For the past decade or so, companies have tried to give employees incentives to work harder by linking a chunk of their annual compensation to performance. But many are finding that the practice does not always work out as intended. The problem, according to management consultant Towers Perrin, could be the performance on which companies have chosen to focus.

A recent Towers Perrin global study of 600 compensation managers at midsize and large companies shows that, while companies were increasing the number of people in variable pay programs, they were making the payout dependent on the company's–rather than the individual's–performance. "Beyond the CEO or the CFO, the performance of the organization as a whole is not truly relevant or even the best measure of performance," says Ravin Jesuthasan, managing principal and practice leader at Towers Perrin. "Variable pay works best when it is linked to the performance of the individual or the team, not the organization."

Towers Perrin found minimal rewards customization beyond the sales function; few extend this approach to other functions equally critical to executing corporate strategy. Perhaps more disturbing:

• 68% of those surveyed have no formal means of measuring the return on investing in their rewards programs;
• 43% of the respondents said that their performance management systems did not link to business needs; and
• Another 42% felt that the systems in place neither adequately identified top performers, nor weeded out weak ones.

Towers Perrin recommends companies shake up their rewards programs in ways that align them with business goals for performance, cost, talent and employee engagement and avoid the one-size-fits-all approach. Finally, companies need to develop metrics to make the reason for the rewards transparent. "Progressive companies are doing the analysis that allows them to be sure that when they pay these bonuses, they know how and why people are being rewarded," says Jesusathan.