Before Sven Jacobson got into VC, he worked with 22 companies owned by a diversified South African conglomerate, Rennies Group, implementing incentive schemes based on Stern Stewart & Co.’s Economic Value Added model or EVA.
EVA is a performance measure like earnings that also considers the balance sheet.
EVA = net operating profit after tax opportunity cost for capital
Stern Stewart recommends several applications for EVA, including a unique bonus system.
“We recommend a few things conventional compensation consultants say you should never do,” says Al Ehrbar, partner at Stern Stewart. Key features of the cash incentive system include:
* Uncapped on the upside Most companies stop adding to bonuses after an employee hits 120% of their operating goals, which Jacobson calls the go-golfing point.
EVA motivates employees to continue producing.
* Uncapped on the downside Conventional bonuses also usually disappear when performance drops below 80% of the operating goals. EVA gives employees a reason to minimize losses.
* Creating a Bonus Bank Part of the bonus carries forward to the next quarter so that employees won’t sandbag a particularly bad quarter or front-load sales.
* Divorce Bonus Calculations from the Annual Budget Base the bonus on improvement over the previous quarter’s EVA numbers, rather than projected improvements.
* Transparency “Identify the value-levers to the management teams,” Jacobson says. Employees should understand the variables that affect their bonus and be able to monitor them.
“Incentives are probably the hardest thing there is to get right,” Ehrbar says.
Jacobson says, “There is a big difference between a bonus payout and an incentive scheme.”