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Incentive Compensation

Although many people use the terms interchangeably, there are considerable differences between bonuses and incentives. And those differences relate to the specificity inherent in incentives, which consist of predetermined performance goals and identified award levels. Bonuses, however, are usually more discretionary in nature.

There are at least 10 good reasons why a company might consider adopting an incentive plan. They are:

  1. Allows the company to focus attention on certain desired performance.
  2. Since rewards are tied to achieving specified performance, uncertainty as to entitlement is eliminated.
  3. The company is forced to actually plan ahead and identify its expectations.
  4. By putting a portion of the compensation “at risk,” the company can control fixed costs associated with salary increases.
  5. Typically, incentives are not included in calculating benefits and therefore can save the company in the long run.
  6. Helps a company to recruit better candidates, since prospective employees recognize the opportunity to earn higher compensation based on their contribution.
  7. Allows the company to “put its money where its mouth is,” by tying pay to results.
  8. Since incentives are typically designed to be “self-funding,” this means funds are available when goals are achieved.
  9. The majority of companies offer some form of incentives; therefore, in order to remain competitive, it is essential to offer some form of incentive.
  10. We’ve run out of reasons, but our clients agree that incentives make sense!

Annual incentive programs are plans that provide incentive pay based on short-range performance (typically performance over 12 months or less). Annual incentive programs may consist of short-term incentives, and may include a component tied to long-term incentives. The form of payment of these incentives may be stock-based, cash-based or a combination of both.

The goals of an incentive program are to:

  • Attract and retain key employees
  • Increase productivity and profitability
  • Focus attention on the achievement of desired goals and objectives
  • Encourage and motivate involvement
  • Cut costs

In order to achieve these goals, annual incentive programs focus attention on desired company results, tie pay to performance, provide “at-risk” compensation and provide a competitive total cash compensation package.

With greater emphasis on “pay at risk,” long-term incentives have become the largest portion of total compensation for many executives. Long-term incentives can be stock-based or cash-based:

  • Restricted Stock
  • Restricted Stock Units
  • Stock Options
    • Non-Qualified Stock Option
    • Incentive Stock Options
  • Performance Units
  • Stock Appreciation Rights (SARs)
  • Cash Performance Target Plan

Developing an effective long-term incentive plan can be a time-consuming process. Consideration needs to be given to the tax and legal implications of the plan, as well as the ability of the plan to drive the desired behaviors, while retaining top talent. However, the long-term benefit of an effective long-term incentive plan is invaluable to the success and viability of a company.

To find out more on how Compensation Resources, Inc. can help you decide if incentives are right for your company, please call Paul Dorf, Harry Schum, Mary Rizutti or Diana Neelman at 877-934-0505.