Author: Michelle Rafter

In trucking, a full crew of drivers is as critical to keeping rigs on the road making money as full tanks of diesel.

    But getting a new driver behind the wheel isn’t easy. Prospects have to pass government physical and drug tests, a road test and, in some areas, state and county criminal checks. After drivers have been cleared, they need to learn how to operate in-cab computers and other equipment and ride along with an experienced driver to learn their route.

    From beginning to end, the process can take a month. That’s a long time to be short-handed if there’s no ready pool of candidates to draw from should someone give notice unexpectedly.

    For all those reasons, it didn’t surprise John Pryor when three years ago executives at Southeastern Freight Lines made a New Year’s resolution to cut hiring time for drivers. On top of that, they wanted the drivers they hired to be better at their jobs–better suited to the work, stay longer on the job, have fewer accidents, and like what they do.

    Carrying out that resolution fell to Pryor, vice president of human resources and safety for Southeastern, a privately held $565.1 million company based in Lexington, South Carolina. Southeastern is what’s known as a less-than-truckload commercial carrier, consolidating freight from multiple customers onto one truck for delivery to a nearby city. Southeastern delivers to a 12-state area in the southeastern United States using 5,000 drivers and freight handlers operating from a network of local and regional service centers.

    Truck drivers and sales clerks don’t have much in common. But when Pryor started looking for a fix, sales clerks became his inspiration. He made the connection reading a magazine article about retailers using software to improve the quality and longevity of employees they hired. He called the vendor from the story, Unicru.

    Unicru, a vendor of recruiting and assessment software, wasn’t looking for the business. At the time, the Beaverton, Oregon, company was working exclusively with department stores, grocery chains and other retailers. It took the better part of a year for the companies to decide to work together and then for Unicru to create an application and assessments suited to the trucking business. Southeastern tested the hiring system in 10 service centers in fall 2003 before rolling it out companywide in early 2004.

    So far, so good. Using Unicru’s recruiting technology,background checks that once took three to five days now take a day or less. Based on such improvements, the period between when someone applies and their first day on the job has dropped by 40 percent, according to the company’s human resources staff.

    The job application Unicru created for Southeastern is helping the company pick higher-quality drivers. The job application includes an assessment that identifies personality traits associated with dependability that Southeastern is using to pick out the most likely job candidates. “Time’s going to tell, but our initial reaction is that the quality of hires is better” because of the assessment, says Bryon Hamrick, Southeastern’s human resources director, in a video testimonial produced by Unicru.

    As part of automating hiring, Southeastern did away with paper applications entirely and put applications on its corporate Web site. Online access made it so much easier to apply for a job that Southeastern received six times the number of applications in 2004–about 39,000—than it used to get in a year. “Our heaviest application day is Sunday. That wouldn’t have been available before because (our offices) aren’t open on Sunday,” Hamrick says in the video testimonial. Of applications processed through the new recruiting technology, Southeastern hired 392 drivers and 765 freight handlers, Pryor says.

    Integrating the recruiting technology had the unintended consequence of helping Southeastern track how well or poorly regional hiring managers were doing at keeping jobs filled. Last year, one regional hiring manager complained he couldn’t get anyone hired, but when the corporate human resources staff checked the application reports Unicru generates they discovered it was the manager who had been slacking off: He had gotten plenty of applications but hadn’t done anything with them for weeks. “That happened once, and it’s never come up again because they’ve learned we can tell what’s happening everywhere,” Pryor says.

    Pryor has mixed feelings about sharing his success with the world. “This gives us a competitive advantage,” he says. “One side of me says keep this a secret, but the other says our industry needs to catch up with others. We need technology like this.”

    Jason Shaw, a University of Kentucky professor who has studied the trucking industry, agrees that by relying on online applications and using assessments, Southeastern Freight Lines is blazing new trails. The fact that Southeastern is receiving so many job applications in the middle of atrucking industry labor shortage speaks to its success, Shaw says. “Any move away from subjectivity in the recruitment and selection process is likely to be more effective,” he says. “Unstructured interviews, which scads of organizations continue to use, are among the worst predictors of job performance.”

    At Southeastern, Pryor’s next goal is to improve training. In late 2003, he brought organizational development and training manager Paul Riddle on staff to direct the company’s college recruiting and Web-based learning. As part of its training effort, Southeastern is recruiting at four historically minority colleges with strong transportation and logistics majors, including Clayton State University in Morrow, Georgia, and Florida A&M University in Tallahassee. For Web-based training, Southeastern recently purchased Microsoft Office Live Meeting and will use it to record training sessions that can be broadcast company wide.

    This time, though, Pryor’s not expecting quick results. Measuring training “is a little harder than measuring turnover and productivity,” Pryor says. “It’ll take us at least five years.”

The old adage that the best defense is a good offense holds new meaning for companies facing the prospect of not one but two beefed-up Internal Revenue Service audits.

    In the past year, the IRS has instituted redesigned, tougher audits of employee pension plans and executive compensation programs at Fortune 1,000 and other large companies, part of a drive to crank up enforcement and crack down on scofflaws. Already, the agency has identified dozens of companies violating tax code provisions on everything from pension plan vesting to golden parachutes, according to consultants familiar with the new audits.

    In the area of pension plans alone, the IRS has assessed individual companies hundreds of millions of dollars in additional taxes after audits revealed miscalculations in pension benefits and related errors. The agency has also imposed tax penalties on underpayments at specific companies “in the six figures,” according to one IRS senior program manager. The agency doesn’t name audited companies.

    In light of the developments, advice from IRS agents and tax experts is straightforward: Don’t wait to get audited to act. Companies should scrutinize their pension and executive compensation plans and voluntarily make needed adjustments. In taking the offensive, they could save tremendous time and money by avoiding a much more intrusive government audit, industry experts say.

    “It’s critical that key players in the organization realize this is coming down the pike. Sooner or later they need to get a better handle on it,” says Monique Guesnon, a manager with PricewaterhouseCoopers’ human resources services in New York who’s helping at least five clients perform self-audits of executive pay programs in light of the stricter policies.

    The IRS is doing its share to alert companies to the changes, sending officials on hundreds of speaking engagements a year and maintaining extensive Web pages to explain how the audits work and what resources and remedies are available.

    “Pay attention to the operation of your plan,” says Mark O’Donnell, an IRS customer education and outreach director for the new pension plan audit program. “Defects often arise because of neglect or not having the information. We want to minimize that.”

Parsing pension plans
    Of the revamped audits, the IRS’ pension plan exam, called the Employee Plans Team Audit Program, has the most far-reaching impact, and the biggest plans are the biggest targets, industry watchers say.

    According to IRS estimates, 690,000 U.S. companies or corporate subsidiaries offer defined-benefit or defined-contribution pension plans, but the top 1 percent accounts for 60 percent of plan participants and 70 percent of total pension assets.

    Historically, the IRS hadn’t targeted top pension providers for audits, and hadn’t kept up with cash balance and other recent changes in plan design. That changed in the late 1990s, when the agency restructured to become more efficient. As part of the revisions, the IRS revamped its pension audits, running a two-year pilot before integrating what was learned into the Employee Plan Team Audit Program exams, which began in late 2003. The focus of those audits: public and private companies running plans with more than 2,500 participants.

    EPTA exams, as they are called, are structured to analyze a sort of “10 Most Wanted” list of pension plan trouble spots. Auditors comb through a company’s Form 5500 pension plan tax filing, looking for dramatic drops in vesting or distribution in a given year, changes in benefits when one company acquires another, how deferrals are treated and whether plan documentation matches operation, among other things.

    The IRS posts its top 10 list on an EPTA Web site, so it’s a logical starting point for a company doing a self-audit, IRS officials and accounting consultants familiar with the audits say.

    Chris Lipski, a partner with Ernst & Young’s human capital practice in Cleveland, is shepherding several companies through IRS pension audits–“very large companies you’ve heard of,” he says, though he could not disclose names. Lipski suggests starting an internal review by forming an ad hoc committee headed by a human resources executive familiar with the company’s pension plan administration, working with finance and tax departments, the general counsel’s office, any contractor responsible for pension administration, plus outside attorneys and CPAs.

    Have everyone meet at least once to orchestrate the review and divide responsibilities, Lipski says. The internal audit itself should include: gathering and reviewing pension plan documents, performing a test or sample to pinpoint weak spots, completing a more comprehensive check in those areas, taking any necessary steps to correct mistakes and documenting every stage of the review.

    With Lipski’s clients, most mistakes have been inadvertent administrative errors, such as using the wrong definition of compensation to calculate pension amounts or mistakenly determining that someone isn’t vested so they don’t begin accruing benefits when they should.

    To further shield themselves from an audit, companies can enroll in the EPTA’s Voluntary Correction Program, where they can formally disclose any errors they may have uncovered and pay a fee based on the number of plan participants. The IRS has 150 days to approve the company’s self-audit, during which time the agency is restricted from starting its own examination. About 2,300 companies have already signed up for the program, according to O’Donnell, the EPTA customer education and outreach director.

    Lipski recommends that companies do a quick analysis, file a Voluntary Correction Program application, and then spend the time it takes the IRS to follow up with a more thorough review.

    If a self-audit sounds like a lot, it’s nothing compared to the real deal. An EPTA audit can involve up to five agents, take up to 200 or more staff days and involve 75 to 150 separate requests for documents, according to agency officials. When they’re on site, agents need desks, phone lines, computer hook­ups and a company liaison to answer questions. Start to finish, the process could take up to two years, says Peter Breslin, the IRS’ EPTA senior program manager. The IRS initially undertook 40 EPTA exams, but eventually (when enough agents are trained) it will have about 90 of the exams under way at any given time, says Mark Hoffman, EPTA national coordinator.

Minding executive pay
    The other revamped IRS audit targets salary and benefits paid to top officers at public and private companies with annual revenue of $10 million—fallout from scandals at companies such as Tyco International and WorldCom, where executives awarded themselves enormous pay packages.

    In a yearlong pilot project started in October 2003 and involving two dozen unnamed companies, the IRS’ large and medium-sized business division zeroed in on seven areas of concern: nonqualified deferred compensation plans, stock-based compensation, fringe benefits, the $1 million cap on deductible compensation, golden parachutes, split-dollar insurance and family limited partnerships.

    The agency investigated but dropped an eighth issue, employee leasing, as not being a significant problem among large and medium-sized businesses. The IRS is using results of the pilot program to craft guidelines that will be included in routine corporate tax audits, according to industry watchers.

    What the IRS found in its initial executive-pay audits ranged from the astounding to the mundane, says Andrew Liazos, a Boston-based attorney at McDermott Will & Emery who has attended agency briefings on the topic. In the pilot, the IRS matched corporate returns against returns for individuals and found that some executives didn’t file tax returns at all, says Liazos, head of his firm’s executive compensation practice.

    The IRS also uncovered instances where companies deducted deferred compensation from their balance sheets before it was paid, allowed executives to collect deferred compensation before agreed-upon dates without tax consequences, or changed targets for executives’ performance-based pay during a fiscal year without first receiving board or shareholder approval.

    The tougher audits also found “a laundry list” of violations of fringe benefit tax laws, such as companies allowing execs to take out loans and never repay them or use corporate jets without declaring such use as income, Liazos says.

    Many problems with executive compensation plans stem not from nefarious intentions but from poor oversight, Liazos says. “We worked with a company with a bonus plan that was supposed to be approved by shareholders every five years, but five years went by and nothing happened,” he says.

    As with pension plans, IRS officials and consultants recommend that companies do an internal review of their executive compensation program.

    Consultants recommend having outside legal counsel or a CPA firm direct an executive pay plan compliance audit because of the complexity of such reviews. If a law firm leads the audit, the information gleaned would be protected by attorney-client confidentiality in the event of an IRS audit. The best course might be to have outside legal counsel hire the CPA, so any communication about a compliance review between the CPA and the company or the CPA and legal counsel would also be shielded, consultants say.

    In all cases, it’s vital that key staff be aware of what’s happening, says PricewaterhouseCoopers’ Guesnon.

    A lot of larger companies have outsourced administration of benefits, including executive compensation plans.

    “But the executives have a fiduciary responsibility even if it is outsourced,” Guesnon says.

Workforce Management, January 2005, p. 60-61 — Subscribe Now!

Give round one to Kathi Cooper. She’s the IBM employee whose lawsuit over the computer giant’s conversion to a cash-balance plan helped transform the plans from one of the most popular kinds of corporate pensions into one of the most controversial, and contentious.

    In late September, IBM agreed to a partial settlement of the class-action suit, saying it would take a $320 million charge against third-quarter earnings to end all but two claims. IBM also agreed to a $1.4 billion cap for any additional liabilities it might be held responsible for, bringing to $1.7 billion the total liability the company could face in the matter.

    But the fight is not over. IBM is still contesting claims at the heart of Cooper’s 1999 suit that the formula it used to convert to a cash-balance plan discriminated against older workers in violation of federal pension laws. In July 2003, a U.S. District Court judge ruled in favor of Cooper and 140,000 IBM employees. IBM is appealing that ruling to the 7th U.S. Circuit Court of Appeals. A verdict could be more than two years away.

    The immediate impact of the IBM settlement on other cash-balance lawsuits appears minimal, but an appellate court ruling could have long-term repercussions for the industry, pension experts and others say.

    Approximately 40 percent of assets in single-employer, non-union defined-benefit plans in the United States are held by cash-balance or similar plans, according to Mercer Human Resource Consulting, which advises companies on pension matters. Since lawsuits such as Cooper’s that challenge the validity of cash-balance plans began appearing in the late 1990s, many companies have frozen their contributions or moved to defined-contribution plans. Some have chosen to stop funding pensions altogether.

    If an appeals court in the IBM case lets the lower court’s ruling stand, it could have a further chilling effect, says Ethan Kra, chief retirement actuary with Mercer Human Resource Consulting in New York. “It would be devastating, and would lead to massive plan termination,” Kra says.

    That’s not true, says Cooper, 54, a 25-year IBM veteran who’s become an active pension reformer since filing her suit, traveling to Washington, D.C., to lobby for fair treatment for older workers and retirees. “They’ve said the entire pension scheme of America could be affected, that everyone will go bankrupt. That’s the phoniest spin they created.”

    Meanwhile, other cash-balance suits are ongoing. AT&T spokesman Andy Backover wouldn’t comment on a pending suit brought by managers in 1998 over the company’s conversion to a cash-balance plan. Similarly, CIGNA retirees sued in 2001 over the company’s conversion to a cash-balance plan, claiming age discrimination. The suit is pending, and a company spokesman wouldn’t comment. Stephen Bruce, an attorney for plaintiffs in the CIGNA suit, says that while an appellate court ruling on IBM’s case wouldn’t set a precedent for the CIGNA matter, it could still have an impact. “They’d listen to what was decided,” Bruce says.

    Even before IBM’s case is resolved, federal lawmakers are expected to pick up next year where they left off earlier this year in drafting new pension guidelines. “I would be shocked if we get through next year without legislation,” Kra says.

Workforce Management, November 2004, p. 24 — Subscribe Now!

In the months leading up to the election, President Bush and John Kerry sparred over lots of things: the war on terrorism, jobs, taxes, gay marriage, stem-cell research. But they ignored one issue that will be critical for whoever takes over the White House in January: how to ease America’s aging population into retirement without bankrupting the country in the process.

    With the oldest baby boomers nearing 65 and experts forecasting impending insolvency for government entitlement programs, reforming Social Security and regulations covering company pensions never seemed more urgent. Yet the candidates have remained all but mum on the subject, reluctant to tackle something so complex, long term and potentially explosive during the campaign. “It’s hard stuff. It doesn’t lend itself to easy sound bites,” says Judy Schub, managing director for the Committee on Investment of Employee Benefit Assets, which represents 15 million employees in 110 corporate pension funds.

    But tackle it they must. The first wave of 79 million baby boomers starts retiring four years from now. As more people stop working, the ratio of individuals paying into Social Security for each retiree collecting benefits will drop, from 3.3 to 1 today, to 2 to 1 by 2030, according to Social Security administrators. By 2018, Social Security won’t collect enough in payroll taxes in a year to cover annual benefits. By 2042, money pledged to the program’s trust funds will run out completely, according to a Social Security trustee report published in March.

    Pension funds face their own problems. A record 35 million Americans and their families are covered by defined-benefit pensions, according to Schub’s group. But despite stock prices that have rebounded from 2000 lows, many plans remain underfunded. The liabilities, along with United Airlines’ August announcement that it will likely terminate its pension plans as part of a bankruptcy restructuring, have put pressure on the Pension Benefit Guaranty Corp., the government agency that insures pensions for 44 million U.S. workers. That, along with uncertainty about proposed regulations and age-discrimination lawsuits over hybrid cash-balance accounts, is causing companies to turn away from defined-benefit plans. Instead, they’re offering more portable defined-contribution plans, putting more of the onus of investing retirement money on employees. Some are dropping pensions altogether.

    Corporate and employee-group lobbyists, academics and other observers say there’s no question that changes are needed. But the shape of the reforms, how quickly they’ll happen and the effect they’ll have on corporate America could be very different under a Bush or Kerry administration, industry watchers say.

    The candidates’ silence on retirement reform doesn’t mean they haven’t taken a position. Bush has pledged that, in a second administration, he would privatize Social Security, though he prefers to call it giving people “ownership.” He might raise the retirement age, according to experts and statements he has made during the campaign. Bush is also expected to continue working on pension-plan regulations introduced during his first term, including rules governing cash-balance plans and new measures for calculating pension-plan liabilities.

    By contrast, Kerry has vowed not to privatize Social Security, cut benefits, raise the retirement age or increase the current 12.4 percent Social Security payroll tax. Instead he’d shore up the program by cutting the federal budget deficit and growing the economy, though he hasn’t specified how that would happen. According to industry watchers, statements Kerry has made during the campaign, and materials on his official election Web site, www.johnkerry.com, he also supports laws keeping defined-benefit and defined-contribution plans strong, and protecting older workers from unfair treatment under cash-balance plans, though again he’s been fuzzy on the details.

Revamping Social Security
    Bush has said he favors partially privatizing Social Security to give people more control over their retirement savings. As he explains it, benefits for current retirees and older workers would remain unchanged, while younger workers could voluntarily divert a portion of their Social Security payroll taxes into some type of personal retirement savings account. Bush made reforming Social Security a major plank in his 2000 campaign platform, and after the election, a Bush-appointed commission that studied privatization came up with several options for how personal retirement savings accounts could work. The push stopped, though, after the 9/11 attacks diverted the administration’s attention to the war on terrorism.

    However, lawmakers have followed through, in the past few years introducing a number of reform proposals, including private retirement accounts. The latest, from centrist Reps. Jim Kolbe (R-AZ) and Charlie Stenholm (D-TX), also includes a government match for low-income workers’ contributions, some small benefit cuts, a faster increase in the retirement age and a small hike in the current $87,000 payroll tax cap. “I wouldn’t be surprised to see something like this take off,” says Kent Smetters, an associate professor of insurance and risk management at The Wharton School at the University of Pennsylvania, and former Treasury deputy assistant secretary under Bush. If Bush is re-elected, “I could imagine [him] saying, ‘I don’t like everything about it, but the good outweighs the bad.’ “

“Both Bush’s people and Kerry’s people realize they have to be careful or they’ll cause more problems” than they solve.

    But running a partially privatized Social Security payroll-tax program could be an administrative nightmare for corporate human resources departments, some industry experts say. Systems would have to be established to collect “extremely small amounts of money and put them together in a way that administrative costs don’t exceed the amounts people are putting in,” says Janice Gregory, senior vice president of the ERISA Industry Committee, a Washington, D.C., lobby group that tracks pensions and other employee benefits for major employers.

    Bush hasn’t fully explained how Social Security would make up for payroll taxes diverted to private accounts, says Nancy George, national grass-roots and elections coordinator for AARP, which represents 35 million Americans over the age of 50. By the administration’s own admission, if 2 or 3 percent of payroll taxes was set aside for private accounts, Social Security would have to come up with $1 trillion over the next 10 years to replace the diverted funds. “If you take money out to set up accounts, it won’t be there to provide benefits for people who are retiring,” George says.

    By contrast, Kerry’s Social Security reforms would include minor changes in calculating cost-of-living adjustments and the payroll tax cap, as well as shrinking the budget deficit so Social Security trust-fund dollars wouldn’t have to be used to pay general government expenses, as they have in the past. The Democratic hopeful has floated the idea of capping Social Security payments to wealthy retirees. Jason Furman, Kerry’s economic policy director, told Cox News Service in August that the cap would likely be for people with incomes over $200,000, but benefits wouldn’t be eliminated.

    Kerry’s critics claim that if he’s not going to substantially cut benefits, raise the retirement age or up payroll taxes, he’s left with only one option: raising general income taxes to make up for coming Social Security deficits. “He’s avoided saying anything that could lose the votes of the elderly,” says Wharton professor Smetters, who predicts that if elected, Kerry wouldn’t make reform a priority.

Revising Pension Regulations
    In the past four years, the Bush administration has been working on a complete overhaul of pension-plan regulations, parts of which have been introduced. Others are expected to appear if the president is re-elected.

    To aid underfunded pension plans, lawmakers in April approved a Bush-backed bill replacing the outdated 30-year Treasury bond previously used to set companies’ annual pension-plan liability. The new law replaces it, but only through 2005, with a composite corporate bond rate that lets companies contribute less to their plans. For a permanent benchmark, the Treasury Department has proposed using a corporate bond yield curve. But pension managers complain that a yield curve will make calculating how much they have to pay into their funds each year more volatile, and cause other pension-funding rules to be rewritten. “If they do something as simple as continue the [temporary] corporate bond rate into law, it’s a non-event for corporate America,” says Gregory of the ERISA Industry Committee. “But if they change the funding rules, it’s a big deal.”

    Industry watchers say Kerry wouldn’t back a yield-curve benchmark. “Normally, Republicans listen to employer groups and Democrats listen to employee groups, but this time Kerry is listening to both,” says Ron Gebhardtsbauer, a senior pension fellow with the American Academy of Actuaries in Washington, D.C.

    When a federal court ruled in July 2003 that IBM’s cash-balance-account pensions violated age-discrimination laws, it cast a pall on the hybrid defined-benefit plans, which hundreds of companies had adopted since the 1980s. The current administration has supported cash-balance plans, holding that they don’t show inherent bias against older workers. But in late 2003, federal lawmakers voted down an administration-sponsored bill that would have clarified cash-balance conversion rules. The Treasury Department issued a revised proposal last spring, but Bush has dropped the issue during the campaign, while the industry waits for a ruling on what back benefits IBM may be liable for in its suit.

    Kerry has promised to strengthen both defined-benefit and defined-contribution plans, and protect older workers from unfair treatment under cash-balance plans, but hasn’t said specifically how he’d do that. He has also vowed to “increase the portability of retirement savings,” according to the Kerry Web site, but again hasn’t offered many details.

    Some observers see Congress, not the White House, leading the charge to come up with rules covering conversions from defined-benefit plans to cash-balance plans that are palatable to employers and retirees. Senate and House committees with jurisdiction over pension affairs are already working on the issue, says Gregory. “In that sense, I don’t think the election changes much,” she says.

    Bailing out the Pension Benefit Guaranty Corp. could also be on the next president’s agenda. The PBGC already has a record deficit, $11.3 billion in 2003, and in the past three years has accumulated $15.9 billion in claims, twice the number amassed in the 18 years before that, according to a new report from the Cato Institute, a conservative Washington, D.C., think tank. Some argue that if other airlines follow United Airlines’ lead and dump their pension plans, the PBGC will go under, leading to higher insurance premiums for the agency’s 31,000 member companies and a taxpayer bailout.

    Others say the problem is exaggerated. The recent market downturn, slow economic recovery and period of low interest rates is unlikely to recur. “It’s a bizarre experience bound to be different in the future,” says John Hotz, deputy director of the Pension Rights Center, a Washington, D.C., employee lobby group.

    Regardless of who is president, he’ll have to walk a fine line, as the retirement issues facing the country are significant: reshaping Social Security for an aging workforce, and regulating pension plans to satisfy older workers and retirees without driving more companies to drop pensions. Says Gebhardtsbauer: “Both Bush’s people and Kerry’s people realize they have to be careful or they’ll cause more problems” than they solve.

Workforce Management, October 2004, p. 49-52 — Subscribe Now!

The golden age of stock options is over. Just ask Russell Posner. As senior director of corporate compensation at Merck & Co., Posner oversees the $22.5 billion global pharmaceutical company’s executive and stock-based pay programs. For the past year and a half, he has grappled with how to comply with imminent accounting-rules changes mandating that public companies expense stock options and yet still provide a competitive long-term equity compensation program for executives and other employees.

    Rules from the Financial Accounting Standards Board requiring companies to recognize the cost of stock-option grants on their financial statements aren’t due until the end of the year and won’t take effect until 2005 or later. But Merck didn’t wait. Since spring 2003, Posner’s department has polled employees, proposed a new plan that includes restricted stock and performance-based stock as well as options, implemented changes, and spread the word to employees through e-mail memos and face-to-face seminars.

    The outcome: this year, Merck switched 4,000 of 55,000 employees worldwide previously eligible for stock options to the new program. Another 1,100 will make the jump in 2005, and more after that. Merck isn’t expensing options yet, and officials at the company, which is located in Whitehouse Station, New Jersey, haven’t publicly stated what effect the revamped program has had on earnings. But employees have embraced it. “We have employees asking to be included,” Posner says.

    For years, options were the long-term incentive of choice for everything from Internet start-ups to established old-industry conglomerates. But they aren’t the carrots they once were, and not just because of accounting changes. For the past few years, options at many companies have been underwater–grant prices exceeding what the stock currently trades for–making them a less attractive job perk. Options have also come under fire from shareholders, whose holdings have been diluted as companies issued more shares to fund present and future employee grants.

    As a result, companies are shying away from options. Many are curbing the amounts they grant, or limiting who is eligible, or both. Employees could see their yearly options reduced as much as 40 percent, according to a recent survey by Mercer Human Resource Consulting. “Companies are making tougher calls; they’re going to really target their A players,” says Russell Miller, a Mercer senior executive compensation consultant in New York.

    Lower-level employees will bear the brunt of the cuts, according to a July survey from Mellon Financial, which polled 108 companies with a median size of $1.1 billion. “When they look to cut costs, where’s the first place they’re going to look? Not at the top-five [officer] level, but across the rank and file,” says Ted Buyniski, a principal with Mellon’s compensation consulting practice in Boston.

    What works for one company isn’t necessarily the best for another, Buyniski says. “Because of the way the expensing rules are structured, every company has to look at their costs in the context of their business versus their industry or sector,” he says. Whatever they choose, the transition is keeping corporate compensation departments on their toes. Compensation directors should be analyzing what the cost of continuing an existing program would be, and what they could do to deliver a comparable perceived value at a lower cost, or whether their programs are already structured to do that, Buyniski says. “The storm is coming, and they need to make sure their people stay dry.”

“Companies are making tougher calls; they’re going to really target their A players.”

    In place of options, some companies are offering other equity compensation, such as restricted stock units, which are grants of shares that vest at the end of a given period if an employee remains on staff. Employers are also adding performance-based shares, grants that vest only if the company meets certain performance targets over a given period. In 2004, for example, Eastman Kodak Co. is granting so-called “leadership stock” to 800 executives that will pay out in 2007 if the company hits certain earnings-per-share numbers in 2006.

    Other companies are steering away from equity incentives altogether, giving employees salary increases or bonuses, or larger contributions to a 401(k) program. In December 2003, Pepsico Inc. overhauled its long-term compensation program when it began expensing options. As part of the redo, Pepsi cut by approximately 50 percent the number of stock options it issues to employees under its 15-year-old PowerShare program in order to fund a new 401(k) plan match of Pepsi stock. At the same time, Pepsi cut stock grants to executives in order to fund a new long-term cash bonus for them, and said it would give managers the choice of receiving grants as options or restricted-stock units. In fiscal 2003, before the changes took effect, Pepsi reported that options cost $510 million, or about 20 cents a share, the equivalent of 10 percent of the company’s $2.05-per-share earnings for the year.

    Managers at Merck began reviewing its long-term incentive program in early 2003 by putting together an ad hoc committee of executives from the legal, finance, tax, employee stock administration, human resources and communications departments to work with Posner and the compensation group. Their directive: come up with a new program to keep Merck’s share-based pay level with that of pharmaceutical-industry competitors and other companies its size, keep employees happy and minimize costs when the time comes to expense options.

    The group’s first step was an online poll of 26,000 U.S. employees on long-term incentives: Did they like options? Were there other things they’d rather have? In all, 12,000 employees responded to the fall 2003 survey, a number Posner calls “very high.” At the time, several of Merck’s most recent options grants were underwater, and poll data showed strong support for adding other equity incentives. The ad hoc committee complied. They restructured the long-term compensation plan so that beginning in 2004, Merck’s top 200 executives globally would be eligible to receive a mix of options, performance-based shares pegged to growth over a three-year period, and restricted stock units, also with a three-year vesting period, with one given for every three previously granted options. A lower tier of 3,800 U.S. managers who previously were eligible for options only would be eligible for a mix of 75 percent options and 25 percent RSUs.

    Merck didn’t need shareholder approval for the changes, which were covered under an existing omnibus stock plan. But the company’s board was required to sign off, which it did in late 2003, after clearing it with an outside compensation consultant.

    Because public companies are already required to expense performance-based shares and RSUs, the change wasn’t cost-free, though Merck hasn’t publicly disclosed the expenses on earnings. “There’s an impact on our bottom line, but we made it because we thought it was the right thing to do,” Posner says.

    Merck initially communicated the changes to all 4,000 employees through a series of documents e-mailed in early 2004. The company followed up by holding approximately 100 town hall meetings at its facilities around the country. Seminars were run by an outside financial-advisory firm because “they could bring expertise to the table, and were viewed as objective in the information they provided,” Posner says. The two-hour seminars included a formal presentation and Q&A sessions where the consultants and Merck compensation department officials fielded questions.

    Today, Posner is preparing to roll out the new compensation program to 1,100 Merck managers outside the United States, a task that had to wait until the company cleared legal and regulatory hurdles in some 90 countries. After that, the compensation team will begin weighing which of the company’s remaining 50,000 employees who are eligible to receive options will be next.

    Not all companies are dropping options and replacing them with something else. One company that unapologetically cut options without adding another type of benefit is Sears, Roebuck and Co. In January, Sears announced an overhaul meant to put it on a par with Wal-Mart and other rivals. Beginning in 2005, Sears will phase out its pension plan, reduce bonuses, increase pay for hourly workers and drastically cut options. Previously, all of Sears’ 17,000 salaried employees were eligible to receive options. Starting next year, only 2,500 employees at the director level or above will be eligible, says Chris Brathwaite, a Sears spokesman. “Most retail companies do not make annual stock-option grants to all salaried associates,” Brathwaite says. “To succeed and grow, we needed to be more competitive.”

    But at other companies, the appeal of stock options hasn’t dimmed, despite industry trends. Costco Wholesale Corp. grants options to about 1,200 store managers and buyers annually or biannually. That didn’t change even after the $42 billion warehouse retailer began expensing options in 2002. The Issaquah, Washington, company estimated that in fiscal 2003, expensing options decreased pre-tax income by 1 percent.

    If Costco were to modify anything, it would be to add RSUs or performance-based shares to options, but not to cut the number of managers eligible to receive them, says Richard Galanti, Costco chief financial officer. “Historically, senior management’s philosophy has been that having some skin in the game is positive,” Galanti says.

Workforce Management, September 2004, pp. 64-67 — Subscribe Now!

When dot-coms ruled the universe, stock options were revered as the best way to snag a prized vice president of marketing or a promising engineer. That was so 20 minutes ago.

    Today, options are under fire, with accounting-rules changes, disgruntled shareholders and stocks trading under grant prices. What’s a company to do? Drop them. Roughly a third of 108 companies responding to a recent Mellon Financial survey said they’ve cut option-grant eligibility, participation and amounts. Hardest hit: nonexempt workers. Of companies dropping options for employees other than executives, more than half said they won’t replace them with anything.

But that kind of thinking could be shortsighted, as it may lead employees to leave for more lucrative pay packages, says Ted Buyniski, a principal in Mellon’s compensation consulting practice in Boston. In addition to helping with the Mellon survey, Buyniski participated earlier this year in roundtable discussions about upcoming accounting-rules changes affecting stock options sponsored by the Financial Accounting Standards Board. Here’s what he has to say about trends affecting options and companies’ stock-based pay plans in general:

Why will lower-level employees feel the brunt of companies’ granting fewer options?
    When options become an income-statement cost, the marginal cost to companies is going to skyrocket. When they look to cut costs, where’s the first place they’re going to look? Not at the top-five [officer] level, but across the rank and file.

If companies cut options, what will they offer instead?
    A minority aren’t going to cut back, and another minority, if they cut back, will increase salary or incentives or something else to make up for it. A majority of companies won’t replace them with anything. That’s a sound notion if you’re in an economy with a lot of unemployment because people are happy to have a job. But in today’s economy, you’re getting more start-ups and hiring is picking up. Those companies that dramatically reduce options and do nothing are going to lose people.

Why would a company do that?
    Because they think they can. But as a practical matter, if you cut pay, most people don’t react positively. Then the question becomes, do you provide something with the same perceived level of benefit, or do you hope employees are going to decide there’s enough other good in being here that they don’t mind?

You describe options as pay. Do employees perceive it that way?
    They may not assign a dollar value to it, but they’ll say, “You took something away from me; are you giving me anything in exchange?” If you take away options and give them a salary increase or a bonus, they may decide the value is worth more than the options, especially at a lot of companies where options have been underwater for two or three years. One of the real questions companies are dealing with is, “Where is the trade-off level?” For example, a company might take away $10,000 of options from an employee and give them a $2,000 salary increase. From the employee’s perception, the $2,000 is worth a lot more to them than the options because options have been underwater. The ideal situation is to create a win-win: reduce the cost to the company and improve perceived value to the employee.

Do you know of companies that have done that?
    A software company I work with significantly cut the percentage of employees receiving options in a given year in anticipation of upcoming accounting changes. Before, half the employees got them; now a quarter do. At the same time, they provided an across-the-board salary increase over normal merit raises. Employee response was good, and compared to keeping their old option program under expensing, they’ve eliminated a third of the cost, even with the salary increase.

Companies that cut options won’t talk about it because they don’t want to look like bad guys. But companies that replace options with something else aren’t talking either. Why not?
    They want to keep a leg up on the competition. If Company A comes up with a good response, the way they want other companies to find out about it is when they start taking good employees.

Some companies are committed to giving stock options even if it depresses earnings. Why?
    One thing that came through in the survey is that equity compensation isn’t dead. You’re still going to have a significant minority, 35 to 40 percent, that uses equity incentives, and options are still the primary vehicle up and down the ladder.

When will the accounting changes take effect?
    That’s the $64 million question. After the FASB roundtables in June, they announced there may be a delay. That may be in response to feedback we gave them that if changes aren’t released until the end of the year, people won’t have their systems up and running for Q1 reporting. I think FASB will make their release after the first of the year.

How could Congress affect the accounting rules?
    FASB is a non-governmental body, so Congress could overrule it. There’s a range of proposed legislation out there, from pro-option to anti-option. The bill [that has gone the furthest] passed the House in July. That would expense options only for the top five executives. It’s a compromise, and compromises are never good accounting. But the Senate Finance Committee said they wouldn’t take it up this year. Another bill says FASB can’t do anything for three years while the SEC studies the issue. Another says you only get a tax deduction to the extent that you take an accounting charge, which is even more onerous. Another bill says executives and directors can’t be granted stock options. If you wanted to put money on something passing this year, I’d be happy to bet against you.

Meanwhile, what’s a human resources manager to do?
    Get ready. Practically speaking, there will be expensing; it’s just a question of whether it’ll be in 2005 or 2006. A good compensation director or vice president of human resources is looking at what the cost would be of continuing the existing program, what they could do to deliver comparable perceived value at a lower cost, and whether their programs are already structured so that they could do that.

Since their inception seven years ago, intensive summer “boot camps” for non-business majors held by prominent U.S. B-schools such as Dartmouth’s Tuck School of Business and NYU’s Stern School of Business have prepared students for corporate jobs with McKinsey, Fidelity, General Mills and UPS, among others. Here’s a quick rundown of some of these programs.

School	Year Started	Description	Cost	Students in 2004	Corporate-Sponsored Students	Companies that have hired program grads
Dartmouth Tuck School of Business Bridge Program	1997	Two four-week, full-time, noncredit sessions for sophomores and older	$7,5000 includes tuition, books, room and board (scholarships available)	260	18 in 2004, 606 to date	American Express, Bain Capital, Fidelity, General Mills, Goldman Sachs, McKinsey, Brandes Investment
NYU Stern School of Business Undergraduate College Stern Advantage Program	2000	One six-week, full-time, three-credit session for sophomores and older	$8,450 includes tuition, books, and room	37	None so far	Boston Capital, CIBC World Markets, Pfizer
Stanford Graduate School of Business Summer Institute	2004	One four-week, full-time, noncredit session for juniors and older	$8,000 includes tuition, books, room and board	55	None so far	Not available
UC Berkeley Haas School of Business Business for Arts, Sciences and Engineering Program	1998	One six-week, full-time, for-credit session for sophomores and older	$5,175 includes tuition, books; optional room and board $1,655 to $2,160 extra	43	None so far	DHL, General Electric, KPMG, McKinsey, Ogilvy & Mather, Price Waterhouse, UPS

Not long ago, companies considered cash-balance pension plans ideal for limiting financial liability and providing a more portable retirement program to today’s mobile workforce. The plans, a cross between a traditional defined-benefit plan and a defined-contribution plan, have been adopted by hundreds of major U.S. corporations since the 1980s, including IBM, Federal Express, Eastman Kodak and Delta, and cover an estimated 7 million workers. Hundreds more businesses looking to exit traditional defined-benefit plans were preparing to convert, according to government and industry experts.

    But in the space of a year, cash-balance plans turned from panacea to pariah. The turning point: a federal court’s landmark ruling in July 2003 that IBM’s cash-balance plan violated age-discrimination laws, throwing into question the legality of all such plans. In February, the same judge ordered IBM to pay back benefits, which plaintiffs in the class-action suit estimate could amount to $6 billion, a claim the company denies.

    Anxiety over cash-balance plans doesn’t end there. Proposals for federal regulation of cash-balance plans have rattled around Capitol Hill for years but remain just that–proposals. In February, the Treasury Department issued its latest proposed guidelines, only to be met by criticism from employer and employee groups. Interested parties now doubt that Congress will act on the matter before the November presidential election. Meanwhile, the Equal Employment Opportunity Commission has logged 950 consumer complaints about cash-balance plans, according to an agency spokeswoman. Karen Friedman, policy strategies director for the Pension Rights Center, a Washington, D.C., retiree lobby group, sums things up, saying simply: “The cash-balance situation is at a standstill.”

    The uncertainties have companies on edge. Some are waiting things out, sticking with existing defined-benefit or cash-balance plans. Others have frozen cash-balance accruals and switched to defined-contribution plans such as 401(k)s. Consultants report that a handful of clients have discontinued pension plans altogether.

    One company typical of those leaving behind cash-balance plans is Avaya Inc. On January 1, the $4.3 billion communications services business froze accruals for both a cash-balance plan and a traditional defined-benefit plan that together covered the company’s 7,500 U.S. salaried employees. In their place, the Basking Ridge, New Jersey, business installed an enhanced 401(k). An $800 million pension-fund deficit prompted the change. But the possible liability associated with cash-balance plans was a major factor, says Mike Harrison, Avaya’s vice president of global benefits and compensation, who spearheaded the overhaul. The IBM lawsuit specifically pushed the S&P 500 company away from cash-balance plans, Harrison says. “We didn’t want to go down that road.”

    Avaya isn’t alone. According to a Deloitte Consulting pension-plan survey released in May, more companies are shifting away from defined-benefit plans. Deloitte polled 125 companies with a median $1 billion revenue and found that 27 percent had recently changed plans. Of that number, 38 percent had moved to defined-contribution plans, says Brian Augustian, head of Deloitte’s retirement practice and the survey’s author. Avaya inherited a portfolio of pension plans when it spun off from Lucent Technologies in October 2000. Salaried employees who’d started at Lucent before 1999 received 1.4 percent of their average earnings from 1994 to 1998 for every year they’d worked before 1999, and 1.4 percent of earnings for every year worked after. Lucent employees hired after 1999 were covered by a cash-balance account, in which the company contributed 3 percent to 10 percent of their annual earnings, depending on the employee’s age. Hourly workers were covered by yet another plan under a union collective-bargaining agreement.

    At the time of the 2000 spin-off, the existing pension plans covered 14,200 U.S. salaried employees, or about 42 percent of the new company’s global workforce. In the ensuing years, Avaya restructured extensively, shedding business units and cutting the total number of worldwide employees by more than half. At the same time, the stock market crash and low interest rates took their toll on Avaya’s pension fund, by 2003 creating an $800 million shortfall in the $3 billion fund. To stem the losses, Avaya used $105 million from a September 2003 stock offering of $352 million to help pay down the pension fund’s liability. At the same time, Avaya announced the switch to a defined-contribution plan.

    Under the new plan, Avaya stopped funding its existing plans, which means that when existing employees retire they’ll get whatever was in their pension fund as of December 31, 2003. In its place, Avaya created an enhanced 401(k) for existing employees and salaried workers hired on or after January 1, 2004. In the enhanced 401(k), employees automatically receive 2 percent of their annual salary and bonus, a 100 percent company match for the first 2 percent they contribute and a 50 percent match for the next 4 percent they contribute.

    After less than five months, Harrison says that changes in the fund had “significantly reduced” future cash-flow requirements and expenses. He declined to elaborate. Avaya uses Fidelity Investments to run the 401(k) program, giving employees 26 options for investing in mutual funds, bond funds and company stock. To help employees understand the change, Avaya held educational seminars from January through April, though Harrison admits the classes weren’t as well attended as he would have liked.

    Even so, Harrison believes that employee dissatisfaction with the new plan is minimal. “We were very up-front about what we were doing, starting with our CEO,” he says. “People understood what we were doing and why we were doing it, and it was consistent with other actions we were taking to manage cash flow and our financial position.”

    Restructuring pension plans at other companies hasn’t gone as smoothly. In February, U.S. District Court Judge G. Patrick Murphy, in the Southern District of Illinois, found IBM liable for retroactive pension benefits. Translation: IBM may have to recalculate benefits for 140,000 employees and retirees. The suit is pending, with both sides preparing damage estimates. IBM maintains that it doesn’t owe anything and has previously stated that a loss won’t materially affect its operations.

    IBM isn’t the only company on the losing end of a cash-balance lawsuit. In February, Georgia-Pacific settled a seven-year-old suit for $67 million that alleged the company underpaid workers who took lump-sum pension payments upon retirement. In November 2003, Xerox settled a similar suit for $239 million, a month after the U.S. Supreme Court refused to stay an appellate court ruling against it. Xerox took an $183 million charge to help cover the costs. As of early May, plaintiffs’ attorneys were determining how many retirees would receive settlements, and how the money would be divided. Cases against AT&T and CIGNA Corp. are pending.

    Meanwhile, the Treasury Department’s February proposal attempts to clear up companies’ concerns about the legality of cash-balance plans. The proposal came three months after federal lawmakers voted down a Bush-sponsored amendment to an annual spending bill that would have limited cash-balance conversions.

    Treasury’s latest proposal provides five years’ worth of transition relief to workers after a company converts to a cash-balance plan. Under the plan, employees would receive the better of what the benefit was under the traditional plan or the cash-balance plan. It would ban so-called “wear away,” in which employees accrue fewer benefits under a cash-balance plan than under a traditional plan. To discourage companies from converting to a less generous plan, it would impose a 100 percent excise tax on the difference between the traditional pension benefit and the lower cash-balance. Finally, it would clear cash-balance plans of violating age-discrimination tests if they met certain funding tests.

    Employer and employee groups aren’t taken with all aspects of the plan. If forced to continue an old plan for five years after converting to cash balance, most employers would just switch to a 401(k) plan, which doesn’t require a five-year conversion period, says Ron Gebhardtsbauer, senior pension fellow with the American Academy of Actuaries in Washington, D.C. However, employee groups want an even longer conversion period, he says.

    The sooner that groups come together to iron out their differences, the better, says Janice Gregory, senior vice president of the ERISA Industry Committee, a Washington, D.C., employer lobby group. A major obstacle: getting lawmakers up to speed on the issue.

    To that end, Sen. Tom Harkin (D-Iowa), an advocate of employee pension rights, has been working to schedule a summit for interested parties to hammer out policies acceptable to all that he could potentially introduce as legislation. “We’re at a crossroads,” one Harkin aide says. “This is a point where we can move.”

Workforce Management, June 2004, pp. 81-82 — Subscribe Now!

Employee Plans Team Audit program main page on the IRS Web site
Contains a history of development of the new, tougher audits, questions and answers, issues to look for, flowchart of how an audit works, glossary and how to contact any of six regional audit teams.

Questions and answers about the program
Answers to common questions asked by outside audit firms and IRS agents about the Employee Plans Team Audit program. Questions should be directed toMark Hoffman, national coordinator.

Top ten issues found in audits
A detailed list of potential pension-plan trouble spots. The Employee Plans Team Audit uses these to help determine which companies they’ll audit, and consultants suggest companies use them as guidelines for their own compliance reviews.

Voluntary Corrrection Program
Companies can make corrections to their pension plans through the IRS’ Voluntary Correction Program.

A year ago, Kennametal Inc. could have served as a textbook example of how big companies hire senior executives. The $1.8 billion multinational tooling and engineering company used search firms to identify prospects, then invited top candidates to its Latrobe, Pennsylvania, headquarters. There they’d spend a half-day interviewing with key executives and human resources managers. “It was a fairly traditional and typical interview process,” says Jeffery Holst, Kennametal’s organizational effectiveness director.

    But over the past few years, as executives sought to improve talent development for the western Pennsylvania company’s 13,500 employees, they concluded that to get higher-performing mid- and upper-level managers they needed to ask better questions in interviews. So in August 2003, Kennametal retained industrial psychologist Bradford Smart and his firm, Smart and Associates, in Wadsworth, Illinois, to conduct a two-day workshop on his “Chronological In-depth Structured” interview process for the publicly traded corporation’s top 65 executives. In the session, staff who typically interview job candidates–human resources and other top-level execs–learned to administer a series of highly formatted interview questions covering candidates’ education and career achievements and how they behaved to accomplish what they’d done. “It’s more than what 95 percent of corporate America does,” Holst says. Kennametal followed up by licensing interviewing guidelines and other materials from Smart and distributing them to human resources managers globally via CD-ROM.

    It has paid off already. Since August, Kennametal has used the technique “dozens” of times in interviews with top-tier job finalists, Holst says. “In several situations, people who we thought were the right people we decided after more in-depth [interviewing] weren’t right after all,” he says.

    Kennametal isn’t an isolated case. Companies large and small are putting middle- and upper-level management candidates through more hiring hoops. Organizations that once considered a recruiter’s recommendation, interviews with senior staff, some solid references and perhaps a skills test good enough are now requiring that finalists for top-tier jobs go through even more vetting. Blame it on the fear factor. Nobody wants their company to be the next corporate scandal splashed across the front page. The bad economy, the stock market decline and security concerns after 9/11 also helped push companies to adopt more stringent executive-hiring practices, according to human resources directors, executive recruiters and other industry watchers. Even as the economy appears to be on the mend, hiring for the corner office will never go back to what it was in the old days.

    “People are scared, boards are scared because they’re being held accountable,” says David Pfenninger, president of Performance Assessment Network, a testing company in Carmel, Indiana.

    Another driving factor is money. One mishire can cost a company 14 times the salary of a manager making less than $100,000 a year, and up to 28 times the salary of someone making $100,000 to $250,000 a year, according to Smart’s 1999 book, Topgrading: How Leading Companies Win by Hiring, Coaching and Keeping the Best People, based on 4,000 interviews with people at public and private companies. By that estimation, firing a single ineffective top manager making $200,000 a year could cost a company roughly $5.6 million. “It could be even more than that,” says Holst, “if you hire someone like a sales manager who alienates all your customers and then leaves after six months. That [cost] is hard to measure, but it’s huge.”

    In the post-Enron world, experts say, candidates for senior posts can expect to be put through a battery of assessments, including tests that measure intelligence, problem-solving ability, people skills, management style and fit with a particular corporate culture. Group interviews are popular, as are workplace simulations in which a candidate may have to assemble facts for a boardroom presentation.

    Web-based tests such as those administered by Performance Assessment Network and a growing pack of executive-search firms are on the rise, giving human resources managers a low-cost method of screening job candidates before forking over big bucks to hire them. Biodata testing, in which testers gather biographical and personal information and match it against normative databases to predict a potential employee’s future performance, is also gaining popularity. Procter & Gamble Co., which has used biodata testing on job candidates at all levels for decades and administers more than 100,000 such tests a year, began marketing the measurements to other businesses late last year.

“If you hire someone like a sales manager who alienates all your customers and then leaves after six months. That [cost] is hard to measure, but it’s huge.”

    Implementing more stringent executive-hiring programs isn’t always cheap. At Kennametal, the Smart and Associates workshop and licensed materials have cost about the same as a single mishire, Holst estimates. The bigger expense has been taking busy managers away from their jobs to go through the interview training. To help cut those expenses, Holst has traveled to corporate divisions in the United States and China to conduct follow-up workshops, and will travel to Kennametal offices in India and Europe this year.

    To Smart and Associates’ basic interviewing protocols, Kennametal added questions designed to identify competencies that the corporate culture considers important, including management integrity, Holst says. Screening potential managers for ethics is especially critical outside the United States because standard operating procedure in some countries can be “rough and tumble,” he says. Kennametal started 66 years ago in a small town outside Pittsburgh, “and small-town beliefs, ethics and behaviors were at the formation of this company, and we’ve hung on to them even though we’ve grown.”

    The popularity of extra pre-employment analysis has been a boon for testing companies and consultants. Pfenninger, a clinical psychologist who markets Web-based assessments from 47 publishers to a client base of 5,000 companies and consultants, says that sales of management tests have increased 40 percent in the past four years. Jill George, consulting vice president and assessment practice leader at Right Management Consultants in Philadelphia, says that the number of companies using her services has tripled since 2002. Interest is coming from a variety of industries, including banking, pharmaceuticals, manufacturing, food, financial services and health care, she says.

    One of Right Management’s customers is DuBois Regional Medical Center, a $120 million nonprofit medical center that owns two hospitals and several physicians’ groups in the city of DuBois, in rural west-central Pennsylvania. Executives at the 291-bed medical center were blindsided when several department heads who had performed superbly in pre-employment interviews fell short on the job. The mistakes were costly. When the managers were let go, the medical center lost $100,000 in recruiting fees, relocation expenses and severance packages–per person–according to Susan Grady, human resources vice president. That sum didn’t include what Grady refers to as “the hidden costs” of leaving a hospital department with no leader, causing employees to fret and disrupting patient care.

    At a time when DuBois was growing quickly to cement its spot as the region’s No. 1 health-care provider, but facing the usual government and insurance reimbursement squeeze, wasting money on more bad hires wasn’t an option. So in 2000, DuBois hired George to perform intensive pre-employment screenings of upper-level job candidates. George also created benchmarks based on existing hospital execs’ characteristics. Those traits included high levels of integrity, strategic thinking, innovation, a passion for customer service and a “workaholic” nature, Grady says. Now, when a spot opens up for, say, a cancer center manager or heart surgery department head, candidates won’t move on to interview with senior executives unless they pass the screening and meet the benchmarks.

    The results have been outstanding: the hospital’s ability to pick top performers has risen 30 percent to 50 percent in the past four years, George says. Without such testing, Grady says, “sometimes you get so involved in thinking ‘I’ve found the right person’ that you don’t ask the right questions.”

    Since 2000, DuBois has spent $125,000 to put 25 job candidates and current managers through Right Management’s assessment program. To Grady, it was money well spent. “Assistance in making the right decision to hire or promote is worth much more than the original investment,” she says. In fact, DuBois senior managers were so pleased with the results that they’ve brought the program down to the supervisor level. The medical center also is using information culled from more rigorous pre-employment screening to map out career paths for the managers they hire. “It’s a good retention strategy because the candidates will feel they’re interested in them,” George says.

    In the past year, DuBois also has begun putting existing managers who’ve been tapped to take over spots on the executive committee through the same assessment program. Grady is using the information to teach the director of human resources, who has been tapped to be her successor, what work he would need to do if she were to leave. “We’re in the middle of a building campaign, and if someone should leave, the board wants someone who could step in who understands our philosophy and traditions,” she says.

Workforce Management, May 2004, pp. 70-72 — Subscribe Now!