Variable compensation can be a great way to satisfy demand for higher pay while addressing upper management’s need to boost productivity and keep base salaries under control.

But there are some major pitfalls.  Here are two proven ways to avoid the most common legal and return on investment risks.

Non-exempt employees

Beware if you use variable comp as a pay-for-performance strategy for hourly employees. Reason: It’s easy to inadvertently run afoul of the Fair Labor Standards Act (FLSA) overtime rules.

Under FLSA, you must recalculate employees’ hourly wages to include all variable pay (such as individual or departmental bonuses) when figuring overtime compensation. Failure to do so could cost your organization more in penalties and back-wage payments than the variable comp plan saved on the front end.

So it’s a good idea to double-check with Payroll to make sure the department knows to make OT adjustments after hourly employees receive bonuses.

Reward the right things

In order to make the criteria for bonuses easier for employees to understand and management to measure, many firms prefer using strictly objective measurements. Example: The plan may pay out based on how much money employees save their department in a year.

But what happens if employees cut corners – on safety, service, quality, etc. – to reach the goal?
At some firms, employees are still rewarded with extra pay, even though their actions potentially did more harm than good to the bottom line. For best results:

• set behavioral criteria for bonuses as well as economic ones, and
• consider using a mix of firm-wide, departmental and individual economic performance measures.