FROM THE SMALL, PRIVATELY owned firms to the big publics, builders all struggle to some extent with recruiting and retaining quality talent. High turnover rates and fiercely competitive markets often leave the talent pool dry. In an attempt to battle these factors, builders resort to creative compensation packages to hook talent. But are they working?

Creating a sound compensation program is key to profitability. When employees are correctly incentivized and rewarded, they perform better. When their performance improves, business benefits. A few simple rules will guarantee your program is successful.

TWO OPTIONS The guiding principle in designing compensation packages is to keep it simple. For peace of mind, builders should limit compensation to two basic types: “constant”—also known as “guaranteed”—payouts and “at risk” payouts. Constant compensation is based on an employee's salary or hourly wage, meaning this is what the employee receives when he or she simply performs his or her job. On the other hand, at-risk compensation, or a bonus, is linked to some evaluation of individual or group performance.

Compensation should be distributed by established metrics. Incomes, be they annual salaries or hourly wages, should always reflect local market conditions. In contrast, bonuses should reward both individual and organizational performance. The easiest way to divvy it up is to tie 50 percent of an individual's bonus to performance beyond simple day-to-day responsibilities and the other 50 percent to a companywide metric such as profitability.

Everyone working for the company should have an at-risk bonus element. Whether it's profitability or unit delivery, error-free delivery or customer satisfaction, budget control or staff turnover, every employee should have a way to measure his or her performance.

The percentage of at-risk compensation should run parallel to salary. For example, the employee with the lowest base salary should have a bonus earmarked for 5 percent to 10 percent of his salary, while the employee with the highest base salary should have a much higher percentage—perhaps even a “sky's the limit” percentage. Following this same structure, at-risk compensation should be paid annually if it's a low percentage and quarterly if it's a much higher percentage.

Builders should discuss compensation with employees frequently. Managers must fully understand the program details and be able to explain it to their employees. Package breakdowns also should be explained in offer letters, annual performance reviews, and general meetings.

AVOIDING PITFALLS One of the most critical mistakes builders make in providing compensation is to pay discretionary monies to key individuals. Avoiding the temptation to arbitrarily pay extras at year end to select employees will prevent headaches down the line by limiting labor and legal woes. Morale is maintained when year-end bonuses permeate throughout the ranks, as determined by criteria such as years with the company.

Although long-term incentives such as restrictive stock grants, options, and cash sound like a great idea, if they come with long-term vesting restrictions, the initiatives may backfire. For a new or younger employee, such compensation has little value. Even worse, the long-term focus may serve as golden handcuffs to poorer performers, who will just wait out their time.

Moreover, compensation management should never be confused with payroll administration. Because payroll administration involves the laws of taxation and often complicated benefits deductions, someone in this role has different competencies than are needed to be an effective compensation professional. Thus, compensation management is best overseen by a professional certified in that discipline. A compensation manager will be able to maintain the program while monitoring the outside market, internal equity, and budgetary issues.