Incentive Pay Plans Too Complex and Too Risky

Many incentive-based pay packages have become too complex and too risky and executives would be happier with a smaller salary paid in a less volatile form, according to research from PwC and the London School of Economics and Political Science (LSE).

The ‘Psychology of Incentives’ study of over 1100 executives found that most are not motivated by deferred bonuses, with the majority valuing a £100 of bonus in a typical deferral plan at only half its value (£50). The perceived value fell to £33 for younger employees (those under the age of 39).

Tom Gosling, head of PwC’s reward practice said: ‘It is difficult to see how a form of pay that has such low perceived value can have a significant influence on behaviour. A very real consequence is that as deferral increases, we would expect there to be pressure to increase pay levels.’

The research also indicated that the more complicated the reward, the more likely participants were to choose the smaller but more certain reward. Two thirds more respondents (51% versus 27%) favoured a cash plan based on profit targets that they understand over a more ambiguous share plan based on their share price relative to other companies.

The study highlighted executives’ concerns about the perceived fairness of pay, with 51% reporting that getting paid more than their peers was more important than getting paid more in absolute terms (27%). PwC warns that the drive for greater disclosure of pay may result in more opportunities for cross-comparisons and consequent pay ratcheting.

Gosling said: ‘Executives are really focussed on the fairness of pay outcomes. Complex and volatile plans lead to windfalls that executives don’t thank companies for, and periods of unfair underpayment that are highly demotivating. This creates a “lose-lose” situation for executives and shareholders. Simpler, more stable plans, with a greater role for remuneration committee discretion, are likely to be more effective at motivating executives and will also cost companies less.’