If you want to increase shareholder value in your business, you need to measure how well the people in charge of the business are doing and use that information to improve the business’s profitability and value.
We also need to make sure that everyone in the business, from senior to middle management, is on the same page or aligned with current strategy when it comes to these financial goals.
One way to ensure alignment is through an incentive compensation program, whether short-term (“STIP”) or long-term (“LTIP”), which is a reward system based on the achievement of specific goals.
For example, here are some tips to create an effective STIP.
Design your STIP to encourage long-term value creation
An effective STIP should be designed to encourage behaviors that drive long-term value for shareholders, not just short-term profit.
By rewarding behaviors that drive long-term value, the program encourages employees to think beyond short-term gains and focus on building sustainable growth for the business.
Balance your scorecard with financial and non-financial goals
The STIP should be based on a balanced performance scorecard that includes both financial and non-financial goals. These goals may incorporate Objective Key Results (“OKR”) goal concepts.
Financial goals might include things like controlling costs, while non-financial goals could be employee engagement or product delivery excellence.
A balanced STIP helps to avoid unintended consequences that can arise from overemphasizing one area of performance over others.
For example, if a company only rewards employees based on financial metrics, it may inadvertently encourage cost-cutting measures to achieve a short-term result that harms the quality of products or services, leading to long-term harm to the value of the business.
By including non-financial metrics in the STIP, such as employee engagement or product delivery excellence, the program can help to balance the incentives and promote a more well-rounded approach to performance tracking.
Here are some areas to consider when creating your balanced scorecard:
- Financial – Corporate, Profit Center, Geographic, Cost Control
- HS&E – Safety, Product Delivery Excellence, Environmental stewardship
- Employee Engagement – Onboarding, Retention, Mentoring/Training,
- Individual Performance- Annual Goals, Dept KPIs, Customer and Key Supplier engagement
Use objective metrics and weight items appropriately
The STIP should be based on objective metrics, not subjective opinions.
Focus on the five key financial fundamentals: cash flow, operating earnings, liquidity, shareholder value, and borrowing capacity.
Each line item in the scorecard may be weighted differently in the calculation of the final incentive payout.
The program can provide incentive awards on a quarterly, semi-annual, or annual basis, depending on what works best for your business.
Formula to calculate STIP
The formula for calculating the payout of a Short-Term Incentive Program (STIP) varies depending on the specific design of the program.
However, in general, the formula for calculating the payout of a STIP will include the following components:
- Target Incentive: This is the amount of incentive payout that would be earned if the employee achieves 100% of the performance targets.
- Performance metrics and multipliers: Specific performance metrics including OKRs that the incentive payout is based on, such as revenue growth, cost reduction, or customer satisfaction.
- Actual performance: This is the actual level of performance achieved by the employee or the business unit during the measurement period.
- Weighting: The performance targets may be weighted differently depending on their relative importance to the overall success of the business.
- Threshold, target, and stretch goals: The STIP may include different levels of payout based on whether the actual performance falls below, meets, or exceeds the target or stretch goals.
Business Unit Scorecard
Shared Services Scorecard
When should you implement a STIP?
A Short-Term Incentive Program (STIP) can be used in a variety of situations where a company wants to encourage specific behaviors or achieve certain goals within a defined timeframe. Some examples of when to use a STIP include:
- During a period of change or transition: If a company is going through a significant change or transition, such as a merger or acquisition, it may use a STIP to help align employees with new goals or values.
- When introducing a new product or service: A STIP can help motivate employees to focus on the successful launch and sales of a new product or service, which can help to increase revenue and market share.
- To improve profitability or financial performance: If a company is struggling financially, a STIP can incentivize employees to focus on improving profitability and reducing costs, which can help to turn the business around.
- To improve employee engagement and retention: A STIP that includes non-financial metrics, such as employee engagement or training and development, can help to improve employee morale and retention.
- To encourage specific behaviors: A STIP can be used to encourage specific behaviors or actions that align with the company’s values or strategic goals, such as safety or sustainability.
When should you avoid a STIP?
While Short-Term Incentive Programs (STIPs) can be effective in certain situations, there are times when they may not be appropriate or effective. Here are some examples of when it may be a bad time to use a STIP:
- During times of financial instability: If a company is experiencing significant financial instability, such as a cash flow crisis or debt problems, incentivizing employees with bonuses or rewards may be seen as tone-deaf and insensitive to the company’s financial situation.
- When there is no clear alignment with company goals: If the STIP is not well-aligned with the company’s priorities or values, it may not be effective in motivating employees to contribute to the company’s success.
- When there is no clear link between performance and incentives: The metrics used to determine the incentive payouts should be objective and measurable, and there should be a clear link between performance and incentives. If the metrics used are not well-defined or if there is no clear link between performance and incentives, the program may be seen as unfair or ineffective.
- During times of low morale or high turnover: If employee morale is low or turnover is high, introducing a STIP may not be effective in improving engagement or retention. Incentives alone may not be enough to address underlying issues that are causing low morale or high turnover.
- When it is not financially feasible: A STIP should be financially feasible for the company to implement. If the cost of the program is too high or if it would create financial strain for the company, it may not be the best time to introduce a STIP.
In summary, a balanced STIP or LTIP can help to align the goals of the business strategy with the behaviors of employees, drive long-term value, and promote a more holistic approach to performance tracking.
It’s important to carefully consider the timing and design of a STIP or LTIP to ensure that it is effective and well-received by employees.
A STIP or LTIP should also be measurable, transparent, and communicated clearly to employees, so that they understand the expectations and how they can earn incentives.
If you’d like some support developing financial tracking systems or implementing a STIP or LTIP in your organization, contact me for a complimentary consultation: Book a Call with Tom