Most firms end up with pay plans that slots jobs into classes or grades, each with its own vertical pay rate range. For example, the US government’s pay plan consists of 18 main grades (GS -1 to GS – 18), each with its own pay range. For an employee whose job falls in one of these grades, the pay range for that grade dictates his or her minimum and maximum salary.
That is why some firms are broad banding their pay plans. Broad banding means collapsing salary grades and ranges into just a few wide levels or brands, each of which contains a relatively wide range of jobs and salary levels. In this case the company’s previous six grades are consolidated into two broad bands.
A company may create broad bands for all its jobs, or for specific groups such as managers or professionals. The pay rate range of each broad band is relatively large, since it ranges from then minimum pay of the lowest grade the firm merged into the broad band up to the maximum pay of the highest merged grade. Thus, for example, instead of having 10 salary grades, each of which contains a salary range of $15,000 the firm might collapse the 10 grades into three broad bands, each with a set of jobs such that the difference between the lowest and highest paid jobs might be $40,000 or more. For the jobs that fall in this broad band, there is therefore a much wider range of pay rates. You can move employees from job to job within the broad band more easily, without worrying about the employees moving outside the relatively narrow rate associated with a traditional narrow pay grade. Broad banding therefore breeds flexibility.
In the United States, compensation is defined as the sum of base salary, short term incentives, and long-term incentives.
For a CEO, a typical mix is 15% base salary, 15% short-term incentives, and 70% long-term incentives. For direct reports to the CEO, a typical pay mix is 25% base salary, 15% short-term incentives, and 60% long-term incentives. In a research of 800 plus US companies across thirteen major industries, the prevalence of CEO long–term incentives ranged from 80% to 95%. It ranged from 88% to 100% for direct reports to the CEO on sampling basis.
Stock options remain the most prevalent vehicle; however, the prevalence of other vehicles has altered the environment. In research of a sample US Fortune 500 companies, a majority of companies are now using more than one long-term incentive alternative.
As a result of a changing corporate governance and business environment, more than half the companies now use performance shares, including industry leaders such as Chevron, IBM and Pfizer among others.
Mercer recently conducted a survey to understand the current HR challenges facing companies. Our research indicates that companies have raised issues of retention, remaining competitive in the market, a growing pay for performance culture, attraction of talent and improved shareholder ‘optics’ or scrutiny as their major business challenges.
73% of companies are choosing to act on long-term incentives, including modifying or adding long-term vehicles, changing performance measures or goal setting practices, and increasing grant levels. They are doing so in an environment characterized by new disclosure requirements and increased shareholder activism.
In India, long-term incentives are still in their nascent phase having first been introduced in the late 1990s. As a result, pay mix is weighted more heavily to fixed pay and short-term incentives. However, trends towards long-term incentives are now increasingly apparent.
Last year, more than 50% of the companies on the Bombay Stock Exchange Index had some kind of long-term incentive in place. Mercer expects this trend to become even stronger and prevalence to approach US levels in future years.
Plans in India usually target employees at the middle management level and above, and tend to pay out over a period of three years to four years.
Stock options are the primary vehicle with an increasing interest in other alternatives in India. We foresee that companies will start implementing more performance cash and share plans, and that in India too, over the long term, the use of stock options may actually decline.
The decline would be driven by the need for risk mitigation given the volatility of the Indian market, a desire to increase line of sight (ability of participants to influence results), a goal of incorporating financial and operating metrics into the plan, a need to further manage dilution, and anticipated changes in accounting standards.
Restricted stock will be increasingly considered, particularly below senior management where contributions are more indirect and retention is critical.