Incentive compensation plans are now par for the course in all walks of banking life. From the internal audit departments to various sales forces, incentive compensation is a primary motivational and behavioral guidance tool.
These plans can change your employees' behavior - but often in unintended ways that do not further shareholders' interests and bottom-line results.
For example, one bank implemented a retail program in which bankers and branch managers were paid for quarterly net deposit growth. The problem: Not all deposits are created equal, yet this plan treated them as such.
Overall deposits did grow, but over 70% of the new deposits were certificates of deposit. Meanwhile, checking accounts and money market balances declined, as did the stock's value.
Another bank's program rewarded lenders only for loan volume growth. The loan portfolio grew rapidly, but the lenders were not held accountable for documentation errors, rapid loan deterioration, special mention loans, etc. As a result, during the recent recession the new loans did not hold up as well as previous loans.
How to avoid these problems?
Make incentives meaningful. Incentive plans work if they make a difference in the financial environment for those who are eligible for them. Calibrate the amounts to the base annual salary of the team member to assure you do not overpay or underpay.
Make the amounts significant - a bonus opportunity of 5% or 10% will not create enough excitement to meaningfully change your staff's behavior. Since you are paying for performance, there is less downside for larger payments. If the program is correctly structured, the more you pay, the more your shareholders make.
Make it simple. Some programs are extremely complex, because they attempt to avoid the pitfalls mentioned above or aim at very specific behaviors. Even if the formula is clearly spelled out, complicated programs have a significant error rate, and any mistakes diminish a program's effectiveness.
Focus on what really matters. Is it behavior? Is it a specific balance-sheet item or product? Think through what you are trying to achieve, then build a plan around it. The more factors that enter the plan, the less focus it will provide and the more confusion your troops will experience when they try to execute it.
Don't change your mind in the middle (unless you said you might). Plans do not always work out as hoped, but they are still an important moral agreement between management and the team. If your team exceeds expectations and you are faced with bigger payments than you expected, it is almost always best to pay the bonuses and change the plan later.
My plans always included this line: "Management reserves the right to change the plan monthly." This gave me the flexibility to make adjustments.
Manage the leading indicators. Often, when a plan focuses on final numbers, it is achieved in the wrong ways. In the deposit growth example, incentives based on a final number did not produce the right behavior in the staff.
Sometimes, when changing a culture, focusing on behavior is more important than trying to improve the bottom line immediately. Achieving the right behaviors will eventually get you the results you are looking for. For example, including incentives for prospecting (number of calls, appointments, etc.) in a commercial lending program may not improve the bottom line today, but it will likely do so tomorrow.
Put the plan in context for the team. Explain the goal (we need more loans because deposits are growing faster; we need more relationships with our customers because we have too many single-service businesses or households). People are more likely to do the right thing when they know what it is, and they will also better understand how the plan is meant to work if they can put it in the appropriate context.
Acknowledge mistakes. Incentive plans, much like everything else, are subject to continual improvements. We all make mistakes, and that is OK, unless you bet the bank on your plan. Acknowledging that a plan did not work as anticipated, and connecting the changes to that, are important steps in the communication process and in building acceptance for changes.
Don't change too often. Some people believe that frequent incentive changes are healthy and keep the troops on their toes. I feel it is important to build a continuity of purpose and skill-sharpening. Consistency - but not stagnation - is important.
