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Entrepreneur’s Notebook

How do effective managers keep valuable employees? Larger salaries are not the answer.

More money is, at best, a temporary solution. Furthermore, it sends the message that management can be blackmailed. Instead, the most effective managers create a compensation package that inspires critical employees to work hard and stay the course. These “golden handcuffs” give essential employees personal, as well as financial, incentives to stay.

One way the pros create golden handcuffs is by structuring compensation packages that recognize employees’ unique and specific contributions to the firm’s overall success. In essence, they make leaving so expensive as to be foolhardy.

Performance-oriented rewards work best for employees whose personal talents greatly contribute to the company’s fortunes. The most effective solutions combine two ingredients into a pair of golden handcuffs that employees willingly wear.

First, weld individual performance to that of the work group and the company as a whole. Second, fuse individual achievement with long-term financial reward. This isn’t as difficult as it might sound.

Effective managers design incentives that tie the employee’s personal rewards to the company’s success. Valued employees must see their individual contribution leverage their personal wealth in a meaningful way. They must feel that their rewards are equal to their contributions. Astute managers create incentive systems that make these special individuals far better off if they stay with the company.

To do this effectively, you must clearly establish the critical individual’s goals, and make sure they closely match department and company objectives. Clearly communicate the risks and rewards of this interdependence. Remind crucial employees of the domino effect that meeting (or missing) individual targets will have on the overall group.

When done right, each person’s job becomes essential to achieving the company’s overall mission. This financial interdependence binds each employee to one another and to the company. The big picture snaps into focus: me and I become us and we. Such reward structures send the message that as the company succeeds through an employee’s personal efforts, he or she will be directly and proportionately compensated.

This is what crucial employees require. Without it, they will go elsewhere.

Profit sharing is a very effective way to achieve this financial interdependence. A financial service client here in Los Angeles recently took the enlightened step of inviting employees to share in the tremendous success their efforts created.

The president established an employee bonus pool equal to 50 percent of pre-tax profits after the company first hit a minimum base. That’s not unusual, but there’s a twist: We designed the system so that it allowed the employees to distribute their own bonus pool among themselves. Remember the power of peer pressure. Teams are known for punishing slackers, especially when such behavior directly impacts each team member’s income. The results were extraordinary.

For firms looking to sell or merge, a similar mechanism focuses not on profits, but on increasing the market value of the enterprise. To encourage valued employees to add to the company’s value, establish the firm’s value in the base year. If the firm later sells for no more than that value, there is no profit sharing. However, if it sells or merges for a greater amount, the team participates in a significant way.

This creates a sense of common purpose that binds indispensable people to the team. If the team does well, so do all its members. If the team fails, everyone suffers. Such interdependence means that no one in the organization can accept mediocrity without letting the team down. It fosters the feeling of a proprietary interest in the company’s success.

It also creates a psychological satisfaction that no amount of money can provide. NASA has it. So does the United States Marine Corps. This sense of common purpose communicates to each employee: We appreciate who you are and value your individual contribution.

Using stock as a link in your golden handcuffs is another step in the right direction. However, instead of actually issuing shares, many enterprises now opt for stock lookalike programs, such as phantom stock and stock appreciation rights (SARs).

These programs are written agreements that tie the value of the phantom stock and SARs to the company’s common stock price. They have the financial effect of real stock without the legal complications of ownership. Through the efforts of essential employees, if the stock value rises, so do the phantom shares and SARs.

When combined with a vesting schedule, these plans further motivate essential employees to stay. Under vesting, full participation is not immediate. Instead, it increases over time. For example, a five-year vesting may provide for participation increases of 20 percent each year. Jumping ship after the first year becomes expensively foolhardy.

An obvious way to create incentives for employees to stay is to make your company a great place to work. This doesn’t always mean costly compensation packages. It may mean taking a little more time to listen to their concerns, or using your imagination to create an enjoyable work environment. Once that has been done, however, golden handcuffs are another option well worth considering.

Constructed properly, golden handcuffs provide a potent mechanism to attract and retain essential employees without going broke in the process.

Chris Malburg heads the consulting firm Christopher R. Malburg, CPAs.

Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1941 with feedback and topic suggestions.

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