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Now that more than one-third of major companies have implemented a group incentive program somewhere in their organization, these organizations are beginning to define the conditions under which pay can exceed market rates (Towers Perrin 1994). One often hears the following refrain: "From now on, we'll be requiring some pay at risk." By putting pay at risk, organizations are attempting to guarantee a suitable return on their investment in compensation.
The problem lies in defining "pay at risk." Although some organizations use the term to describe a variable pay program, the two are not necessarily synonymous. Many variable pay programs merely layer an incentive on top of base salary. Employees in this kind of program are not 'risking" anything in the true sense of the word. Their pay may vary year to year, but it will not fall below an established base, even in the event of poor performance.
Even in the "new pay" literature, the terminology is not consistent. One variable pay expert includes all performance-based pay in his definition (Lawler 1990); two other experts exclude "add-on' programs, which offer rewards in excess of base salary for superior performance, from their definition (Schuster and Zingheim 1992).
Ironically, far from instilling a risk/reward stakeholder mentality, labeling the add-on approach as "pay at risk" simply heightens the sense of entitlement among employees. Because organizations usually communicate employees' new "target" compensation, these employees are likely to see the incentive as a basic part of the total yearly package. A good example is at many of the Regional Bell Operating Companies ("Baby Bells"), where "pay at risk" often is used to describe an add-on program that has been in place for several years. Employees at these organizations expect to get every penny of their "at risk' pay every year.
For the purposes of this discussion, a pay-at-risk program is defined as a program in which a portion of the base pay that employees expect becomes contingent on business performance. This definition includes current base pay and "expected" merit pay. Generally, merit pay budgets are linked to changes in market conditions (Heneman 1992). Under a pay-at-risk arrangement, this deal changes. If performance is good, employees may earn more than the market, but if performance is poor, their earnings...