in Total Rewards

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The perennial challenge of setting meaningful, yet

realistic, incentive-plan goals has become ever

more difficult in an increasingly complex and

rapidly changing business world.

Companies now must also accommodate the growing

importance of a range of stakeholders. Historically,

incentive plan goals have largely focused on meeting

the needs of shareholders and driving total share-

holder return (TSR). Yet, contemporary thinking has

companies taking a more holistic view, one that

explicitly recognizes the concerns of employees,

customers, suppliers, regulators, and the community

at large. (See The Growing Range of Stakeholders

on page 7.) Although shareholder expectations likely

remain primary, meeting the expectations of other

stakeholders is fundamental to generating long-term,

sustainable shareholder value creation.

The need to get it right by gauging performance

in ways that reflect stakeholder concerns has been

further heightened by the introduction of annual say

on pay, in which goal-setting rigor is subject to regular

and increasing scrutiny by institutional investors and

Mark Emanuel Semler Brossy Consulting Group

Seymour Burchman Semler Brossy Consulting Group

Goal Setting: Meeting Stakeholder Expectations in an Increasingly Dynamic and Complex World

Third Quarter 2015



proxy advisers such as Institutional Shareholder Services (ISS) and Glass-

Lewis & Co. LLC.

With so much at stake, what is a company to do?

On the following pages, that question is answered in two ways. First, the article

describes three sets of criteria to help guide companies in establishing mean-

ingful goals that serve to meet key stakeholder expectations. Next, two cases are

provided to illustrate how these criteria can be used in varying situations.

CRITERIA TO GUIDE INCENTIVE GOAL SETTINGThe three criteria for effective goal setting in an increasingly dynamic and

complex world are:

1 | Adherence to stakeholder expectations

2 | Accommodation of organizational capabilities and the business environment —

the factors that affect the company’s ability to meet expectations

3 | Accordance with benchmarks and standards of success.

1. Adherence to

Stakeholder Expectations

In its simplest form, this first set of

criteria asks, “What should we do to

compete in this new world where

sustainable success requires that we

satisfy a broad range of stakeholders?”

The objective is to define what is

required to advance key shareholder

priorities, enable the company to

meet its various talent needs, as

well as meet the requirements of

customers, suppliers, regulators and

the community at large over the

short, intermediate and long terms.

To simplify the explanation of this

element of the framework, the focus

has been narrowed to two of the

company’s primary stakeholders —

shareholders and employees.

❚❚ Shareholders. Traditionally,

shareholder priorities have

been narrowly defined in terms

of creating shareholder value

(i.e., through stock price appre-

ciation and dividends). However,

The Growing Range of Stakeholders

Contemporary thinking highlights the need to consider a broad spectrum of stakeholders in a way that extends beyond the traditional view that shareholders are the singularly relevant stakeholder. Several factors have driven this shift in philosophy:

❚ The war for talent has gone global and innovation-fueled startups increasingly compete against established companies for the best and brightest.

❚ The pervasiveness of the Internet and mobile devices has made the acquisi-tion and retention of customers more difficult because they are increasingly knowledgeable of a company’s products, other customers’ level of satisfaction and competitors’ offerings.

❚ Supply chains have also become global and suppliers have become as funda-mental to product cost and quality as in-house operations.

❚ Meeting the ever-broader requirements of regulators has become a necessity, with fines or more onerous penalties a conse-quence of not doing so.

❚ The clout of the community at large has grown as interest groups and govern-ments demand more of corporations. Ignoring these outsiders heightens the potential for reputational risk.


issuers are encouraged to go both broader and deeper to focus on the key

drivers that influence sustainable TSR. This helps provide greater guidance to

the management team, focuses on aspects of performance that are more directly

controllable and enhances line of sight. Some of the drivers of TSR that might

be addressed are:

❚❚ Financial. The key financial measures that influence a company’s stock

price performance.

❚❚ Strategic. The strategic priorities that enable the company to build sustainable

competitive advantage and remain viable over the long term.

❚❚ Operational. The aspects of operational excellence (e.g., timeliness, reliability,

quality) that are fundamental to both financial results and the achievement of

strategic priorities.

❚❚ Employees. An organization’s talent goals should be defined comprehensively

to address the entire employee value proposition that enables the company to

attract, retain and motivate the desired talent (e.g., direct and indirect financial

rewards, affiliation, work content, career opportunities). The value proposition

should explicitly reflect the company’s unique talent needs. For example, a

struggling brick-and-mortar retailer making a foray into e-commerce might

appeal to expert-upon-hire e-commerce talent through incentive plan designs

that are sufficiently insulated from the results of the company’s brick-and-

mortar operations.

The focus in this article is on direct financial rewards. These need to be

sufficiently competitive to enable attraction and retention of key talent and be

appropriately structured to motivate and engage this talent to meet the expecta-

tions of the other stakeholders.

Balancing the shareholder and employee expectations with organizational capa-

bilities and the business environment requires that, over time, goals should result

in performance and payouts that:

❚❚ Are sufficient to generate returns above the company’s risk-adjusted cost of

capital and, in turn, drive shareholder value creation.

❚❚ Align relative pay and performance with peer companies.

❚❚ Represent a fair sharing of the value created between executives and shareholders.

❚❚ Are sufficient to keep executives retained, motivated and engaged.

2. Accommodation of organizational capabilities and the business environment

that affect the company’s ability to meet expectations

At its core, the second set of criteria asks, “What are we able to do?” The objective:

setting realistic goals given the organization’s strengths and weaknesses, as well

as the operating environment’s constraints and opportunities.

Organizational capabilities include the company’s talent, brand, infrastruc-

ture (e.g., systems and core processes, tangible assets, especially those that are


proprietary), and intellectual

property. These include what is

available in-house and/or through

alliances and partnerships.

The assessment of the business

environment is meant to iden-

tify the various headwinds and

tailwinds that exist outside the

company. This assessment covers

a whole spectrum of factors,

including macroeconomic health

and trends, competitive influences,

technological advancements and

regulatory developments.

The more detailed the assessment

of the organizational capabili-

ties, the more valuable this set of

criteria can be in the goal-setting

process. What opportunities

exist to improve the company’s

support of the long-term strategy?

Over what timeframe? At what

cost and benefit?

The same is true for evaluating

the business environment. What

is a reasonable or likely range

of potential changes to environ-

mental factors over the established

timeframes and what is the associ-

ated impact on the business? This

process may begin as a qualitative

exercise, but should ultimately

become a quantitative one.

It is helpful to examine a range

of possible scenarios to better

understand and quantify the

impact on results for the different organizational capabilities and external head-

winds and tailwinds. (See Figure 1 on page 10.)

3. Accordance with benchmarks and standards of success

In its simplest form, this means “What does good performance look like on a

long-term, sustainable basis?” These benchmarks are the references against which

Proxy Advisers — the Shadow Stakeholder —

and Meeting Their Priorities

❚ Further complicating the challenge for issuers has been a heightened focus on the rigor of goal setting by another stakeholder in today’s say on pay-centric world — proxy advisers. ISS is the most influential of the proxy advisers, and in recent years, the frequency of ISS’ commentary on the rigor of goal setting has increased significantly.

❚ To date, ISS has largely taken an overly simplistic approach in its assessments of goal-setting rigor. Its assessments focus primarily on whether the goal (at target) increased year-over-year relative to the prior year target and/or actual results and whether payouts have been consistently above target. This approach often lacks in-depth analysis and consideration of the company’s specific circumstances, but frequently carries meaningful weight in ISS’ final vote recommendation. This element of ISS’ review is particularly troublesome for companies in turnaround situations, which might reasonably be expected to lower goals year-over-year to ensure continued engagement and motivation of employees.

❚ ISS has signaled that more is likely on its way with this topic. ISS’ 2014 policy survey indicated that 43% of investors believe that if performance goals are significantly reduced, target award levels should be modified commensurately (Institutional Shareholder Services 2014). In October 2014, ISS announced its acquisition of Incentive Labs. In its press release, ISS (2014) touted Incentive Labs’ proprietary analytical tools for assessing the rigor of performance targets and “measuring the efficacy of the link between pay and performance.”

❚ Given ISS’ present (and possibly increasing) focus on goal setting, the ability to describe the rationale and rigor underlying goals in the Compensation Discussion and Analysis (CD&A) is of the utmost importance, particularly for turn-around companies. To this end, the framework can serve as a foundation to structure more nuanced and thoughtful disclosures for share-holder and proxy adviser constituents.


the business measures itself and others measure it. They endure over the long

term and through economic cycles. Common references include:

❚❚ Historical performance of the company (e.g., average, best ever) and peers

(e.g., median, top-quartile)

❚❚ Best-in-class performance among the company’s own business units (where

there are comparables) and other relevant benchmarks for key parts of the

value chain, regardless of industry (e.g., firms that are exceptional in marketing

and sales, supply chain, manufacturing, managing inventories, serving

customers, etc.)

❚❚ Analyst expectations for the company and peers/industry

❚❚ Theoretical limitations (e.g., outcomes if existing processes are optimized).

These standards should be measured over a time horizon that is sufficient

to encompass multiple economic cycles and reflect the underlying timeframes

for key stakeholder expectations. When used for goal setting, these standards

should be considered with respect to the amount of value that is created by the

organization when achieved (i.e., the extent to which returns will exceed the

risk-adjusted cost of capital).

The most effective standards are established through rigorous benchmarking

in a multi-staged process. This process starts with the high-level financial

drivers of value creation (e.g., top-line revenues, bottom-line earnings, returns),

but then delves deeper into the second-order operational and strategic factors

that drive financial performance. Not only will this process inform goal setting

within a given incentive plan, but it will, by establishing a connection between

FIGURE 1 Illustration of Scenario Modeling

85

100

120

DownsideRisk

B4 B3 A4 A3 Baseline A1 A2 B1 B2 UpsideOppty.

Organizational Capabilities

A1 – Productivity improvement (+)A2 – Defer technology investment spending (+)A3 – New product risks (-)A4 – Accelerated hiring to fill key positions (-)

External Factors

B1 – Economic recovery improves sales trend (+)B2 – Decline in raw material costs (+)B3 – Increased regulatory costs (-)B4 – Competitors’ increased promotional activity (-)


drivers, also help ensure consistency across the company’s various incen-

tive plans. In addition, it will help identify opportunities for performance

improvement and the actionable decisions that executives can make to drive

value creation.

CASE STUDIESUsing each of these three criteria, individually and in sum, will help provide a

structure and discipline to ensure that the goal-setting exercise meets the needs

of the company’s key constituents.

CASE STUDY 1: A CYCLICAL COMMODITY BUSINESS — TRUCKING Presenting challenge

Trucking and freight services are largely commoditized, and as a consequence,

business results are highly correlated with the macroeconomic cycle. Because

of the cyclical and unpredictable nature of the business, the actual operating

environment may vary significantly from the assumptions made during the

budgeting and planning process. Incentive payouts may thus vary widely inde-

pendent of management’s contributions to results. If gross domestic product

(GDP) growth is unexpectedly robust, achievement of the original goals may

warrant a smaller payout; if GDP growth is unexpectedly weak, achievement

of the original goals may warrant a larger payout. The trucking company’s

challenge in this case study was to design an incentive program that reflected

the uncertainty of the goals and ensured that payouts, on average, were fair

to shareholders.

Criteria 1: Stakeholder expectations

Given the cyclical nature of the business, key stakeholder expectations in trucking

are highly dependent upon the time horizon. Over the short term, shareholders

expect management to be flexible and responsive to a cycle-dependent operating

environment. Shareholders also expect that executives will manage the asset base

and costs at a level that is sustainable throughout the cycle.

Talent needs are equally cycle-dependent. Management needs to be retained

and engaged in a down-cycle when incentive plans are typically underwater.

Management also needs to be motivated to stretch for incremental opportuni-

ties in an up cycle when incentive plans are likely to be a layup. Thus, it is

critical to ensure that goals have an appropriate level of stretch and executives

have sufficient line of sight to the levers that can be pulled to drive results

in various market environments.

Over the long term, shareholders want management to optimize the asset base

and maximize operational efficiencies to ensure shareholder value is created

over the entire cycle, and multiple cycles, by generating returns that exceed the

company’s cost of capital.


Criteria 2: Organizational capabilities and external factors

The cyclical nature of the external operating environment is an important deter-

minant of top-line performance over both the near and longer term. Because it is

difficult to predict when the cycle might turn, the actual operating environment

may not reasonably be understood at the time the goals are set.

In addition to top-line growth, the ability to build value for shareholders is

largely a function of asset efficiency (e.g., fleet and supporting infrastructure) and

the development of effective systems (e.g., manpower planning, fleet management

and logistics) that enable the company to operate at the lowest possible cost while

meeting the needs of customers.

Criteria 3: Benchmarks and standards of success

Because top-line and bottom-line growth are both highly correlated with GDP

growth, the company focused on operating leverage as the basis for developing

a benchmark. Analysis of company and peer historical results and extensive

financial modeling indicated that, over the cycle, the operating leverage could

and should achieve a 3% premium in operating profit growth above GDP growth.

The Solution

Given the uncertainty associated with forecasting GDP growth, the appropriate-

ness of annual goals is more accurately judged at the end of the year when actual

GDP growth is known. Therefore, the company introduced a formulaic approach

for the annual plan whereby goals were adjusted after the fact to reflect how

the actual operating environment varied from the assumptions underlying the

budgeting process. (See Figure 2 on page 13.) Adjustment criteria were established

based on the sensitivity of results to assumed GDP growth.

This approach to goal setting recognized that exogenous factors are a key driver

of results and that management’s response to any given market environment is

an element that can be measured and rewarded. It also provided a mechanism

to provide relief (and improve retention) in a down cycle and require additional

stretch in an up cycle. Further, it avoided the need for blanket discretion and

reduced the incentive for management to sandbag the budget.

To complement the goal-setting solution, the company incorporated a number of

operational and non-financial goals in the annual incentive plan to encourage the

behaviors and decision making that would allow the company to generate returns

in excess of the cost of capital. Cost per ton shipped and equipment downtime

were included to determine improvements in fleet efficiency and management.

Measures of capacity utilization were used to assess whether managers were taking

the actions necessary to “right size” the business to the market environment. These

measures were seen as being controllable in the short term and across a variety

of market environments and were also required to achieve the desired long-term

3% premium in operating profit growth relative to GDP.


For the long-term incentive plan, the company used the 3%-premium-to-GDP

standard as the basis for setting long-term operating profit goals (e.g., the multi-

year goal was set at 3% above forecasted GDP growth irrespective of positioning

in the cycle). For example, if GDP growth was forecast at 2.5% over the next three

years, the operating profit goal would be set at 5.5%. This approach to long-term

incentives rewarded and encouraged strategic investments and behaviors that

provided the foundation for long-term, sustainable value creation.

CASE STUDY 2: AN INDUSTRY-LEADING PERFORMER — RETAILThe study company, a retailer, had delivered industry-leading growth in prof-

itability and shareholder returns on a regular basis. Its strategy focused on

constantly improving its customers’ experience and making disciplined, long-

term investments in a seamlessly integrated omnichannel presence (i.e., brick

and mortar and e-commerce) to yield sustained growth and top-quartile TSR.

This strategy was supported by a results-oriented culture that sought constant

improvement without shying away from aggressive stretch goals.

FIGURE 2 After-the-Fact Adjustment Schedule for Case Study 1

Illustrative Adjustment SchedulePlan Payout as a Percentage of Target

GDP Growth

Actual Profit v. Budgeted Target

+0.6% to +1.5%

+1.6% to +2.4%

Expected: +2.5% to

+3.5%+3.6% to

+4.5%+4.6% to

+5.5%

170% 200% 200% 200% 200% 200%

160% 200% 200% 200% 200% 167%

150% 200% 200% 200% 200% 133%

140% 200% 200% 200% 167% 100%

130% 200% 200% 200% 133% 67%

120% 200% 200% 167% 100% 33%

110% 200% 200% 133% 67% 0%

100% 200% 167% 100% 33% 0%

90% 200% 133% 67% 0% 0%

80% 167% 100% 33% 0% 0%

70% 133% 67% 0% 0% 0%

60% 100% 33% 0% 0% 0%

50% 67% 0% 0% 0% 0%

40% 33% 0% 0% 0% 0%

30% 0% 0% 0% 0% 0%


The challenge for this company was twofold: to drive sustained improvement

in long-term returns and to ensure the alignment of pay with both absolute

and relative performance. That challenge was complicated by the company’s

successful track record, which created a high bar from which to grow. Coupled

with continuing pressure to set ever more difficult goals, the company could easily

find itself paying executives at the market median for performance materially

above competitive levels or paying little or nothing for average performance. In

either case, the outcome would likely be demotivating to executives and potentially

heighten retention risk.

Criteria 1: Stakeholder expectations

Shareholders were expecting the company to sustain its history of industry-leading

performance and continue to deliver long-term shareholder value creation. To do

this, the company needed to: 1) focus on a disciplined approach to investment in

its omnichannel strategy; 2) continue to deliver an outstanding customer experi-

ence; and 3) seek to retain and motivate the existing leadership team, which the

board and shareholders valued greatly.

From an employee perspective, pay and performance needed to be aligned so

that pay was commensurate with the results produced on both an absolute and

relative basis. To achieve this, goal setting and incentive plan design (e.g., target

pay opportunities, payout leverage) needed to be calibrated to ensure that

industry-leading performance was rewarded with industry-leading actual/realized

pay, while industry-matching performance needed to be rewarded with industry-

competitive actual/realized pay. Further, goals needed to be set to support the

high-performance culture.

Criteria 2: Organizational capabilities and business environment

Thanks to an established and revered brand, outstanding talent, great store loca-

tions and a well-integrated e-commerce platform, the company maintained a

position of strength. The company’s ability to continually raise the bar, however,

was becoming increasingly constrained because the low-hanging fruit for opera-

tional improvements had already been harvested and the pool of desirable store

locations had been shrinking. The company needed to identify new opportunities

for growth and profitability and preserve its high-performance talent and culture.

Although forecasts indicated that the challenging market environment would

make significant year-over-year improvements difficult in the subsequent year,

over the three-year planning horizon, the market environment was likely to

brighten considerably.

Criteria 3: Benchmarking

The company had a history of performing at or above the 75th percentile on

all high-level financial metrics, such as revenue, earnings growth and return on


invested capital (ROIC). Also, it had consistently improved performance over prior

years and beaten analyst expectations, leading to top-quartile TSR growth. Setting

an “on-average, over-time” standard for revenue or earnings growth did not seem

appropriate since the continuous compounding of high-growth would, over time,

require unrealistic increases on a dollar value basis. Instead, the company focused

on ensuring continued discipline in its long-term investments and improvements

to operational efficiency by establishing a targeted ROIC of 5% to 7.5% above the

company’s weighted average cost of capital (WACC).

The company’s benchmarking exercise had showed that it consistently underper-

formed peers on inventory turns and payroll as a percent of sales, both of which

were attributable to its long-standing focus on delivering a superior customer

experience. Executives realized that new technologies offered solutions that could

reduce costs and inventory levels without sacrificing the customer experience. In

addition, the company could reap additional benefits from the continued rollout

and expansion of its omnichannel platform. Improvements in these areas would

allow the company to deliver returns in the targeted range.

THE SOLUTIONBoth the new annual and long-term incentives were designed to maintain the

company’s best-in-class performance while ensuring that pay was aligned with

performance. The annual plan also focused on key strategic changes that would

be needed to support this performance.

The key financial metric in the annual incentive plan was operating income

and goal setting was deliberately divorced from the budgeting process. The target

goal was set at what was considered to be median performance, and yielded a

target (i.e., 100%) payout. However, internally, all budgeting and planning were

focused on providing the progress needed to meet the on-average, over-time ROIC

goal, which was also generally consistent with 75th percentile earnings growth

(determined to be about 15% above median levels). Based on historical analysis

of peers, this level of earnings performance was consistent with a payout at 150%

of median. Thus, the payout curve was structured so it paid target for median

performance and 150% of target for stretch performance. (See Figure 3 on page

16.) Knowing that the macroeconomic environment presented headwinds for the

coming year, planned first-year growth was relatively modest. Subsequent growth

goals were set more aggressively to ensure that the annual goals delivered the

targeted multiyear performance levels.

Asymmetric payout curves were used to help emphasize the top-tier focus.

Thresholds were set at 90% of goal (median performance) and maximums were set

at 125% of goal, well above the stretch target of 115% of goal. Payouts were 67%

of target at threshold and 225% of target at maximum, providing significant upside.

To emphasize the changes needed to support both near-term and longer-term

performance, nonfinancial objectives were used to reinforce improvements in


inventory turns, employee productivity and the omnichannel rollout. Goals for

the first two metrics were initially targeted at peer levels and later exceeded

them. To ensure that the goals were met without diminishing the company’s very

positive customer experience, a modifier was added to reduce payouts if those

scores dropped.

The long-term incentive plan focused on ROIC. The ROIC goal was also set

at median, but again, internal planning was organized around delivering stretch

75th percentile performance (consistent with the targeted return of 5%–7.5%

above WACC). Although high threshold and maximum levels were used in the

long-term incentives (LTI), payouts were not as leveraged, reflecting that stock

price movements would provide the desired levels of realized pay. The trajectory

of annual operating income and inventory turn goals was established to ensure

that executives would achieve the long-term ROIC goal. To further reinforce

strong relative performance, a relative TSR modifier was also included.

FIGURE 3 Annual Incentive Leverage Curve

Step 1 — Company establishes a “stretch” budget that is representative of 75th percentile performance

Step 2 — A review of competitive pay data suggests that a 150% of target payout would typically deliver 75th percentile pay

Step 3 — Payout leverage curve is shifted to deliver a 150% of target payout for achieving the stretch budget

Step 4 — Company reaffirms that the sharing rates are appropriate above/below target and that the 100% payout is representative of what is typically considered to be 50th percentile performance

67%

$90

100%

$100

225% 225%

$125

150%

$115

Typical Payout Leverage Curve for 50th P Budget

Payout Leverage Curve for "Stretch"

(75th P) Budget

% o

f Tar

get P

ayou

t

Payout Leverage Curve


CONCLUSIONThe complicated exercise of goal setting can be both simplified and made more

effective through the use of the three-part goal-setting framework. The overarching

goals of incentive compensation design — to advance key shareholder priorities

and meet the company’s talent needs — can be supported by an approach that

focuses on the expectations of key stakeholders and the company’s ability to meet

those expectations. It can also be supported by consideration of the benchmarks

that will be used to assess results. Not only can this framework be applied across

a spectrum of company circumstances, including companies in cyclical industries

and companies with track records of sustained high performance, but can also

help companies faced with compensation challenges operate effectively in today’s

increasingly uncertain and complex environment.

AUTHORS

Seymour Burchman ([email protected]) is managing director at Semler Brossy Consulting Group. Burchman has been an executive compensation consultant for over 20 years. His work focuses on reinforcing key strategies and leading to improved shareholder value through the identification of performance measures and goal-setting processes. He has served companies across a wide range of industries, including financial services, health care, high technology and publishing.

Mark Emanuel ([email protected]) is senior consultant at Semler Brossy Consulting Group. He joined SBCG in July 2007. He has broad experience consulting to senior management and boards of directors on a variety of compensation and governance related matters in both public and private settings. Emanuel serves clients across all industries but with a particular focus in financial services and retail apparel. Emanuel graduated from Harvey Mudd College with a bachelor of science degree in engineering and a minor in economics.

REFERENCES

Institutional Shareholder Services. 2014. “2014-15 Policy Survey Summary of Results.” Viewed: May 19, 2015. www.issgovernance.com/file/publications/ISS2014-2015PolicySurveyResultsReport.pdf.

“ISS to buy Incentive Lab.” Oct. 16, 2014. Institutional Shareholder Services. Viewed: May 19, 2015. www.issgovernance.com/iss-services-acquire-incentive-lab.


Substantial research supports the hypothesis that

aligning rewards with performance motivates

employees to put forth their best efforts and

focus on achieving the desired results. In order for that

motivation to materialize, employees must understand

what the objectives are, consider them attainable and

believe that the rewards for performing will be equi-

table, competitive, valuable and appropriate. Gallup

research indicates that “knowing what is expected”

is the most impactful factor on employee satisfaction

and effectiveness (Coffman and Buckingham 1999). So,

clarity up front about what the objectives are and how

results are measured is a prerequisite for motivation.

If a plan is to provide the incentive to perform well,

employees must know how the organization defines

performance and what their role is in helping the orga-

nization perform well.

Defining performance at the organizational, unit

and individual levels can provide clarity about criteria

and standards. The standards must be measurable, but

measurable does not necessarily mean quantitative.

Many measures are based on subjective judgments.

Robert J. Greene Ph.D., CCP, CBP, GRP, SPHR, GPHR, CPHRC

Incentive Compensation:Measures Matter

Third Quarter 2015



For example, how well a customer believes he/she has been treated is that

person’s reality, and will influence future actions. In an incentive plan for

customer-service personnel based on customer evaluations of the service

provided, the metric for evaluating performance is subjective, but measur-

able. Often incentive-plan designers try to select only performance measures

that are countable. This may be wrongheaded because countable does not

always mean important. Although it may be more comforting to use hard

numbers when determining incentive awards and defending their fairness to

plan participants, it may result in underweighting criteria that by necessity

are based on subjective judgments.

USING MEASURES TO SET PERFORMANCE STANDARDSWhen performance measures are identified, a choice must be made as to how

the performance standards are set. There are three options:

1 | Compare current results to past results (look back).

2 | Compare current results to industry or competitor results (look around).

3 | Set standards at a level that is required in the future (look ahead).

No matter the approach used, the standards must be considered reasonable

by plan participants.

Based on Past Results

Basing standards on current results compared to past results is reasonable

if the present is similar to the past. But if a measure such as compounded

improvement in ROI is used in a troubled industry or struggling company,

basing standards on the past may be unreasonable. In the past, newspapers

in the United States often enjoyed ROIs of 20% or more. In today’s environ-

ment, returns of half that amount may be difficult to attain. So establishing

a threshold at which an incentive plan begins to be funded based on better

returns than those realized in the past would almost certainly result in no fund.

When setting plan thresholds and targets, it is advisable to examine long-

term trends to recognize what has happened in the past. Examples 1–4 present

different patterns of past results and each raises questions as to where the

threshold and target for a current year plan should be set.

Example 1: Improving Results

The trend evident in Example 1 shows that results have been improving

in the past 20 quarters. It might therefore be reasonable to assume that

establishing the plan threshold at the level of last year’s results is realistic.

Incentive plans are typically intended to reward improvement over what

would have probably occurred without them. This assumes management

does not believe that major changes have occurred that would significantly

affect current performance.


The fact that the results in

the past 10 quarters have

been relatively f lat might

cause management to set the

plan threshold even with the

past few quarters and require

improvement in order to

trigger an incentive fund.

Example 2: Growth,

Stability, Decline

This pattern in Example 2

poses considerable chal-

lenges. It appears results

showed major improve-

ment over the first seven

quarters, stabilized over the

next eight and then turned

sharply downward in the

most recent six quarters. If

the organization is oper-

ating in an industry subject

to major swings, consider-

able judgment is necessary

when establishing a plan

threshold and a target. This

pattern suggests variation

every two years. The most

recent three quarters suggest

a bottoming out and perhaps

an upturn, so management

may be comfortable setting

the current year threshold

and target at the level realized in the past three quarters. On the other hand, if

there is a pattern of industry fluctuations that cycle every six to eight quarters,

it would be reasonable to believe that results for the next four to six quarters

will improve substantially. If that is the expectation, the threshold and target

may be set at a level above the most recent results.

Example 3: Seasonality

Example 3 indicates there is seasonality in results. If the incentive plan is an

annual plan, it would be reasonable to average the four quarters in each of the

EXAMPLE 2 Growth, Stability, Decline

Last 20 Periods: Where to Set Baseline?

• •

• • • •

• •

• • •

• •

• • •

•

•

•

•

EXAMPLE 1 Improving Results


• • • •

• • • •

• • •

•

• • •

• •

•

•

•


five prior years and set the

threshold and target based

on the trend of those aver-

ages. In this case, it would

indicate an upward trend,

arguing for a threshold and

target somewhat higher than

last year’s average perfor-

mance. On the other hand,

if the plan is tied to quarterly

results, as some sales plans

are, another pattern should

be taken into account. It

appears that the dispersion

of quarterly results is getting

larger, which may call for

consideration of moving to

an annual plan or manage-

ment may find the measure

being used is too erratic to

determine the size of the

incentive fund. In any event,

management should attempt

to determine the causes of

this pattern and consider

alternative strategies.

Example 4: Seasonality With

an Upward Trend

This pattern in Example 4

also suggests seasonality

in the results, as well as

an upward trend overall.

Because there is less dispersion than the pattern shown in Example 3, it

would be reasonable to conclude that results are on an upward trend and that

the threshold and target should be set at or above the level of results during

the prior year.

No matter what the pattern, if current results are to be compared to past

results, it is mandatory that a historical analysis is extended sufficiently into the

past to detect trends. It is also necessary to attempt to explain trends that are

apparent. For example, if an upward trend is attributable solely to significant

capital investment by the organization in technology, equipment or product

EXAMPLE 3 Seasonality


•

•

•

•

• • •

• • •

•

• • •

• •

• • • •

EXAMPLE 4 Seasonality With an Upward Trend


•

•

• •

• •

• • • • •

• •

• • •

• •

• •


improvement, management should set the threshold and target high enough to

ensure that the incentive fund rewards better performance rather than merely

the improvements attributable to the organization’s investments.

Based on Current Results of Industry/Competitors

When an organization is in an industry with identifiable competitors and the

results of those competitors can be determined, it may be advisable to use

industry/competitor results rather than past results to establish plan thresholds

and targets. This is particularly the case if the current environment differs from

the past and there is significant uncertainty about future economic conditions.

In some industries, associations gather performance data and share the aggre-

gate results with members. For example, some industry associations gather

operating and financial data in an annual survey that enables users to determine

how their profits, revenue growth, cost of sales and other measures of perfor-

mance compare to their peers.

One of the difficulties with the “looking around” approach is that competitors

often balk at sharing their results. Publicly traded organizations can use measures

such as total shareholder return as their basis for comparison to other publicly

traded organizations since some performance measures are readily available

through proxy statements and other required filings. However, if an organization

wishes to use performance criteria that are not reported publicly, it will have diffi-

culty using competitor results to establish performance standards for an incentive

plan. But even measures based on subjective data may be used if industry rankings

(i.e., J.D. Power and Associates; Consumer Reports) are accessible.

Based on Future Requirements

In some cases, standards must be set at minimum levels before incentive funds are

made available. Boards often mandate that a minimum level of shareholder return

or profits be produced before incentives can be paid. This minimum level may

be viewed as performance that justifies the cost of salaries and benefits and that

minimum level must be exceeded before any further compensation is made avail-

able. Profit-sharing plans often have a formula that prescribes an incentive fund

that equals a set percentage of profits after a predetermined return to shareholders.

Organizations facing economic difficulty may need to set the incentive plan

threshold at a survival level of performance. Turning around the fortunes of the

organization may require considerable effort on the part of competent people,

so getting, keeping and motivating the required effort may necessitate offering

incentive opportunity.

SELECTING MEASURESHistorically, measures used for organizational incentive plans were dominated

by past financial results. Kaplan and Norton (1992) were influential in providing


a broader view and richer definition of organizational performance, including

customer and people measures to augment financial measures. In a later book,

Kaplan and Norton (2004) provided examples of how multiple measures can be

integrated. Financial and operating results can usually be based on quantitative

data in a relatively unarguable way.

Customer measures are more difficult to obtain due to the limited availability

of data and difficulty in getting at what the organization is trying to measure.

For example, market share for a product can generally be determined, but an

analysis of which customers are contributing to that share may be more diffi-

cult. It may also be challenging to measure customer loyalty (repeat purchases)

or share of wallet (what percentage of the customer’s expenditure goes to

the organization). Getting accurate measures can be especially important in

sales incentive plans, since different commission rates may be set for new

versus existing customers or purchases of new/more profitable products versus

recurring purchases of mature/less profitable products. One of the most chal-

lenging measures to use is customer satisfaction. Hotels often place customer

response cards in the room and airlines often send follow-up emails to gauge

customer experience. But these attempts tend to succeed in only hearing from

customers who are unhappy, limiting the responses to complaints rather than

valid indicators of satisfaction.

Finally, people measures pose significant challenges. HR functions are some-

times evaluated using measures such as average time to fill a vacancy, turnover

and implementing new systems on time and on budget. These quantitative

metrics can be misleading. Vacancies can be filled very quickly by lowering

selection standards. Turnover can be minimized by paying significantly above

market levels. And systems can be implemented quickly and on budget but not

deliver the quality desired. Some criteria require further definition to decide

how measures should be used and how standards are set. Whether human

resources should be charged with managing total turnover at a specified level

is debatable. Example 5 breaks down turnover into several types and in this

case what on the surface looked like a staggering level of turnover (24%)

turned out to be a much smaller number (13%) if only dysfunctional turnover

was used as the measure.

Example 5: Determining Dysfunctional Turnover

When incentive plan participants from human resources are measured on turnover,

the types of turnover should be factored in (see Example 5) and some consideration

given to their ability to affect results. Human resources may design sound recruit-

ment, onboarding and compensation programs but the impact of these programs

on retention will be determined by how well they are executed. The principle

of holding people accountable and rewarding them based only on things they

can influence should be followed. Therefore, a great deal of thought should go


into deciding what measures

drive incentive awards.

USING MEASURES TO EVALUATE INCENTIVE PLAN EFFECTIVENESSImplementing an incentive

plan to motivate employees

to produce improved perfor-

mance is a common practice.

Often it is difficult to deter-

mine if the plan had a positive

impact on the performance

measure the organization

wished to improve. Evaluating

results before and after plan

implementation can provide

information on the impact

of the plan. Examples 6–9

are illustrations of attempts

to determine whether the

desired results materialized.

Example 6: Improvement

Since Implementation

In Examples 6-9, X repre-

sents the plan and time

at which the plan was

implemented. In Example

6, it appears that results,

however measured, steadily

improved after implemen-

tation. Since historical data were not evaluated, it is unclear whether the

improvement would have occurred without the plan. This example illustrates

the importance of ensuring measures are tracked prior to taking an action so

that the impact of that action can be evaluated.

Example 7: Implementation During an Upward Trend

If the measure used in Example 6 had been tracked historically, a different

conclusion might be justified about the impact of the plan. It appears in

Example 7 that results were on an upward trend before plan implementation

and it is therefore difficult to give the plan much credit for improving results.

EXAMPLE 7 Implementation During an Upward Trend

Did “X” Make a Difference?

EXAMPLE 6 Improvement Since Implementation Did “X” Make a Difference?

º

º

º

º

º

º

º

º

º

X

º

º

º

º

º

º

º

º

º

•

•

•

• X


It is possible that the plan

contributed to sustaining

improvement but t ha t

cannot be demonstrated by

tracking the measure.

Example 8: Improvement

After Plan Implementation

In Example 8, there is strong

support for concluding that

the implementation of the

plan changed the pattern

of results. The historical

data show results vaci l-

lat ing somewhat with a

sl ight downward t rend.

Immediately a f ter plan

implementation, the pattern

shifted abruptly, suggesting

an initial and ongoing posi-

tive impact on results. There

may have been other factors

that caused the pattern to

change. Those factors should

be explored to ensure that

at t r ibut ing improvement

solely to the incentive plan

accurately reflects reality.

Example 9: Increased

Improvement

After Implementation

Example 9 suggests the plan had an immediate positive impact on results

and that this was sustained, at least up to the present. Although there was

an upward trend in results prior to plan implementation, the slope was more

gradual than after implementation and there was a decided jump from just

before to just after implementation. The immediate jump might have been a

Hawthorne effect, caused by an increased focus on the results triggered by

communication during plan design and implementation. But it is reasonable

to conclude the plan had a positive impact on results that was sustained at

least over the periods measured.

EXAMPLE 8 Improvement After Plan Implementation

Did “X” Make a Difference?

EXAMPLE 9 Improving Results


º

º

º

º

º

º

º

• • º

• • • º

• •

X

º º

º º

º

º

º º

º

• • •

• •

• • •

•

X


CONCLUSIONIncentive plans can be a source of motivation, encouraging increased effort and

sharper focus on specific results the organization wishes to improve. Once the

criteria used to define performance are established, it is necessary to decide

how results relating to those criteria will be measured. Then the performance

standards must be determined so that the incentive plan threshold and target

can be established. Setting thresholds too low can result in an incentive fund

that is too large and does not provide a return that justifies the cost. Setting

thresholds too high can lessen the perception that the results required to

generate an award fund can be achieved, resulting in cynicism rather than an

increased motivation to perform.

The standards established for a plan can be based on what the organization

has achieved in the past, what competitors are achieving currently or what the

organization must achieve in the future. Historical results must be evaluated

if the threshold is set based on what has been done to increase the prob-

ability that it can be achieved and/or that it is set at a challenging level that

warrants an incentive award. If the threshold is set by comparing to industry/

competitor current performance, the organization must ensure the comparator

sample is reasonable and that accurate performance data can be obtained. If

the plan threshold is set at a future level, it is necessary to be able to create

reasonable forecasts.

Determining Dysfunctional Turnover

Is Dysfunctional Turnover Too High?

Avoidable Dysfunctional

7%

Dysfunctional9%

Involuntary3%

Voluntary13%

Functional4%

Unavoidable2%

External16%

Total Turnover24%

Internal 8%Functional 4%Disfunctional 4%


A final use of measures is to determine if the adoption of an incentive plan made

a positive difference large enough to justify its cost. That determination should be

based on a comparison of pre- and post-plan implementation results.

Measures matter. The right measures must be selected and the information

necessary to measure results accurately must be available. It may be necessary

to employ measures that are subjectively determined but all interested parties

must accept that they are appropriate. The performance standards that are

attached to the measures must be set at a level that is both challenging and

attainable. Both the organization and incentive plan participants must believe

they are equitable and competitive. Getting measurement right is not easy but

mandatory for incentive plans to accomplish the organization’s goals.

AUTHOR

Robert J. Greene, Ph.D., CCP, CBP, GRP, GPHR, CPHRC ([email protected]) is the CEO of Reward Systems Inc. and a faculty member at DePaul University’s master of business administration and master of science in HR degree programs. He has more than 30 years of industry and consulting experience and has published more than 100 articles and book chapters, as well as the 2011 book “Rewarding Performance: Guiding Principles; Custom Strategies.” He was a principal designer of the CCP and GRP certifications and the first winner of the WorldatWork Keystone Award for achieving the highest level of excellence in the field.

REFERENCES

Coffman, Curt and Marcus Buckingham. 1999. First Break All the Rules. New York: Simon & Schuster.

Kaplan, Robert and David Norton. 2004. Strategy Maps: Converting Intangible Assets Into Tangible Outcomes. Boston: Harvard Business School Press.

Kaplan, Robert and David Norton. 1999. “The Balanced Scorecard — Measures That Drive Performance.” Harvard Business Review, January-February, 71-79.


Frank Giancola

Is the Safelite Auto Glass Case Study All It’s Cracked Up to Be?

When compensation professionals look for

support in academic research on the effec-

tiveness of financial incentives to motivate

employees, they are likely to find the case study of

Safelite Glass Co. (Lazear 2000). At the time of the study

in 1995, Safelite was the largest provider of automo-

tive glass replacement and repair services in the United

States. In an industry that was highly fragmented with

approximately 20,000 competitors, it had the largest

market share of about 13%.

The company was founded in 1947 and is based

in Columbus, Ohio. In the 1990s, it was owned by a

large private equity investment company and a new

management team was trying to inject new life into

the company. It employed about 4,000 employees and

had annual sales of about $400 million. Company

services were provided through 500 company-owned

and independently operated service centers and 1,000

mobile vans. It is now a subsidiary of Belron, a vehicle

glass repair and replacement group based in Belgium,

which operates in 35 countries and employs more than

24,000 people.

Third Quarter 2015



In 1996, Safelite made the business news by replacing its hourly pay system for

windshield installers with a piece-rate system, as management believed produc-

tivity was below where it should have been. The new pay system paid employees

based on the number of windshields installed instead of on the number of hours

they worked. Following the change, the company experienced a remarkable 44%

increase in output per worker.

The article is a popular one since there are few case studies on the productivity

effects of establishing a new compensation system using financial incentives.

The article has been cited 1,797 times by other authors since it original publica-

tion in 1996, according to Google Scholar. By contrast, a journal article describing

a case study involving skill-based pay by a well-known and highly respected

compensation scholar, Gerald E. Ledford Jr., has been cited 28 times since its

publication in 1991.

In 2000, the Safelite story received the distinction of being made into a Harvard

Business School case study. Harvard believes that the case study method of instruc-

tion, which places students in the role of decision maker, is the best way to prepare

students for the challenges of leadership.

Given the visibility and recognition the study has experienced, compensation

professionals should have a clear understanding of what it says and does not say

about motivating employees with financial incentives. This author has looked

at the article closely and used sources not described in the article to provide a

clearer picture of the circumstances behind this change and its effects on the

employees and company.

Like all good case studies, a great deal of information is presented but the

reasons why the main characters acted as they did are not always spelled out.

Readers must sift through and piece together key facts from the case, investigate

outside sources of information and use their business acumen to get a better

picture of what happened at the company.

A GOOD PLACE FOR A PIECE-RATE PLANSafelite offered an excellent setting for installing a piece-rate pay plan due to the

nature of the work of its dominant classification, windshield installer.

The task of installing a new pay plan was also made easier by the availability of

a sophisticated IT system to facilitate plan administration.

❚❚ Work output was easy to measure and verify. It is not difficult to keep track of

the number of windshields each employee installed per day.

❚❚ Windshield installers worked independently and their output was easy to isolate.

The incentive pay plan did not affect teamwork because there was little team-

work involved in the work.

❚❚ If installers worked too fast to boost their pay and quality suffered, it was easy

to identify the responsible worker, who then had to install a new windshield

on his/her own time.


Professional and managerial jobs may not be as well suited to piecework, so the

study has limited applications.

The New Pay System

Initially, Safelite management approached its employees with the idea of

improving productivity by granting an across-the-board base wage increase and

requiring a higher level of minimum output from each employee. Employees

rejected the idea because it did not affect each of them in the same way.

The employees favored a piece-rate system that would allow some to earn more

if they desired and allow others to continue at their present pay if they, in the

words of the case author, “put forth less effort,” and earn a minimum guaranteed

rate. Under the new system, employees would earn either the guaranteed amount

or the piece-rate wage, whichever was higher.

New employees were not covered by the guarantee, and “those who were

not making it were fired or quit early.” From statements like these and outside

sources cited later in this paper, the company was operating with a de facto

minimum output standard of employee performance. The case did not state

what the performance standard was under the piece-rate plan and how many

employees were discharged for not meeting it.

It is also not clear from the article how many, and for how long, employees

could continue to receive the minimum guaranteed amount without experiencing

negative consequences. The case study does indicate that “Many employees

ended up in the guaranteed range.” Safelite, however, knew that this would

probably be a temporary situation, as the company had a high employee turnover

rate (40%). So if the existing turnover rate continued after the new plan went

into effect, many employees would soon be subject to the piece-rate plan, as

current employees covered by the guarantee would be replaced by new ones

who were not. Turnover increased slightly under the new plan.

The change in pay plans was introduced gradually in 1994 and 1995, which

allowed the researcher to see how an employee’s performance changed from the

old to the new plan. Under the old plan, and under the guarantee, employees

were paid $11.47 per hour. Under the new plan, they received $20 for each

windshield they installed. A source outside the case indicates that the top hourly

rate of $11.47 was earned after employees mastered their craft (Passell 1996).

The employees earned on average 10% more under the new plan. Ninety-two

percent of incumbents experienced a pay increase, with 25% receiving an

increase of at least 28%, according to the study author (no further breakdown

is provided). These numbers suggest that a minority of the employees were

working to increase their earnings, while a majority might have been working

just enough to keep their jobs.


The Effect on Productivity

The case does not indicate what management’s productivity goal was for the

new pay plan. Productivity did increase substantially during the study — to 44%.

The increase was split between performance improvements of incumbent

employees and hiring more productive employees to replace less productive ones.

The average number of windshields installed per day by each employee

increased from 2.7 per day (13.5 per week) to 3.24 per day (16.2 per week).

The industry average was 3.0, and later statements and writings by company

officials stated the daily rate rose after the study to 3.9 at Safelite, an indica-

tion that the improvements attributable to the piece-rate plan lived beyond the

19-month period in the case study. According to the case study, the new piece-

rate plan was supported by a sophisticated information management system, but

the cost of such a system would probably not “overwhelm” the positive effects

on the bottom line of the productivity improvement.

It is not clear how the employees improved their productivity. Through brief

references in the case, it appears that worker productivity was a matter of effort

more than skill. However, separating one from other might be difficult. Although

certain low-skill jobs involving physical tasks might appear to depend heavily on

effort, they can favor people with good manual dexterity, strength and stamina.

More capable employees actually might have to expend less effort to succeed in

such a job than less able ones.

No mention was made of new equipment or methods being introduced during

this period that could account for the improvement or to training that might enable

employees to work more efficiently.

The case is noteworthy in one respect — the employees did not seem to

receive a commensurate share of the gains attributed to the productivity improve-

ment. Although productivity improved by 44%, wages increased by only 10%

on average. In addition, the number of windshields installed each day (3.9)

exceeded the industry average (3.0) by 30%, which seems like a reasonable basis

for greater sharing of the productivity gain.

Employee Turnover

The case report indicates that only about half of the 44% productivity improve-

ment was attributed to incumbent employees working at a higher level of

performance. The other half was due to employee turnover. New employees

were performing at higher levels than the ones who left the company. Turnover

was substantial during the 19-month period of the study. The turnover rate was

43%, which is slightly above, but not statistically different than, the 40% figure

that existed before the plan went into effect. The tenure effects were significant,

according to the study. One year of experience raised productivity by 10%.

The mean employee tenure was 8 months.


Conclusive evidence that poorer performing employees were leaving in higher

percentages than higher performing employees could be not be found.

The pattern did exist, but the difference between the two groups was not

statistically significant.

Interestingly, although high performers thrived under the new plan and their

separation rate declined by 17% under it, they were still leaving the company

in substantial numbers — 35% per year (Lazear 1999). Apparently, the prospect

of earning higher wages was not enough to keep some employees from leaving,

even though they were capable of thriving monetarily under the new plan. This

study demonstrated that there is more to retaining high-performing workers than

rewarding their superior performance. It is possible that some employees did

not believe that they were being adequately compensated for their contributions

under the piece-rate plan.

It is frustrating that the case study did not report the reasons why people

were leaving in large numbers, even before the new plan went into effect. It is

not known if the company was not keeping separation records, if the researcher

failed to consider the records, or if Safelite cared about the issue and had plans

to address it. An outside source said that prior to the pay change, the company

was not a demanding employer and had tried to address the turnover problem

with high levels of training and supervision (Passell 1996).

However, there is some evidence that management adopted a more hard-

line approach under the new pay arrangement. Early on under the piece-rate

plan, when a windshield installation was defective, the fix was assigned at

random to other employees in the center. As noted in the case, the company

hoped to create peer pressure from other employees to get the responsible

person to improve his/her performance or quit. Later, this aspect of the plan

was abandoned and the fix was assigned to the responsible installer. But here

again, it appears the company adopted another failed practice that had to be

abandoned. The responsible worker not only had to install a new windshield

on his/her own time, but had to reimburse the company for the cost of the new

windshield before paying jobs were assigned (Lazear 1996). The final practice

did not require reimbursement.

One advantage of having a high turnover rate may have come into play at Safelite.

If a company desires to reduce headcount, there is less of a need to lay people

off and incur severance costs when employees are quitting in sufficient numbers.

Outside sources of information prepared by the company indicate that reported

service center closures made this a plausible dynamic (Safelite 1997).

About 3,707 employees worked as installers during the study, which had an

average monthly headcount of 2,040 (Lazear 1996). Without providing demo-

graphic or employment details, the case study author indicates that the company

had a very different workforce at the beginning of the study than it did at the end

after the new plan had been fully installed (Lazear 1999).


PERSONNEL ECONOMICSData in the Safelite case were analyzed and described by a Stanford University

labor economist, Edward Lazear, who was the chief economic adviser to President

George W. Bush. Lazear is considered to be the father of a branch of labor

economics, personnel economics, which involves the application of economic

theory and methods to a company’s HR systems.

One technique used is insider economics, which is the application of econo-

metric methods (advanced mathematics and statistics, such as predictive modeling)

to massive amounts of confidential company information to uncover patterns to

help explain the effects of HR practices on company performance. In these studies,

which include the Safelite study, researchers generally do not introduce changes

in HR practices. They only study how prior changes affect company performance

or compare the effects of different practices at several companies.

The approach sometimes requires the use of simplifying assumptions that results

in concrete, but limited applications (Gibbons and Woock 2007). Lazear alludes

to this outcome in his explanation of how personnel economics differs from the

traditional HR approach: “The typical human resources text is verbose and short

on general principle. Indeed, many books eschew generalization, arguing that

each situation is different. The economist’s approach is the opposite. Rather than

thinking of each human resources event as separate, the scientific method that

economists use places a premium on finding the underlying general principle and

on downplaying other factors” (Lazear 2000a).

He also has stated that, “The language of economics allows the personnel econo-

mist to remove complexity. Details may add to the richness of the description,

but the details also prevent the researcher from seeing what is essential.” Based

on these statements, labor economists’ work can become problematic when they

downplay key causal factors and important contextual factors that challenge their

general principle by misjudging the significance of matters relating to HR manage-

ment as well as economics.

MISSING INFORMATIONThe effects of the personnel economics approach on the Safelite study can be

seen in the following characteristics of the case study:

❚❚ Company and industry conditions. No information is provided on the condi-

tions in the company or industry that might help explain what is driving the

change in pay practices. Even basic information about the company, such as

number of employees, revenue and market share, is absent from the article.

(This author has provided that type of information in this paper.) The case study

provided one piece of potentially important information about the company

related to the lower cost per unit of installing windshields under the piece-rate

plan: “The firm’s earnings are up substantially since the switch to piece rates,

but this could reflect other factors.” The statement cannot be given much weight


as the case study did not describe what the other factors were and how much

the new plan contributed to the earnings improvement — information that was

available to the case study author.

❚❚ Workforce profile. No description is provided of the Safelite workforce that

might help readers understand why the workers behaved as they did following

the introduction of the new plan. Basic information, which HR professionals

have come to expect in case studies by management researchers, is missing. It

does not provide the gender, age, marital status, education, company tenure

and industry experience of the windshield installers. Union affiliation is impor-

tant, but not shown. An outside source indicates 330 of the 4,000 employees

in the company were unionized (Safelite 1997). A comparison of the profile of

low-productivity workers and high-productivity workers that might help readers

understand why the latter were more productive than the former is not there.

The reader does not know, for example, if the company had a core group of

long-service employees and how those workers performed.

❚❚ Hourly pay practices. A detailed description of how employees were paid

under the hourly pay system is needed to ascertain if employees were paid an

entry-level rate and then a fully qualified rate after demonstrating job profi-

ciency. If this was the case, it would be important to know what criteria were

used to determine if an employee was eligible for the higher rate. An outside

document refers to employees being paid the top rate after they “mastered the

craft” (Passell 1996). The case mentions that the rejected pay plan “required a

higher level of minimum output,” as if one were in place before the new plan

went into effect (Lazear 2000).

❚❚ Worker earnings. Actual annual earnings of employees were not provided,

which would have given readers a feel for how the new pay system was impacting

actual worker earnings. This is a basic item in any study of how a pay system

affects worker motivation.

❚❚ Rationale for change. Regarding the rationale for the change, readers

are told only that management believed “productivity was below where it

should have been.”

❚❚ Employee briefings. No information is provided on what the employees were

told about why the change in pay practices was being made, which could affect

their desire to stay and perform at a higher level or eek employment elsewhere.

❚❚ Turnover reasons. The reasons why the company had a very high employee

turnover rate were not described in the case.

❚❚ High performers. About 35% of the high-performing employees left

the company during the study, but the case study does not explain why

they left, even though they appeared to be thriving under the new plan.

The study is long on the statistics used to analyze the data, presumably to satisfy

economists, but short on key information about the employees, the company and


the economic conditions in the industry to allow readers to apply the research

results. One might expect light treatment of the first item from an economist, but

the lack of information about the company’s financial condition, strategy and the

economics of the industry are somewhat unexpected because they relate directly

to the case and are economic factors more than HR factors.

Greater Information Gaps Revealed

There are additional serious gaps in information in the case study if one considers

outside sources of information. These sources show how management dealt with

underperforming employees and identified major operating conditions that existed

in the industry and company at the time the piece-rate plan was introduced:

Job Loss and Low Performance

The Safelite turnaround is described in a New York Times article (Passell 1996)

that shows that the threat of job loss was real for underperformers. It suggests

the real possibility that employees were motivated to perform at higher levels for

fear of job loss, as much as to earn additional income.

“Safelite had its own kind of glass ceiling,” Mr. Barlow, Safelite’s president and

chief operating officer, joked. “No more than three glass repairs per installer a

day.” His proposed solution: piecework with a safety net. Under the plan, installers

receive $19 to $23 for replacement jobs in the shop or at owners’ homes, and about

half that for multiple jobs in the lots of rental car companies. They can also make

commissions for selling auto parts to customers — from $1 for windshield wipers

to 10 percent of the invoice for an alarm system. Workers’ pay never falls below

a guaranteed floor. But in a typical month, said Bill Rapp, the Safelite treasurer,

two-thirds of the workers earn more than the minimum, and in the long run,

almost all do. Indeed, if an installer clings to the safety net for long, “it is treated

as a management problem,” Mr. Rapp said.

No information could be located in the research report on how many

employees were discharged for low productivity. Efforts to improve an employ-

ee’s ability to work successfully under the new plan, such as additional training,

were not mentioned.

Job Loss and Company Closings

Two outside documents provide information about another possible reason why

employees might have been concerned about losing their jobs that caused them

to perform at higher levels — the closure of company service centers. These

documents suggest that the new incentive plan had a goal of increasing produc-

tivity so that headcount could be reduced without degrading service, a possibility

not mentioned in the article. One factor mentioned in the case supports this idea.

If productivity increased as stated by 44%, and the business was not growing,

fewer employees would be needed to operate the service centers.


❚❚ In an article in an industry publication, Aftermarket Business, Safelite’s CEO

admitted that there were “too many glass replacement stores already dotting

the country” (Aylward 1993).

❚❚ A Securities and Exchange Commission (SEC) document filed in 1997 by the

company stated a new management team had undertaken a comprehensive

review of the company’s operations. In 1992, restructuring charges totaling

approximately $10.0 million were recorded, including $2.7 million in connec-

tion with the planned closing of 72 service centers. In 1993, the company

recorded $4.6 million in restructuring charges related to the planned closing

of about 70 service centers. In 1995, Safelite recorded $6.3 million in restruc-

turing charges. Of this amount, $5.6 million related to the planned closing

of 100 service centers (about 15 percent of the total of about 650) and

$0.7 million related to field management reorganization.

There is a pattern of closing service centers in the period shortly before

and during the case study. The readers do not know how the closures were

handled from a personnel standpoint and whether affected employees were

offered jobs at other centers to fill vacancies. In any event, employees were

aware of the contraction in jobs and that the new pay plan was reducing

the need for employees as productivity was increasing by 44%. In one sense,

employees were working harder to put themselves out of work. So it makes

sense to cover the closures in the case study because it is one important prob-

able reason for installing a pay plan that would raise productivity to allow for

a reduced headcount level.

The SEC document also showed that the company had much riding on the

success of the new pay plan. It was as a key component of its competitive

strength of being the low-cost provider: “The Company’s management esti-

mates that its performance incentive program has increased the productivity

of its installation associates from 2.5 installations per day in 1991 to 3.9 per

day in 1996 (56% gain), while the industry averages an estimated 3.0 instal-

lations per day” (Safelite 1997).

These documents raise important issues that the study does not address.

Were some employees motivated to perform at higher levels by the prospect of

earning more money or by the fear of losing their jobs? Was the incentive plan

installed to support reductions in headcount? One reading of the study might

lead the reader to believe that the case demonstrates that financial incentives

motivate employees to work harder to better themselves financially. But one

cannot be confident another significant reason for working harder, the potential

for job loss, was not at play. It appears as though it was.


SUMMARYThe Safelite case lacks great value for HR practitioners and many business people

for three reasons.

1 | Limited focus. The case’s narrow focus on low-skilled workers in a high-

turnover industry who are paid a piece-rate limits its applicability beyond these

particular circumstances.

2 | Missing information. A substantial amount of relevant information, which

would help readers understand why the company and employees acted as

they did, is missing. For example, little is known about management’s reasons

for making the pay change, how much information employees were provided

about it, workforce demographics, employee turnover reasons, how employees

were paid under the hourly pay plan and why highly productive employees left

the company in large numbers after the change was put in place. In addition,

the business conditions that the company and industry were operating under

were not addressed.

This lack of basic, practical information and key unanswered questions

greatly limits the value of the case in the real world. The case study does

present an impressive array of numbers, charts, statistics and explanations of

how they were determined. This will primarily help people understand the

mathematical relationship between pay and productivity, not an organizational

or behavioral relationship.

Five years before the Safelite study was published, an article on labor

economics and psychology by Lazear recognized this issue. “Economics is

sometimes accused of being sterile, unrealistic and inhumane. We are often

charged with ignoring psychological and institutional issues that may have

most of the explanatory power. This stereotype has some truth, bit it is

becoming much less accurate. In labor economics and other areas, previous

non-economic issues are being systematically incorporated it to economic

analysis” (Lazear 1991). The Safelite case is arguably one instance were an

expanded analysis seems in order.

3 | Job security versus motivation. The case is said to demonstrate that

employees are sensitive to incentives and that paying on the basis of output

will induce them to supply more output. On one level it did this, but the primary

effect of the incentive plan on most employees was to establish a minimum

level of acceptable performance for continued employment. Do incentive plans

typically create fear of job loss in a vital segment of the workforce to motivate

performance? Do they produce massive turnover? Are they part of a plan to

reduce headcount? Do they vastly change the composition of a workforce?

Safelite’s predicament represents an extreme situation that most compensation

professionals will not face in their careers.


The study provides little knowledge compensation professionals can apply to

their jobs. If they encounter it in academic and in pursuit of advanced professional

certifications, hopefully they will use the information in this paper to provide new

issues to consider.

AUTHOR

Frank Giancola ([email protected]) has written more than 90 articles analyzing HR trends and practices. He has over 40 years of HR experience, 25 with Ford Motor Co, primarily in various compensation and benefits positions. He has taught HR and compensation courses at several colleges. He graduated from the University of Michigan with a bachelor’s degree in psychology-sociology and received a master’s degree in business administration and industrial relations from Wayne State University in Detroit. He is a regular contributor to WorldatWork publications and Online Community.

REFERENCES

Aylward, Larry. 1993. “Glass Roots.” Aftermarket Business, Oct. 1, 8.

Gibbons, John, and Christopher Woock. 2007. Evidence-Based Human Resources. A Primer and Summary of Current Literature. New York: The Conference Board Inc.

Lazear, Edward P. 2000. “Performance Pay and Productivity.” American Economic Review 90(5): 1346-1361.

Lazear, Edward P. 2000a. “The Future of Personnel Economics.” Economic Journal 110(467): 611–639.

Lazear, Edward P. 1999. “Personnel Economics: Past lessons and Future Directions. “ Working Paper 6957. National Bureau of Economic Research.

Lazear, Edward P. 1996. “Performance Pay and Productivity.” Working Paper 5672. National Bureau of Economic Research.

Lazear, Edward P. 1991. “Labor Economics and the Psychology of Organizations,” Journal of Economic Perspectives 5(2): 89-110.

Passell, Paul. 1996. “Earning it: Paid by the Widget, and Proud,” New York Times, June 16, F1.

Safelite Glass Corp. 1997. Form S-4. Securities and Exchange Commission. Feb. 18. Viewed on Feb 12, 2015. https://www.sec.gov/Archives/edgar/data/1033671/0000950135-97-000756.txt


Driving Compensation Strategy Alignment: Using Analytics to Benchmark Practices from European Normative Data

Rewards constitute a significant investment for

all organizations. Thus, it is important to stra-

tegically leverage this key investment most

effectively. This includes formalizing rewards programs

to help drive employee attraction, retention and

behavior — all of which, in turn, drive business objec-

tives. However, such strategy most often is informed

by informal or qualitative evidence (e.g., relying on

surveys) to benchmark practices.

This article offers an objective approach to investigate

differences in practice from norms and inform areas of

focus. It uses a unique application of predictive analytics

to measure strategies for employee rewards at a country

level, taking advantage of incumbent-level data collected

for pricing jobs. Statistical tests can then assess how a

company’s strategy varies from the country norm.

Key differences are shared across a set of European

countries examined, and a blinded example illustrates

the value of looking to company-specific differences.

From the latter, important insights related to compensa-

tion imperatives are emphasized, including the:

❚❚ Extent to which organizations pay for performance

Tom Jacob Mercer

Min Park Mercer

Brian Levine Ph.D. Mercer

Third Quarter 2015



❚❚ Value of general versus company-specific experience

❚❚ Degree to which pay differs by gender after account for other relevant factors.

Steps companies can take to generate related insights from archival, employee-

level data also are highlighted.

METHODOLOGY: APPLYING PREDICTIVE ANALYTICSMercer collects extensive data to help organizations benchmark pay rates and

other aspects of the rewards package. Data on thousands of companies is main-

tained in the firm’s “Total Remuneration Survey.” To date, the use of this data

primarily has been for benchmarking: to understand typical pay outcomes in an

appropriately defined market or for a given role. This helps companies track what

happens outside their walls.

Mercer also has engaged with organizations to drive workforce strategy from

hard data, using predictive analytics to analyze administrative information stored

in their Human Resource Information Systems (HRIS) and related platforms.

The intent of this work is to understand which employee experiences or contribu-

tions the organization actually rewards through pay and progression. It is also

possible to measure how employees value different aspects of the employment

experience through parallel analysis of employee engagement and retention.

For more than 20 years, Mercer has proven predictive models to be highly effec-

tive in helping organizations understand how practices play out on the ground.

This type of analysis looks at what happens inside an organization, addressing

the effectiveness of an organization’s programs relative to its unique priorities.

The structure of the survey data allows for the marriage of these two approaches,

applying predictive analytics to assess compensation philosophies at an economy-

wide level, leveraging employee-level data across thousands of companies. Further,

it can be used to drill down on differences between economy-wide practices and

those of a specific company.

In summary, the analysis can compare typical practices outside the organization

with what occurs inside it, and from that, focus on what appear to be alignments

or misalignments with desired practice. For example, when looking at an organiza-

tion focused on pay for performance, a relatively weak association between pay

and above-average performance would recommend deeper-dive examination and,

potentially, programmatic changes.

The analysis presented in this article is based on extensive incumbent-level data

for seven European countries and encompasses approximately 640,000 employees

across 1,750 organizations in 2012. (Note: More recent data are used to support

the investigation of specific issued posed by Mercer clients.) The predictive algo-

rithm is a linear regression for each country to identify economy-wide drivers

of total cash compensation (TCC) (i.e., base pay rate plus, where applicable, the

most recent bonus).


Furthermore, the analysis tested for organizational differences from econ-

omy-wide effects related to each explanatory factor in Mercer’s model by using

“interaction terms.” Interaction terms allow Mercer to estimate, for a given company,

a separate effect related to each variable in the model. Furthermore, interaction

terms provide the opportunity to test the statistical significance of each difference

from the economy-wide norm. The method provides for greater statistical power in

identifying differences when such interaction terms are considered one at a time,

especially in the case where a given company has a small number of employees.

All models account for basic items to address a critical set of issues:

❚❚ Age and tenure. In comparing these effects, the analysis can assess, on a

relative basis, whether the organization is more focused on general experience

(proxied by age, once tenure is taken into account) or firm-specific experience.

Essentially, the analysis assesses whether the organization is more focused on

paying for outside experience or building and retaining home-grown talent.

❚❚ Gender. The analysis can identify whether the organization is at risk with

regard to pay equity.

❚❚ Pay for performance. The analysis identifies employees who have received

an above-average bonus (which proxies for having achieved an above-average

performance level) in the most recent year. This explores the relative strength

of the organization’s pay-for-performance practice.

Models also include factors not detailed in this article, including:

❚❚ The class of the job based on Mercer’s International Position Evaluation (IPE)

methodology, to consistently account for differences in career levels between jobs

❚❚ The location in which the employee works, to account for differences in

pay across markets

❚❚ Organization-specific effects, to account for differences in pay-to-market philoso-

phies that generally transcend industry affiliation.

The goal is to continually tap the Mercer data to help organizations be more

strategic in setting compensation policies.

CAVEATS: SELECTION AND CAUSATIONTwo important caveats are an issue for any use of such data. First, as is typically

the case with survey data, the sample is not random; therefore, it is not fully

representative of an economy. Organizations select whether to provide data to

Mercer and, furthermore, whether to provide data for all of their employees in

a country. Figure 1 on page 42 provides information on the size of participating

organizations and their representation across countries and industries for the

reader’s consideration.

Second, the models presented in this article cannot account for a high level of

organizational specificity. For example, similar models run at the organizational


level to address gender pay equity would account for actual pay grades (which, of

course, vary greatly across organizations), performance rating histories, job histo-

ries and other differentiating information about an employee’s role. While the

analysis presented in this article is a useful starting point to raise areas of

concern and jump-start a strategy discussion, the authors recommend that it

be followed by a more detailed analysis that relies on a company’s own, more

detailed workforce data.

ECONOMY-WIDE RESULTSThe analysis focuses on seven countries: Finland, France, Germany, Italy, Sweden,

Switzerland and the United Kingdom. First, consider the results from the United

Kingdom in order to focus on the results of one economy before placing the

results in the context of other economies.

Relative Value of General Experience vs. Company-Specific

Experience in the Economy

As an economy, the United Kingdom generally appears to modestly value both

general and company-specific experience, though there is a tilt toward valuing

general experience more so than firm-specific knowledge. Every 10 years of

additional general experience, proxied by age, is associated with a 3.9% higher

TCC. Compare this to the same amount of firm-specific experience, proxied

by tenure, which is associated with only a 2.6% increase in TCC. This is all

FIGURE 1 Organization Demographics

This figure represents the distribution of industries within countries included in the dataset used for the analysis. This article focuses on the United Kingdom’s economy as an example.

Distribution

Industry

Finland, France, Germany, Italy, Sweden,

SwitzerlandUnited Kingdom

Durable 29.6% 26.2%

Consumer Goods 23.5% 24.0%

Nondurable (excluding Consumer Goods) 13.3% 9.7%

High-Tech 8.3% 7.0%

Services 6.4% 10.5%

Retail/Wholesale Trade 3.6% 4.9%

Energy 2.4% 4.3%

Insurance 0.8% 0.5%

Finance/Banking 0.7% 1.6%

Other 11.5% 11.3%


after controlling for other relevant pay-related factors (e.g., job size, job family,

educational attainment, geographic location).

Extent to Which Women Are Falling Behind on Pay

There is potentially a significant gap. Women appear to be paid 9.3% less than

men who are in similar jobs and locations, with similar educational attainment

and experience. There may be additional legitimate factors within each organi-

zation that can explain some of this disparity. However, the size of the gap is

concerning (relative to past research using similar methodologies at the country

level) and suggests an economy-wide issue.

Extent to Which Performance Is Rewarded

As an economy, the United Kingdom tends to pay for performance. An employee

whose bonus exceeds his/her target (a proxy of a high performer) is paid better

on TCC by 7.6%, on average, after controlling for other relevant factors. Putting

these findings for the United Kingdom in the context of other nearby economies,

there are some important points of distinction. (See Figure 2.)

Specifically, the analysis reveals that the United Kingdom:

❚❚ Values firm-specific experience more highly relative to general experience than

other countries examined

❚❚ Has a larger, unexplained gender gap

❚❚ Pays significantly more for performance than the other countries examined.

FIGURE 2 Pay Drivers in the United Kingdom

The bars show the effects of various drivers on TCC. For example, in the United Kingdom, 10 years of additional general experience (proxied by age) is associated with a 3.9% increase in TCC, after controlling for factors such as years of service, Mercer IPE “position class” (a consistent, cross-company leveling variable) and educational attainment.

N=81,068, reflecting 325 companies

Years of Age: +10

Years of Service: +10

Female vs. Male

Typical Education: High School vs. University

Bonus Exceeds Target

IPE Position Class: +1

3.9%

2.6%

-9.3%

-1.3%

7.6%

6.6%

Total Cash Compensation

-10% 0% 10%

United KingdomPercent change in pay associated

with each driver comparison


Interestingly, similar analyses looking at IT employees in India show much

greater value than any of these countries linked to general experience, and

significant negativity associated with years of service. In India’s IT sector, which

has been rapidly developing, employees who sit still are penalized.

COMPANY SPECIFIC FINDINGS: IMPLICATIONS FOR STRATEGYConsider Company X, a multinational consumer goods organization with head-

quarters in the United States and more than 100,000 employees globally. Here,

the focus is on results for Company X’s less than 5,000 UK employees and

relevant strategy questions:

1 | Focus. General experience, proxied by age, is paid 66 percent more

at Company X (6.5% vs. 3.9% for every 10 years in the UK), making

it almost three times more valuable than firm-specific experience.

Strategy question: Should Company X be more focused on paying a premium

for outside experience than its local peers?

2 | Pay equity. Women are less underpaid at Company X than they are in

the average UK economy, but there remains a significant difference that is

concerning Strategy question: Can Company X improve the value proposi-

tion to its female talent and act to minimize compliance risk by engaging in

pay equity review?

3 | Pay for performance. Pay is rewarded highly, but is on par with other

companies in the United Kingdom.

FIGURE 3 Percent Change in TCC Associated with Each Driver Comparison

Driver comparison Finland France Germany Italy Sweden SwitzerlandUnited

Kingdom

Years of Age: +10 years(general experience)

5.7% 8.1% 5.4% 9.5% 4.4% 6.8% 3.9%

Years of Service: +10 years(firm-specific experience)

N/S 1.0% 2.6% -1.3% -0.4% 0.7% 2.6%

Female vs. Male -6.1% -4.1% -6.7% -3.4% -4.1% -5.8% -9.3%

Bonus exceeds target (performance) 5.9% 6.2% 5.7% 7.3% 7.0% 6.7% 7.6%

A comparison of the drivers of pay, TCC, across seven European economies. “N/S” implies an effect is not statistically significant at conventional levels.

N=637,844, reflecting 1,753 organizations.


Strategy question: How strongly should pay vary with current-year performance?

How should pay-for-performance sensitivity vary across key workforce segments?

USING ANALYTICS TO GAIN A DEEPER VIEWOrganizations can gain great value from using predictive analytics to assess how

their rewards practices play out and, from that, in questioning whether those

practices are optimized. Data once solely used for benchmarking pay levels

can now be used, leveraging predictive analytics, to benchmark the efficacy of

practices. Furthermore, data that sits in the HRIS and supporting systems can be

harnessed to support more thorough diagnostics. Indeed, an increasing number

of organizations are tapping into the value of such data to support fact-based

compensation strategies.

AUTHORS

Brian Levine, Ph.D. ([email protected]) is partner and co-leader of Mercer’s Workforce Strategy & Analytics practice and fellow of Mercer’s research arm, the Workforce Sciences Institute. He is based in New York.

Min Park ([email protected]) is principal in Mercer’s Workforce Strategy & Analytics practice. She is based in Los Angeles.

Tom Jacob ([email protected]) is senior partner and global leader of Mercer’s Information Solutions Research and Insights Products. He is based in Philadelphia.

FIGURE 4 Company X vs. UK Norms

Pay drivers for Company X in comparison to the United Kingdom. Percentage increases are after controlling for factors such as years of service, IPE posi-tion class (a consistent, cross-company leveling variable) and educational attainment. The asterisk (*) next to a factor indi-cates that the effect is statistically significantly different from the norm.

Years of Age: +10*

Years of Service: +10

Female vs. Male

Typical Education: High School vs. University

Bonus Exceeds Target

IPE Position Class: +1*

6.5%

Company X

-20% 0% 40%30%20%10%-10%

UK economy-wide norm

Percent change in pay associated with each driver comparison

3.9%

2.6%2.6%

-7.0%-9.3%

-3.0%-1.3%

7.6%7.6%

12.5%6.6%


This paper examines cost-of-living allowances

or adjustments (COLA) for Social Security,

private-sector pension plans and various public-

sector pension plans.

The concept of the cost-of-living adjustments origi-

nated in collective bargaining in the auto industry in

1947. It quickly spread to other industries, due in part

to the “contract bar rule.” The National Labor Relations

Board would accept a petition for decertification of

a recognized union only between the 90th and 30th

day before the expiration of a labor agreement with a

maximum duration of three years (or after its expira-

tion). This greatly reduced the chances of the union

being “raided” by another union, a common occurrence

at the time. A “three-year book” also gave the employer

three years of “no-strike-clause” protection and unin-

terrupted production. These provisions quickly became

the standard and contributed significantly to labor-

management stability.

At that time and for years after, inflation was more of

a concern than it is today. If the union entered into a

multiyear agreement, it ran the risk of the real wages

John G. Kilgour, Ph.D., California State University,

East Bay

Cost-of-Living Adjustments

Third Quarter 2015



(purchasing power) of its members being eroded by price inflation. One solution

was an annual “wage reopener,” with the possibility of a work stoppage. This

had little appeal to management. The other solution was a COLA provision that

adjusted wages to some measure of inflation.

While COLA arrangements have largely been replaced by specified annual

increases in private-sector collective bargaining, due in large part to the taming

of inflation, the concept of indexing wages and salaries to inflation has been

adopted by Social Security and to defined benefit (DB) pension plans in

the public sector.

ECONOMICS OF RETIREMENT INCOMEWhile COLAs were important

in multiyear labor agreements

during past periods of high

inflation, they are much more

important for participants in

DB pension plans. Retirees

and beneficiaries typically

live and collect retirement

benefits for many more

than three years.

Table 1 reports life expec-

tancy at birth and at age 65

for men and women. We are

accustomed to reading about

improved life expectancy

at birth. The improvements

have been impressive. Life

expectancy of a male born

in 1980 was 69.9 years. By

2013 it was 76.5, an increase

of 6.6 years (9.4%). Over the

same period, life expectancy

at birth for females went from

77.7 years to 81.3, an increase

of 3.8 years (4.9%).

For retirement income purposes, the more relevant measure is life expectancy

at age 65. For the period 1980–2013, male life expectancy at 65 went from 14.0

years to 18.0, an increase of 4.0 years (28.6%). For females, it grew from 18.4

years to 20.5 years, an increase of 2.1 years (11.4%). A male age 65 in 2013 can

TABLE 1 Life Expectancy at Birth and at Age 65,

Selected Years 1980–2013

LIFE EXPECTANCY

AT BIRTH AT AGE 65

Year Male Female Male Female

1980 69.9 77.5 14.0 18.4

1985 71.1 78.2 14.4 18.6

1990 71.8 78.9 15.1 19.1

1995 72.5 79.1 15.4 19.1

2000 74.0 79.4 15.9 19.0

2005 74.8 80.0 16.7 19.1

2010 76.1 80.9 17.6 20.2

2011 76.1 80.9 17.7 20.2

2012 76.4 81.1 17.9 20.4

2013 76.5 81.3 18.0 20.5

Additional Years*

6.6 3.8 4.0 2.1

Percent Increase*

9.4 4.9 28.6 11.4

* Calculated by author. Source: 2014 Social Security Trustees Annual Report. Table V.A3. Retrieved from www.ssa.gov October 12, 2014.


expect to live to 83.0 and a

female to 85.5. Women live

longer than men, but the

differential is shrinking.

Increased life expectancy

is usually considered good

news. We all want to live

longer and we want our

children and grandchildren

to live longer still. For the

Social Security program and

for DB pension plans, it is

not good news. The longer

participants and beneficia-

ries live, the longer they

collect benefits. In the

absence of a COLA provi-

sion, the longer they live, the

less the pension benefit is

worth in purchasing power.

Table 2 presents a picture

of the impact of inflation

on a basic (initial) pension

benefit of $12,000 per year

($1,000 per month) over

one through 30 years of retirement. While few people live to 95 (65 + 30),

lots of people retire earlier than age 65. At the current inflation rate of about

1.5%, a $12,000 basic benefit will be reduced to $10,317 (86.0%) in 10 years

and to $8,870 (73.9%) in 20 years. At a more likely long-run average inflation

rate of 3.0% per year, a $12,000 annual pension benefit will be reduced to

$8,849 (73.7%) in 10 years and to $6,526 (54.4%) in 20 years. Remember, life

expectancy at age 65 is 18.0 years for men and 20.5 years for women. Clearly,

a COLA provision is an important feature in any retirement-income plan.

SOCIAL SECURITYTo most people, the term Social Security means the Old Age, Survivors and

Disability Insurance (OASDI) program. It is funded by equal contributions

from the employer and employee (the self-employed pay both) and provides

retirement and disability benefits. The Social Security Act of 1935 has been

amended many times and now consists of a large number of benefit programs

including the Supplemental Security Income (SSI). SSI is a federal needs-

based welfare program that provides payments to low-income individuals and

TABLE 2 The Impact of Inflation on a $12,000

Per Year Basic (Initial) Pension Benefit.

Basic Benefit

Inflation Rate

Years Since Retirement

Future Value

Percent of Basic Benefit

12,000 1.5% 1 11,820 98.5%

12,000 1.5% 5 11,127 92.5%

12,000 1.5% 10 10,317 86.0%

12,000 1.5% 15 9,566 79.7%

12,000 1.5% 20 8,870 73.9%

12,000 1.5% 25 8,224 68.5%

12,000 1.5% 30 7,625 63.5%

12,000 3.0% 1 11,640 97.0%

12,000 3.0% 5 10,305 85.9%

12,000 3.0% 10 8,849 73.7%

12,000 3.0% 15 7,599 63.3%

12,000 3.0% 20 6,526 54.4%

12,000 3.0% 25 5,604 46.7%

12,000 3.0% 30 4,812 40.1%

Source: Calculated by author.


families with limited assets. To many, SSI payments supplement retirement or

disability benefits under OASDI. SSI is financed from the general fund of the

U.S. Treasury.

The Social Security Amendments of 1972 established automatic cost-of-living

adjustments for OASDI and SSI benefits effective 1975. Before that, Congress

increased OASDI benefits by special legislation as deemed necessary.

OASDI and SSI benefits are indexed to the Consumer Price Index for Urban

Wage Earners and Clerical Workers (CPI-W), one of the several indexes published

by the Bureau of Labor Statistics. Specifically, the benefit adjustment is deter-

mined by comparing the price levels of a “market basket” of goods and services

for the third quarter ( July, August and September) of each year with the same

period in the previous year. Initially, benefits would increase automatically only

if the CPI-W increased by 3% or more. The “3% trigger” was eliminated in 1986

(Social Security Administration 2013).

During the 1970s and early 1980s, price

inflation was high and, thus, so were the

Social Security cost-of-living adjustments.

For example, in 1975 the COLA was 8.0%

and in 1980 14.3%, an all-time high. They

then declined and, as indicated in Table 3,

have been quite low since 2000. In 2010

and 2011, there was no increase at all due

to the Great Recession.

The COLA effective for January 2009

was 5.8% based on the CPI-W for the

third quarter of 2008 compared to the

same period in 2007. However, the Great

Recession hit in the fourth quarter of

2008 and continued into the first quarter

of 2009. A recession is defined as two

consecutive quarters in which gross

domestic product (GDP) declines. In 2009,

OASDI and SSI recipients received a 5.8%

benefit increase to compensate for price

inflation that had disappeared.

In 2010 and 2011 price inflation was

negative. When that happens (this was

the only case), benefits are not reduced.

They remain unchanged until the CPI-W

surpasses its former high, as it did in 2012.

Since then, the COLA has been low: 1.7%

in 2013; 1.5% in 2014; and 1.7% in 2015.

TABLE 3 Social Security COLAs,

2000–2015.

Year COLA

2000 2.5

2001 3.5

2002 2.6

2003 1.4

2004 2.1

2005 2.7

2006 4.1

2007 3.3

2008 2.3

2009 5.8

2010 0.0

2011 0.0

2012 3.6

2014 1.5

2015 1.7

Source: Social Security Administration (Official Website). History of Automatic Cost-of-Living Adjustments.

Retrieved from www.socialsecurity.gov Feb. 2, 2015.


The automatic CPI-W COLA is also used to adjust the Social Security wage

base, the cap on the amount of wages and self-employment income subject to

OASDI payroll taxes, and to adjust the retirement earnings test for those recipients

between 62 and the full retirement age (now 66), who continue to work. The U.S.

government uses the CPI-W COLA for its own pension plans.

PRIVATE-SECTOR PENSION PLANSThe most dramatic fact about private-sector pension plans is the massive shift

from DB plans to defined contribution (DC) plans, depicted in Table 4. DC plans

almost always provide retiring or terminating participants with a lump sum

distribution. There is no need for a COLA in a DC plan. In theory, the retiree

can protect the lump sum from inflation by prudent investment.

Table 4 tells only part of the story. Many nominal DB plans are hybrid cash

balance and pension equity plans that function more like DC plans and do

not need COLAs.

Private-sector automatic COLAs have received little attention in recent years.

A dated study found that the proportion of full-time workers participating in

“medium and large” pension plans (more than 100 participants) with any kind

of post-retirement benefit

adjustment declined dramat-

ically from 54% in 1983 to

10% in 1993. Moreover, the

proportion that had an

automatic COLA during that

period remained in the 3% to

5% range. In 1992, only 4%

of workers in both “medium

and large” establishments

and in “small” private-sector

establishments (less than 100

participants) had automatic

COLAs (Weinstein 1997).

Automatic COLAs were

never widespread in private-

sector pension plans. During

periods of high inf la-

tion, such as in the 1980s,

many sponsors voluntarily

improved retirement bene-

fits on an ad hoc basis. But

overall, they shied away

from automatic COLAs. One

TABLE 4 The Private Sector Shift from Single-

Employer Defined Benefit to Defined Contribution

Pension Plans

Basic Benefit

DEFINED BENEFIT PLANS

DEFINED CONTRIBUTION

PLANS

Year PlansActive

ParticipantsPlans

Active Participants

1980 145.8 23.7 340.8 18.4

1985 167.9 23.3 461.2 32.2

1990 111.3 21.2 598.2 33.9

1995 67.7 18.9 622.6 40.4

2000 47.0 17.3 685.6 48.9

2005 46.1 15.7 630.1 59.3

2010 45.1 12.8 653.1 70.0

2011 43.8 12.3 637.1 70.3

2012 42.2 11.8 637.1 71.9

Source: U.S. Department of Labor, Employee Benefit Security Administration. Private Pension Plan Bulletin Historical Tables.

Version 2. Released December 2014. Tables E1 and E8. Retrieved from www.dol.gov/ebsa Feb. 6, 2015.


reason for this is that they did not want to add the inflation risk to the list of

other risks inherent in sponsoring a DB pension plan: investment, interest rate,

longevity and timing risk.

There may also have been complications associated with accounting and

funding due to the requirements of the Financial Accounting Standards Board

(FASB) and the Pension Benefit Guaranty Corp. (PBGC). The inflation risk does

not lend itself as well to risk pooling, duration spreading and probability theory

as do other pension risks. An automatic COLA would at least complicate the

calculation of the PBO (projected benefit obligation), net position (liabilities –

assets), funded ratio (assets ÷ liabilities) and, hence, the employer’s ARC (annual

required contribution). Of course, the sponsor could craft an automatic COLA to

control the “COLA risk” as is routinely done in the public sector.

PUBLIC-SECTOR PENSION PLANSThe public sector includes the U.S. government, 50 state governments and 89,004

local governments. Local governments include 19,522 municipal governments,

16,364 townships, 12,884 independent school districts and 37,203 special districts.

They sponsor 2,550 public employee retirement systems: 218 administered by

states and 2,332 by local governments (U.S. Census Bureau). These numbers do

not sum. Presumably, the missing 3,031 local governments are counties.

Public-sector pension plans are more generous than those in the private sector.

In contrast to the private sector, most public-sector employees are required to

contribute to their pension plans. Public employees typically remain with one

employer for a long time. When they do change employers, it often involves

staying in the same pension plan or transferring to one with reciprocity arrange-

ments. In addition, membership in public-employee unions has remained high

and those unions are active in political

fund-raising and election activities.

They often also exert influence through

membership on boards of trustees of

the public-pension funds.

Table 5 reports union membership

and the percent of employees repre-

sented in the private and public sectors

in 2014. Note how the union member-

ship and representation is especially

high at the local government level.

Public-employee union leaders routinely

attend county and city council meet-

ings and often have knowledge and

opinions that allow them to influence

outcomes on matters of importance to

TABLE 5 Union Membership and

Employees Represented in 2014

Percent Members

Percent Represented

Private Sector

6.6 7.4

Public Sector

35.7 39.2

Federal 27.5 31.6

State 29.8 32.8

Local 41.9 45.5

Source: U.S. Bureau of Labor Statistics, News Release dated Jan. 23, 2015. Union Membership 2014. Table 3.


their members, such as pensions. Traditional defined benefit pension plans with

COLAs have fared well in the public sector.

It is much harder to generalize about pensions in the public sector. Private-sector

DB pension plans are under one body of federal law: the Employee Retirement

Income Security Act of 1974 (ERISA) as amended. Public-sector pension plans are

largely governed by the legislation of the 50 states, many of which have multiple

laws that apply to different categories of employers or employees. Arrangements

vary significantly among jurisdictions. In addition, many state plans provide

pension services to county, city and other local governments. Some county plans

provide pension service to some of the local governments within the county.

FEDERAL GOVERNMENTThe United States government maintains a number of pension plans including

the Civil Service Retirement System (CSRS) and the Federal Employees Retirement

System (FERS). The Social Security Amendments of 1983 required that federal

employees hired after Jan. 1, 1984, be covered by Social Security and the newly

established FERS. Existing employees were allowed to remain in the CSRS or shift

to the FERS with Social Security. Given that more 30 years have elapsed, the vast

majority of federal employees are now in FERS.

Under CSRS and FERS, the COLA takes effect on Dec. 1 of each year and appears

on the January pension check. As is Social Security, it is based on the CPI-W

for the third quarter of the current year compared with the same period in the

previous year. Adjustments are not provided until age 62, other than for disability

and survivor benefits and for other special-provision retirees (public safety).

If the increase in the cost of living is 2% or less, the COLA is equal to the CPI-W

increase. If it is between 2% and 3%, the COLA is 2%. If it is more than 3%, it is

1% less than the CPI-W increase.

For 2013, 2014 and 2015, the COLA for both CSRS and FERS was the same at

1.7%, 1.5% and 1.7%. Before that, they differed with the CSRS rate being higher

than that of the FERS rate (federal retirement).

STATE AND LOCAL GOVERNMENTSThe 50 states administer 218 retirement systems. The 89,004 local governments

either operate their own pension plan or contract with the state or county for

pension coverage, thus creating a complex mosaic that makes generalization

difficult. In regard to COLAs, it is even more complex. In at least one state

(California), local governments contracting with a state plan may elect to pay for

more generous COLA provisions.

The Wisconsin Legislative Council has tracked approximately 85 major public

employee pension systems in even-numbered years since 1982. Table 6 on page

53 exhibits data on the types of COLA provisions in those plans for 1982, 1992,

2002 and 2012 (the most recent year for which data are available). Note how the


two automatic COLA categories (Adjustments Limited to CPI and Automatic Percent

Increase) grew significantly from 1982 to 2002 and then contracted in 2012. The

contraction reflects the extensive amount of public-pension reform in recent years.

Rather than examine aggregates, the author will look at the COLA provi-

sions of the three large statewide public-pension plans in California with which

he is familiar.

CalPERSThe California Public Employees’ Retirement System (CalPERS) has 1.7 million

members, 587,959 of whom are annuitants (retirees and beneficiaries). CalPERS

has three categories of employers and members: “state” including the massive

California State University (CSU) system; “school” classified employees (secretaries,

custodians, etc.); and “public agencies” (local governments). As of February 2015,

there were 1,513 school districts with 442,088 members and 1,580 contracting

public agencies with 345,279 members under contract with CalPERS.

The COLA provision for state and CSU members (including faculty) is limited

to the actual rate of inflation up to a 2% maximum. There is a commonly held

misconception that the 2% maximum is simply applied to the gross pension each

year. It is a bit more complicated.

There is no COLA in the first year of retirement. It starts in the second year and

is then calculated annually and applied to the May 1 pension benefit thereafter.

CalPERS calculates the compounded 2% maximum each year as follows: (1.02 X

1.02) -1 = .04; (1.02 X 1.04) -1 = .061; (1.02 X 1.061) -1 = .082, etc. (rounded). The

result is then compared to the actual rate of inflation as measured by the Annual

Average of the All Urban Consumer Price Index (CPI-U) based on 1967 (1967 =

100). Contracting public agencies may elect to pay for a 3%, 4% or 5% maximum

COLA calculated in the same way.

TABLE 6 Types of COLA Provisions, Selected Years 1982–2012

1982 1992 2002 2012

Number Percent Number Percent Number Percent Number Percent

Adjustments Limited to CPI

34 42.5 43 50.6 39 45.9 30 34.5

Automatic Percentage Increase

10 12.5 13 15.3 22 25.9 24 27.6

Investment Surplus 3 3.8 4 4.7 3 3.5 5 5.7

Ad Hoc or No Provision 33 41.3 25 29.4 21 24.7 28 32.2

Total Plans in Survey 80 85 85 87

Source: Wisconsin Legislative Council. 1982, 1992, 2002 and 2012 Comparative Study of Major Public Employee Retirement Systems.


CalPERS provides another level of inflation protection called the Purchasing

Power Protection Allowance (PPPA). For state and school members, the PPPA

ensures that the purchasing power of the pension benefit will not fall below 75%

of its initial value. That would be when the hypothetical $12,000 per year pension

benefit used above would have been reduced to $9,000. At an inflation rate of

1.5% per year, the PPPA would kick in about 19 years. At a 3.0% rate of inflation,

it would take only about 9.5 years (author’s calculations).

For contracting public agencies, the guarantee is generally 80%. For a $12,000

annual pension, the trigger would be $9,600. At a 1.5% inflation rate, the PPPA

would take effect in 14.8 years and at 3.0% in 7.3 years. However, those public

agencies that have elected a more generous COLA percentage, it would kick in

later or perhaps never (CalPERS).

CalSTRSThe California State Teachers’ Retirement System (CalSTRS) covers certificated

teachers and community-college instructors (K–14). In 2014, it had a 603,702 active

and inactive members (420,887 active and 182,815 inactive) and 275,667 retirees

and beneficiaries.

The CalSTRS COLA provision is 2% of the basic allowance per year. Adjustments

are not tied to changes in the CPI and are reportedly not compounded. However,

if 2% is added to the base each year, there is some compounding ($12,000 X 1.02

= $12, 240; X 1.02 = $12,485, etc.).

CalSTRS also has a purchasing power protection arrangement that is currently

set at 85% of the initial benefit. This generous inflation protection is appropriate

because teachers in California (and 14 other states) are not covered by Social

Security with its 100% COLA (CalSTRS). Even if a teacher has a spouse who does

participate in OASDI and/or if he/she is entitled to a retirement benefit in his/her

own name, that benefit is greatly reduced by Social Security’s Windfall Elimination

Provision and the Government Pension Offset (Kilgour 2009).

UCRP The University of California Retirement Plan (UCRP) covers faculty and staff

employees at the 10 UC campuses, the Hastings College of Law and other UC

affiliates. In 2014, the UCRP had 218,921 total members: 120,407 active partici-

pants, 21,892 retirees and beneficiaries, and 35,027 separated (inactive) vested

participants (UCRP 2014).

The UCRP COLA provision is 100% of the CPI increase up to 2% and 75% of

any increase over 4% to a maximum of 6%. The CPI used is the average for the

Los Angeles and San Francisco metropolitan areas (University of California 2015).

The UCRP does not seem to have an automatic inflation protection feature, as

do CalPERS and CalSTRS. However, with its more generous COLA provision (up

to 6%), it may not need one.


CONCLUSION In the absence of an automatic COLA (or timely ad hoc benefit increases), the

real value of a pension benefit depreciates over time due to price inflation. If

the retiree or beneficiary is blessed with great longevity, the benefit will be a

fraction of what it once was. In the absence of family or other support, the result

will be a lot of elder poverty. Fortunately, the OASDI and SSI are fully inflation

protected. Most public employees are largely protected, including the 30% of the

public-sector employees not covered by Social Security (mainly police, fire and,

in 15 states, teachers). The private sector is another matter.

COLAs are virtually nonexistent in private-sector pension plans. Single-employer

and multiemployer pension benefits, plus those paid by the Pension Benefit

Guaranty Corp. to participants of trusteed plans, atrophy with time. This further

dramatizes the retirement income disparity between the private and public sectors

and will add to the pressure to curtail public-employee pensions.

AUTHOR

John G. Kilgour, Ph.D. ( [email protected]) is a professor emeritus in the Department of Management at California State University, East Bay. He holds an MILR and Ph.D. in Industrial and Labor Relations from Cornell University. Kilgour has published numerous articles on compensation and benefits topics. He is a long-time member of WorldatWork and a frequent contributor to the WorldatWork Journal.

REFERENCES

CalPERS. California Public Employees’ Retirement System website. Viewed: Feb. 8, 2015. www.calpers.ca.gov.

CalSTRS. California Teachers’ Retirement System website. Viewed: Feb. 8, 2015. www.calstrs.com.

Federal Retirement. “Cost of Living Adjustments (COLA).” Viewed: Feb. 8, 2015. www.federalretirement.net/cola.htm.

Kilgour, John G. 2009. “Social Security in the Public Sector: The Windfall Elimination Provision and the Government Pension Offset.” Compensation and Benefits Review, September/October, 34–42.

Social Security Administration. 2013. “Cost of Living Adjustment.” Viewed: Feb. 2, 2105. www.socialsecurity.gov.

University of California 2015. “A Complete Guide to Your University of California Retirement Benefits.” p. 15. Viewed: Feb. 8, 2015. http://ucnet.universityofcalifornia.edu.

UCRP. University of California Retirement Plan (UCRP). 2014. “Summary of Plan Data for 2014.” Viewed: Feb. 9, 2015. http://ucnet.universityofcalifornia.edu.

U.S. Census Bureau. Viewed: Feb. 7, 2015. http://factfinders.census.gov.

Weinstein, Harriet. 1997. “Post-retirement Pension Increases.” Compensation and Working Conditions. Viewed: Feb. 4, 2015. www.bls.gov. (This study was based on “establishment data.” It excludes agriculture and the federal government and includes only full-time employees, not retirees.)

Published Research in Total RewardsA review of total rewards, compensation, benefits and HR-management research reports.

(Compiled by the editors from the WorldatWork Newsline column at www.worldatwork.org.)


Organizational Culture, Employer Brand Are Top Competitive Advantages in RecruitingCompanies that focus on offering higher salaries or promoting quickly alone may not be as competitive when recruiting talent, according to the results of an executive survey from Futurestep, a Korn Ferry company. 61% of respondents said organizational culture is the most important recruiting advantage for global organizations, followed by a leading employer brand at 26%.

“Focusing on culture and how that brand is represented in the marketplace has a critical impact on attracting and retaining the talent that will drive business success,” said Neil Griffiths, Futurestep global practice leader, talent communications and employer brand. “The survey results indicate that employers need to think more broadly about what attracts top talent to their organization.”

The survey also found that as the hunt for talent gets more difficult (61% of respondents said it’s harder to find qualified candidates than it was a year ago), there is a strong need for employers to closely evaluate and understand what attracts and motivates the ideal candidates for their company. While salary continues to be the “top negotiation sticking point” at 51%, “flexibility” comes in second at 33%, followed by “title” at 11% and “vacation” at 4%.

“The challenge is for organizations to listen to what employees want from their workplace, such as flexibility and, when possible, find a practical and effective way of delivering,” Griffiths said.

“In today’s digital, social and mobile world, it’s easier than ever to enable employees to work when, where and how they want to, as long as they remain productive.” There were more than 1,000 responses to the global survey, which was conducted in May.

Total Rewards and Employee Well-Being PracticesThis WorldatWork survey was conducted to identify traditional wellness plans and new trends in employee well-being. The objective was to gauge how many programs and initiatives organiza-tions offer. The survey also focused on how those offerings are expanding to include a more integrated well-being approach beyond one that is related solely to physical health.

Employers continue to depend on health and wellness initiatives to curb health-care costs and foster a successful and productive workforce. Ninety-six percent of organizations support well-being components and nearly three-quarters of organizations are increasing or considerably increasing their well-being offerings in the next two years. There were more than 400 responses to the survey, which was conducted in January.

Third Quarter 2015



Promotional GuidelinesWhile many aspects of promotional practices are largely unchanged from WorldatWork’s past two surveys on this topic in 2012 and 2010, the percentage of employees receiving a promotion has increased by two full points since 2010.

Respondents report that an average of 9% of their employees received a promotion during the past fiscal year.

This is a significant improvement from the 7% reported in 2010 and is further evidence that organizations are relaxing the purse strings in their pay budgets.

There has been little change however in the average amount of increase that employees are receiving. In determining promotional increase amounts, organizations continue to consider salary range position and the pay levels of similarly situated employees as primary determinants. Less than half (42%) budget separately for promotional activity. The prevalence of this practice appears to be falling as more organizations are either budgeting for promotions in their merit budget or simply funding with salary or vacancy savings. There were nearly 500 responses to the survey, which was conducted in December.

Trends in Employee RecognitionRecognition programs remain a mainstay in organizations, with a WorldatWork Survey finding 89% of organizations having programs in place. Sixty seven percent of organizations offer between three and six different programs, with 4.6 as the average number of programs. The average number of programs is back to the 2011 level after dipping to 3.9 in 2013. The prevalence of programs has experienced an interesting shift in the last few iterations of this survey, with a growing number of organizations relying on recognition programs that drive organizational results. However, the staple recognition program, length of service, still holds the top spot, with 87% of organizations offering this type of program. It has been at the top since the inception of this survey.

It is also interesting to note that in both 2011 and 2013 surveys, when asked to write in other programs that are offered in organizations, participants responded with “wellness programs.” With the increase in wellness programs and the continuing increase in programs to motivate specific behavior, WorldatWork speculated whether wellness programs and programs to moti-vate specific behavior were intermingled. Therefore, in this survey they were listed as separate programs. The results for “Programs that improve biometric indices through wellness initiatives” debuts as sixth on the list, with 32% of organizations offering these programs and the highest average number of employees recognized in the past 12 months (68%). There were nearly 500 responses to the survey, which was conducted in March.

Published Research in Total RewardsA review of total rewards, compensation, benefits and HR-management research reports.

(Compiled by the editors from the WorldatWork Newsline column at www.worldatwork.org.)

Documents

06 - WorldatWork · 2018-04-02 · Karen Ickes, CBP Director Sara McAuley, CCP, WLCP Director Alan Gardner WorldatWork () is a global human resources asso-ciation focused on compensation,