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With Money Tight, Who Should Get Pay Hikes?

Only the cream of your crop, one expert advises. Also to be decided: how many to reward, and how truthful to be.

January 2009
by David McCann/CFO Magazine

If your company historically has budgeted a total annual salary increase of about, say, four percent, in this gritty year the payout typically might be reduced to one or two percent. The question, of course, becomes how the meager pool should be allocated.

It is a big issue for companies this year, the first following a roughly 10-year period in which the average salary increase has hovered close to 3.6 percent, according to Sibson Consulting. It will put to the test the closer partnerships between finance and human resources departments that have evolved over that same time span, during which many companies have accepted that base pay hikes should be based on the labor market rather than the old barometers — cost of living and company performance.

In such a partnership, CFOs and their staffs bring to the table intelligence about where expenses should be set relative to revenue, and HR brings job-market knowledge. With so many companies' revenue languishing this year, the CFOs' perspective may reassert its dominance.

Sibson released a missive today urging companies not to succumb to the temptation to spread a one or two percent total compensation raise evenly across the employee base. The most important effect from doing that will be to irritate the high performers who create value and are most desired in the job market.

"Many managers find it difficult to tell people that they're getting nothing, or reason that they won't be able to get anybody jazzed about getting three percent instead of two percent, so they give everybody two percent," said Jim Kochanski, a senior vice president for Sibson. "What they ought to be doing is not giving any increase to anyone who is not a high performer or underpaid compared to the market for their role. You don't want to give the same increase to the person who is a low performer and/or highly paid as to the person who is a high performer and/or low-paid."

A significant issue here is defining "high performer." It is, of course, relatively easy to identify the very highest performers, but at some point as the bar moves down toward the middle performers, there will be a question as to where to draw the line on pay raises. To Kochinski, the line should be based on company performance. In other words, where a company that's doing very well might justify calling 30 to 40 percent of its workers high performers, that number should go down when results are in a downturn. But historically, he added, only about 10 percent of companies have factored this in when determining salary increases.

Further, Kochanski told CFO.com, companies should not necessarily be honest with employees about the size of the raise pool. If the budget is two percent, advertise that it is 1 percent so as to carve out an amount for high performers. "Otherwise you've got everybody sitting there thinking they're going to be angry if they don't get at least two percent," he said.

Of course, for some companies these days, reining in salary increases accompanies the twin strategy of reducing head count. That can be problematic, because it often requires employees to work harder without reward.

Only a relative handful of companies have actually reduced salaries in order to avoid layoffs, and Kochanski said that while it's very likely more will take that route as the recession progresses, overall average wages will not start to come down until companies resume hiring but at lower rates of pay.

If pay is going to be cut, a common mistake is to cut the wrong kind of pay, he added. The seemingly easy decision not to pay any bonuses will in most cases affect only current-year expenses, whereas reducing a salary becomes an ongoing fixed-cost reduction.

This article has been excerpted from CFO magazine.

David McCann is a Web News Editor at CFO.com.

© CFO Publishing Corporation 2008-2009. All rights reserved.