Page 388 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

374 The Complete Guide to Executive Compensation

accomplishments. Some try to rationalize having it both ways (i.e., cutting back when outside
events would generate too much bonus, but identifying with shareholders when results are
negated by outside events). In such situations, it could be said that the decision makers are
consistent in their inconsistency (i.e., they keep bonus amounts down). For many, a more
rational approach is to consider the impact of extraordinary items, within FASB rules, in
determining the bonus fund. Clearly, if managers are unprepared or unwilling to make
adjustments, they place an unrealistic burden on the efficacy of the bonus formula.
Conversely, they must resist pressure to make adjustments when bonuses are legitimately low
due to less than optimal performance without outside factors.
Identify Divisional Goals. In order to establish a quantitative reference, the first step is to
identify the division’s goals—both quantitative and qualitative. Quantitative goals are most
directly applicable to marketing and production operations, whereas qualitative goals are
more compatible with the staff functions of legal, finance, and personnel. Actually, however,
there is crossover; the quantitative and qualitative goals are present in all functions, although
admittedly to different degrees. Quantitative goals are measured by “how much”; qualitative
goals by “how well.” (Chapter 2 includes a review of performance measurements.)
Each division’s goals are listed under the two categories, quantitative and qualitative.
Before proceeding any further, there must be an understanding between division manager
and company president concerning the value of attaining those goals. Many corporations
bypass this step and it is here that they can get into real trouble. One division manager may
be the optimistic type, setting very difficult objectives within an almost-impossible-to-meet
timetable; another may know how to play the game, setting goals that, although impressively
stated and possibly many in number, are rather easy to attain. The president has two alterna-
tive: either readjust all goals to a reasonable level or, following the concept of mutual agree-
ment, leave the goals unchanged but readjust the normal fund for each division up or down
in relation to the difficulty of its objectives.
One of the more difficult tasks is to allocate divisional funds from a short-term incentive
plan. In spite of all the formulas developed (including performance relative to others in the
industry), a subjective judgment must be made about the degree of difficulty that tempered
performance outcome. However hard it may be to make that assessment, the likelihood of
inequity in the treatment of two divisions is much less than if no tempering judgment is applied.
Furthermore, it is important that divisions understand that divisional targets have equal
stretch and degree of difficulty even though the targets are different. Otherwise, very
profitable divisions, even though falling below their target, will expect a large payout because
their absolute level of achievement exceeds other divisions.
Having weighted the sum total of the division’s goals and objectives against a normal
fund, the next step is to relate the value of each of the objectives. The simplest technique is
to begin by assigning each objective an equal value and then adjusting plus or minus. To make
this work quantitatively, assume a total value of 100. If the division has five goals, each begins
with an arbitrary value of 20. This value is adjusted by reference of one to another, after the
ranking of the five in order of importance. There is nothing magical here. It is merely a
trial-and-error method of structuring the basis for determining the subsequent size of the
divisional fund at the end of the year.
Measure Divisional Performance. Having weighted each goal one to another, the next step
is to determine how to quantitatively measure attainment of the objective. Two philosophies