Should “Soft” Targets Be a Part of Your Company’s Bonus Strategy?

 “Soft” bonus targets are one of the more powerful tools a board and CEO can use to set priorities, reinforce corporate values, and develop the company’s leadership team.  Yet our research indicates that the use of such targets is found predominantly among only larger companies.

A recent MarksonHRC study revealed that 55 percent of large-cap companies—defined as those with a market capitalization in excess of $4.0 billion—used one or more soft targets as bonus metrics at the executive level.  However, among small-cap companies—those with a market capitalization of less than $200 million—only 25 percent used soft targets in their bonus plans.

Whereas more widely used “hard” targets are numerical, objective, and usually based on outcomes, soft targets are more often individual, subjective, and measured by the performance of an activity.  Because they provide an executive team with guidance on how they should prioritize their time and how the strategic financial plan should be achieved, soft bonus targets are effective at encouraging executive behaviors and actions that lead to sustained business improvement.  They can also stimulate performance improvement among lower-level executives whose staff-function roles have no direct impact on financial results and for whom hard financial targets may therefore have less meaning.

Variations in the application of soft metrics are often found in a bonus override.  Dell Computers, for example, calculates executive bonus payouts using standard financial metrics, to which a factor of 0% to 150% is applied on the basis of “a mix of objective and subjective performance criteria.”  Those criteria include:

• Strategic and transformational objectives related to each executive officer’s function or business unit ;
• Leadership, including manager effectiveness, employee satisfaction and diversity; 
• Ethics and compliance; 
• Brand health and momentum scores; and
• Measurement against net promoter score goals. 

El Paso Energy computes individual performance ratings using a similar 0% to 150% multiplier, but the criteria on which those ratings are based reflect a distinctive tailoring to correspond with company priorities:

• Living our core values of stewardship,
• Integrity, safety, accountability, and excellence,
• Leadership training and development initiatives, and
• Supporting volunteer efforts in the communities in which we work.

The very process of establishing soft bonus targets initiates productive discussions among the board, the CEO, and the executive team as they work through what needs to be done and set priorities to produce desired financial results in the coming year.  The recurring mandate to “increase shareholder return” instinctively elicits a tell-me-something-I-don’t know reaction.  But the task of defining soft targets tends to force the question of how to do it.  Should we be hiring and investing in new products?  Or cutting costs and allocating resources to improve productivity through new systems and processes?  Or, do we increase scale by hunting for an acquisition?   Discussions stemming from that kind of exploration yield much more innovative outcomes than standard directives to increase revenue or cut costs.

So if soft metrics have such demonstrable power to influence behavior and set priorities, why don’t more companies use them? 

1. For one thing, they can be administratively burdensome to implement and monitor; it’s much simpler to set a few global financial targets, allocate them among the various business units, and check in at the end of the year.  Smaller companies, in particular, feel they lack the resources.
2. Some CEOs and boards view the use of soft metrics as micro-management of the executive team, who should instead be given broad financial goals and left to figure out on their own how to attain them.  While this perspective is a valid one, it can often be an excuse for avoiding the time commitment and difficult discussions required to determine how financial goals are to be achieved.
3. A legitimate concern for public companies is that the use of soft metrics could result in the payment of strong bonuses in years when the stock price, earnings, and revenue were down.  While theoretically such a result is not necessarily wrong, it can be a tough one to communicate to shareholders.
4. An additional concern for large public companies is the deductibility of executive compensation in excess of $1.0 million. Although IRC Section 162(m) allows for a carve-out from the $1.0 million limit on performance-related compensation, most soft targets will not fall within this exclusion. 

Despite these concerns, however, it has been our experience that adding soft targets to bonus plans can be worth a company’s time, regardless of its size.  This is most reliably true for companies that integrate the development of those targets into their strategic planning process, rather than using them as bonus-payout mechanisms only.   By also utilizing soft targets as part of succession planning and career development discussions, companies can  further leverage their value to more easily justify the admittedly large investment of time required to design and implement a soft-metrics process.