Ken Abosch and Iwan Barankay discuss bonuses vs. raises for employees

Expecting a salary raise this year? You could end up with a bonus check instead. More and more companies are moving toward giving performance-based bonuses instead of handing out pay raises unrelated to results achieved on the job. The trend is a key finding of the “2014 Salary Increase Survey”by Aon Hewitt, a human resources and consulting services firm based in Lincolnshire, Ill. Spending on variable pay among U.S. employers reached a record-high level of 12.7% of payroll in 2014the highest in the 38 years that Aon Hewitt has conducted these studies. At the same time, salary increases for U.S. workers accounted for just 2.9%, reflecting a continued focus among companies on controlling fixed costs. 

“Salaries tend to have a cascading effect,” explained Ken Abosch, compensation, strategy and market development leader at Aon Hewitt. He said the increasing emphasis on variable pay, including bonuses, has been occurring over the past 10-15 years and is not merely a response to the 2008 recession. “It is a quiet revolution,” he added. Wharton management professor Iwan Barankay noted that the balance between the salary component and variable pay reveals who has more bargaining power —and that employers are increasingly coming out on top. 

Barankay and Abosch recently discussed those emerging trends and the takeaways for employers and employees on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

According to an Aon Hewitt news release, the survey found that 91% of the 1,064 companies polled currently offer a variable pay program that would make up 12.7% of payroll spending in 2015. By comparison, in 2005, just 78% of companies offered a variable pay program, which accounted for 11.4% of payroll. Improved financial performance and results seem to be driving the trend: Abosch said two-thirds of the survey participants reported meeting all of their performance requirements, and 18% exceeded them by 10% or more. “You see a correlation between performance, results and reward as opposed to some uncontrollable circumstance,” he noted.

“You see a correlation between performance, results and reward as opposed to some uncontrollable circumstance.” –Ken Abosch

Winners and Losers

According to Aon Hewitt’s survey, workers in some U.S. cities can expect to see salary increases higher than the national average in 2015. That’s good news for people living in Denver (3.5%), Houston (3.4%) and Los Angeles (3.2%). However, workers in New York, Minneapolis/St. Paul and Milwaukee should anticipate pay increases of 2.8%, lower than the national average, the survey found. 

Abosch noted that Denver and Houston lead the pack on pay hikes because of the concentration of energy companies in those cities. The energy industry is the leader in not just variable pay, but also salaries, he added. Other industries with the highest variable pay component are life and health insurance, entertainment and communications, and industrial machinery and equipment.

The industries that can expect to see the highest salary increases in 2015 include energy/oil/gas (3.8%), real estate (3.4%), telecommunications (3.2%) and pharmaceutical (3.2%), according to Aon Hewitt. The lowest increases are projected in education (2.7%), government (2.6%) and forest and paper products/packaging (2.6%).

The Chief Bonus Drivers

According to Abosch, employers’preference for bonuses is a result of the strengthening economy and some tightening in the job market. “Salaries represent a fixed cost and have a compounding effect, whereas bonuses are a lump sum payout, which have a one-year impact on the balance sheet.” Employers also see bonuses as a useful tool in motivating employees, he added. “[Also], shareholders and analysts like seeing that employees [have] skin in the game.”

“When you look inside a company at individual productivity, it is very skewed. A small fraction of the employees generate the bulk of the value inside a company.” –Iwan Barankay

Salary increases are not being completely pushed out, though, noted Abosch. After the 2008 recession, which saw the study’s lowest recorded level of salary increases at 1.8%, there has been some improvement. Average salary increases have since crept up to 2.9%-3% forecast for 2015, and Abosch predicts that they will stay at those levels for a while.

Barankay asked Abosch if the companies surveyed based their variable pay on performance or luck. “We know from past research that CEOs in particular have been rewarded much more for luck than for actual effort and their ideas,” Barankay said. Abosch agreed that “structuring these arrangements properly is critical.”

Barankay noted that the latest trends reveal that employers are gaining increasing leverage over employees. , which basically give a lot of money to those who perform the best. And that really reflects that employers have a lot of power at this point in time.”

According to Barankay, data analytics can be a powerful tool to separate what results are related to employee effort and which are a matter of luck. “Otherwise, we are left with a situation where employers are basically rewarding gambling, and people are performing well because they were at the right place at the right time,” he said.

The broader question for companies is to determine the kind of workplace they want to offer, according to Barankay. “If you offer a very individualistic, high-powered incentive structure where you will reward individuals for their performance, that could hurt cooperation and team spirit,” he said. “It you really want people to work together, to be innovative, creative and just be able to enjoy being in the workplace, then these high-powered incentives could be a drawback.”At the same time, he noted that high performing employees may not want to pull along underachievers. 

“When you look inside a company and look at individual productivity, it is very skewed, meaning that a small fraction of the employees generate the bulk of the value inside a company,” he said. “Employees who know their worth …can put pressure on their employers and get [attractive compensation] contracts. For the firms, it will be a question of how they balance these conflicting forces— [creating] a nice, cooperative environment but also feeling the pressure from the highest-talent people in the workplace who want stronger compensation and bonuses.”