Using a strong compensation philosophy, best practices and crisp communication, organizations can better manage the impact of external shocks and differentiate themselves in a volatile market.
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Author: Chris Crawford

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In today's volatile market, organizations are grappling with unprecedented challenges at nearly every level — including challenges impacting one of the largest employer investments: compensation.

From geopolitical risks to labor market shifts, inflation and stock market volatility, employers are experiencing significant compensation ambiguity.

Leaders are finding these rapid and unpredictable swings in pay structures and outcomes difficult to manage. While 20% stock market selloffs can feel unsettling, best practices can help organizations regain confidence in delivering the best outcomes for compensation dollars spent.

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By integrating compensation decisions with long-term business goals, employers can navigate external shocks, like market fluctuations, with more confidence and resilience.

Establish a solid compensation philosophy

At the heart of effective compensation management lies a clearly defined philosophy. However, in our consulting experience, fewer than 5% of companies can point to a documented compensation philosophy that aligns with company objectives and the external market.
A strong compensation philosophy not only anchors decision-making during uncertain times, but also emphasizes a variable pay structure over fixed compensation. Variable pay weathers economic volatility by rewarding performance based on company success rather than tying compensation solely to base salaries.

Broaden incentive plan targets

Given the unpredictability of market conditions, employers must adopt flexible incentive plans that consider lack of clarity. Traditional performance metrics tied to absolute financial goals may not be sufficient during volatile periods.

Companies could consider broadening performance ranges between threshold, target and stretch goals for both short and long-term measures. These "wider shoulders" help employers maintain pay-for-performance philosophies and mitigate the impact of unplanned negative or positive swings in performance.

Shorten performance metric periods

Due to the lack of clarity in the current volatile market, company leaders may consider shortening annual performance periods to two six-month periods and/or shortening long-term incentive performance to three one-year periods. Shorter performance periods reduce the pressure to meet exact metric hurdles, thereby revealing true performance relative to the operating environment.

Use relative performance metrics

Organizations increasingly use relative performance measures in their short and long-term incentive plans to identify the type of performance management that teams are achieving in volatile environments. Even if an employer is using absolute measures in a current measurement cycle, leaders may opt to use those measures after the fact to make relative performance discretionary decisions.

Balance multiple performance metrics

Incentive plans always should focus on the core drivers of the business. While operating profit and revenue are key drivers, compensation committees may consider other metrics. Customer satisfaction, employee engagement and safety as metrics all support the long-term health of the company and can help mitigate compensation volatility. When adding metrics, ensure the weightings or relative importance of each metric are meaningful; for example, 20%+ of compensation rests on achieving customer satisfaction goals.

Use long-term incentives effectively

Long-term incentive compensation has seen considerable growth in prevalence and value opportunity over the past 10 years. The weighting between performance-vesting and time-vesting elements has shifted toward retention-orientation or time-vested measures in compensating positions below the CEO. Given challenges in establishing reliable long-term performance and the competition for executive talent, organizations might consider either:

  • More long-term compensation overall
  • Adjusting the balance between performance- and time-vested elements to enhance the value proposition of awards.

Communicate, communicate

When communicating compensation practices, performance updates or payouts, compensation leaders should clearly outline their decision-making process and rationale early and often. Linking this communication back to a thoughtful compensation philosophy can reinforce with employees the intentional and even variable nature of a market-based compensation plan.

Implement a proactive compensation calendar

Many organizations react only to end-of-year events. However, a well-thought-out compensation calendar helps mitigate the need for last-minute negotiations or adjustments.

The compensation calendar should include dates set for base salary increases, incentive plan updates, company performance snapshots, economic condition reviews, labor market assessments and more. By anticipating these key decisions throughout the year, companies can avoid a reactive stance by using thoughtful decision-making throughout the year.

Stand out as an exceptional performer during stressful times

Developing and managing compensation programs during periods of uncertainty — whether driven by economic instability or shifting labor markets — requires a strategic, thoughtful approach. By establishing a strong compensation philosophy, implementing best practices and communicating crisply, companies become more capable of managing the impact of external shocks. Further, proactive employers can separate themselves as standout performers while delivering the best return for the compensation dollar.

Gallagher can help

Gallagher uses data, technology and trust to design and evaluate compensation models to fit your strategic goals. Our team can work with your compensation committee to proactively analyze market shifts and determine how the incentive model may need to evolve to align with changing business dynamics.

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Consulting and insurance brokerage services to be provided by Gallagher Benefit Services, Inc. and/or its affiliate Gallagher Benefit Services (Canada) Group Inc. Gallagher Benefit Services, Inc. is a licensed insurance agency that does business in California as "Gallagher Benefit Services of California Insurance Services" and in Massachusetts as "Gallagher Benefit Insurance Services." Neither Arthur J. Gallagher & Co., nor its affiliates provide accounting, legal or tax advice.