Page 232 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

218 The Complete Guide to Executive Compensation

Thus, while a company may set a merit budget of 8 percent with 5 percent inflation
assumption, it may also set an 18 percent budget with a 15 percent increase in the CPI. While
the absolute difference is identical (i.e., 3 percentage points), the relative difference has been
reduced from a 60 percent increase (i.e., 8 percent/5 percent) to a 20 percent increase (i.e.,
18 percent/15 percent). Thus, the opportunity to truly differentiate in pay levels has been
lessened.
Needless to say, this places great pressure on pay planners to devise effective pay-delivery
systems that maximize the utilization of available dollars in times of high inflation. During
inflationary periods, increased pressure tends to restrain growth in executive pay. By holding
executive pay increases to slightly below the average, a greater proportion of the remaining
exempt employees receive higher percentage increases.
Each year, the matrix has to be reexamined in terms of appropriateness. The matrix in
Table 5-26 reflects the position that a “very good” performer in the middle of the salary range
should keep pace with the increase in competitive pay in the marketplace (here assumed to
be 7 percent). The remaining matrix is expanded on the double premise that (1) those
lower in the range should move faster than those higher up and (2) increase should vary
directly with performance. After the matrix is constructed, it has to be tested under varying
structural-increase assumptions to track the rate at which different-level performers move
through the salary range.
Table 5-38 shows an example of how this type of simulation can be performed. The seven
performance ratings are expressed in numerical form (6 high and 0 low). In this illustra-
tion, a range of $71,000 to $129,000 is tested for a 6 percent annual structural increase for
10 years. The issue is how quickly a person currently at the minimum ($71,000) will progress
through the range if the structure is adjusted annually by 6 percent.
Note that performance rating of 0 drops progressively further below minimum; howev-
er, this effect is purely academic, since such an unacceptable performer would soon be termi-
nated. Rating 1 just stays even with the minimum, whereas rating 2 achieves a very limited
growth. Rating 3 does not move to the middle one-third until the seventh year, whereas rat-
ing 4 reaches this level in the fifth year, rating 5 in the fourth year, and rating 6 in the third
year. Only ratings 5 and 6 move into the upper one-third—the former after eight years and
the latter after five years.
These progressions must be examined in terms of what appears reasonable. Assuming the
norm is performance rating 3, should such an executive take seven years to move to the mid-
dle one-third (i.e., to perform in a fully satisfactory manner)? Probably not. It may be con-
cluded that for this particular level, four or five years is more logical.
Another reason salary ranges get wider as one progresses through the organization is the
recognition that it will take longer to attain a level of fully satisfactory performance. There
are four ways to improve this rate of progression: (1) lower the structural-increase percent-
age, (2) increase the merit percentage amounts, (3) narrow the range, or (4) shorten the inter-
val between increases.
Assuming the structural pay increase is a reasonable assessment of market increase, logic
dictates not to lower it. On the other hand, increasing the merit amounts sets a troublesome
precedent. A compromise strategy would allow the desirable position to be attained over sev-
eral years and, thereby, minimize significant up-down repercussions.
Narrowing the range can have a significant impact. In the earlier example, the maxi-
mum-over-minimum spread was 82 percent; by lowering this to 50 percent (and thereby