The objective of variable remuneration is to harmonize owner and management interests by paying higher wages for rising performance.
The predominant method of setting variable remuneration levels is the competitive compensation strategy, which ensures that a company's compensation levels are competitive with those of peer companies in the industry. The goal of the competitive compensation strategy is to retain top talent by paying enough, while also not overpaying. Competitive compensation methods set compensation levels by comparing them to those of similar managers at other companies. The fixed component is typically set at the median pay for comparable executive functions in the industry, while the variable component is set at the third quartile.
The idea of benchmarking compensation to peers is not a bad one, nor is the goal of simultaneously trying to retain good managers with financial incentives without incurring excessive costs. The main problem with the competitive performance approach is a motivational one: the variable component represents an almost fixed amount, independent of performance. Consultants also often recommend linking variable pay to pre-agreed goals. This is problematic because higher performance only leads to higher and therefore less attainable goals in the subsequent period. This situation can actually encourage underperformance when goals for the year are met early, or when it becomes evident that they are unattainable. Additionally, external effects often render previously agreed targets irrelevant. Thus fixed goals can backfire, actually doing the opposite of what they are intended to do, which is certainly not in the interest of shareholders.