Short-Term Incentives: Determining Who Is Eligible

HR & Safety

The following article first appeared in the Insights section of Mercer’s website. It is reposted here with permission.

Variable pay is an important part of a comprehensive rewards and compensation strategy for attracting, engaging, and retaining employees.

Determining which employees should participate in a plan design requires a clear understanding of the business’ performance objectives and which jobs and roles will deliver expected results.

On the practical side, implementing an STI plan allows organizations to convert fixed compensation costs into variable ones.

As the earned payments under the plan are contingent on performance, STI plans give companies more financial flexibility.

Additionally, STI plan designs allow organizations to directly involve employees in both the risks and rewards incurred by the company’s performance, motivating employees to improve their individual performance and better align their actions and priorities with those of the organization.

Identifying Eligible Employee Groups

To determine which employees should participate in an STI plan design, identify which employee segments represent and may influence your plan design’s use cases.

For example, one may categorize employees by the type of work they do, their job title, and how their activities contribute directly to results that create value for the organization.

Most organizations will have executives, managers, and other professional positions that are included for both financial flexibility and behavior reasons. Some will be paid hourly, others by salary or commission.

Other relevant considerations include:

  • Job levels
  • Job families
  • Specific or targeted jobs

The key to refining the identification and selection processes is to match each group to targeted use cases and leadership-defined performance objectives and to prioritize what may be measured and influenced by the participants.

For each group, consider whether the incentive plan and the targeted employee segment can:

  • Impact and influence expected performance measures as defined by shareholders, financial and operational needs, and customer objectives for the organization.
  • Align their performance with important business metrics to be rewarded according to the organization’s performance.
  • Prioritize the right work activities and outcomes for success.

Affordability, Implementation

After eligible participants have been identified, the next step is to assess the affordability of including different employee groups in an STI plan.

This involves a detailed analysis to ensure alignment with the plan’s design and a determination of financial affordability.

By following these steps, organizations can design an effective and financially viable STI plan that aligns employee performance with the company’s strategic goals.

1. Establish variable pay opportunities. Each employee’s variable pay is determined using market pay levels, targeted affordability by participating jobs, and alignment with the existing STI incentive opportunities of comparable jobs.

As a starting source of information, compensation surveys provide target values for expected performance levels and ensure competitive and equitable pay opportunities. Mercer provides multiple ways to examine STI targets by job and/or by pay levels.

2. Set performance metrics and goals. Establish performance metrics and related goals. Selected metrics are calibrated to achieve the standards of excellence envisioned by the organization’s leadership. This alignment ensures employees strive to achieve strategic objectives.

3. Define plan funding. Whether self-funded, budgeted, or a hybrid of budgeted and self-funded, the funding strategy should be based on the established performance metrics and goals.

This step is critical in determining the inclusion of roles in your STI plan. It involves calculating the relationship between performance and payout, allowing the organization to compare different cost scenarios inclusive of roles’ participation.

4. Customize performance-to-payout curves. In concert with the earlier steps, customizing the performance-to-payout curves helps to determine affordability.

This process step involves building sensitivity models that clearly assess and evaluate the expected investments, associated risks, and impact on financial results by including the new jobs in the plan design.

Other Eligibility Considerations

Two other considerations are relevant to employee STI eligibility.

Establishing rules for participation. After defining the plan structure, which includes the newly included jobs and incentive target opportunities, the next step is to establish and communicate participation rules in the plan document.

Transparent documentation should explain who is eligible for the plan, how calculations occur, and what specific guidelines are needed for understanding participation and payouts.

Clear communication ensures employees understand the qualification and payout processes.

Defining participation. Clearly define rules to set compensation expectations. Typical considerations on this point include:

  • Employment status. Factors like hire date, length of service, and full-time or part-time status should align with organizational philosophies. Active employment status is one consideration, but details like permanent or temporary status should also be defined.
  • Performance status. Include performance standards to adjust payouts based on conduct and results. Plans typically specify that only those meeting performance standards are eligible for full payouts, with modifiers for varying levels of performance.
  • Participation in other plans. Ensure employees participate in only one variable pay plan for consistency in performance metrics. This alignment prevents conflicting incentives and focuses efforts on achieving unified organizational goals.
  • Termination/retirement/health. Define eligibility for those who leave or retire before the performance period ends. Typically, employees who lose active status before the performance period concludes are not eligible for a payout. However, exceptions may exist for retirees with long, successful careers, depending on organizational policies.

By addressing these considerations, organizations can create clear and effective STI plans that align with their strategic goals and ensure transparent communication with employees.

Properly defining and communicating these elements enhances trust and ensures employees understand the criteria and processes involved in their compensation plans.

About the author: Julian Pawlowski is a senior principal at Mercer, with over 20 years of consulting experience focused on rewards and compensation strategies.


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