Variable Compensation: Incentive, Bonus or a Reward?

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Let me start by wishing all of our readers a happy and prosperous New Year. I hope you had a wonderful holiday season, hopefully had some relaxing time with family and friends, rang in the New Year with good cheer and are back to work with a positive outlook. This month’s topic is inspired, in part, by a discussion I had with my staff on this topic at our planning meeting a month ago, as we were massaging our variable compensation program for this year. A week or so later, my friend, Gerhard Beenen, sent me an article, Why Not Give Money Instead of a Gift  that added some fodder. Finally, given that many of you might be planning your compensation programs for this year, I thought this topic might be apropos.

Is there value to supplementing base compensation with variable compensation? Do you have a variable compensation program in your company? Although the employer benefits by indexing a portion of the employees’ compensation to the performance of the company, does it drive the intended behavior in the employees? Is variable compensation an incentive, a bonus or a reward? To explore this, let us focus on the distinction between an incentive, a bonus and a reward, in the context of variable compensation for employees.

An incentive is a contractual agreement (written or verbal) between the employer and the employee in which the employer sets certain predetermined goals upon achieving which the employee is entitled to a predetermined amount of compensation. The presumption is that the opportunity of this compensation will incentivize the employee to work harder to achieve the goals. Typically, incentive compensation is not paid for trying hard or for “almost” meeting the goal; but when the goal is met the employee is entitled to the agreed compensation. So, in an incentive compensation there is an a priori contractual agreement, an expectation that the employee’s behavior will be influenced and the employee has a sense of entitlement when they meet the goal.

A bonus is a contractual agreement between the employer and the employee that allows the employee to share in the “profits” of the company. Although the amount to be shared is usually pre-determined and agreed, there is no expectation that the employee’s specific behavior (drive, motivation, etc.) will be influenced by the bonus program. Nevertheless, both the employer and the employee feel good when the bonus program pays out, and they all feel part of the team. As in the case of an incentive, if the company does well, the employee feels entitled to the bonus. So, a bonus is similar to an incentive but there is no expectation of influencing the employees’ behavior.

A reward has no a priori contractual agreement and, as such, there is no expectation of influencing the employees’ behavior. Nevertheless, the employer, ex post facto, offers the employee(s) some compensation for a job well done – e.g., completing a project, finishing the year with a bang, achieving superior business results, etc. In this situation, the employee has no expectation, and is pleased by the magnanimity of the employer.

To drive home the distinction between the three, let us highlight a subtle point. When an incentive is paid out the employer thanks the employee. When a reward is paid out the employee thanks the employer. When a bonus is paid out they both thank each other.

What works best – incentive, bonus or a reward? Do incentives work? Do people’s behaviors really change? Are people motivated by money to the extent that their behavior can be affected? The article mentioned above has some interesting insight into these questions. Is there value to a bonus? If it is not intended to change behavior, why create the sense of entitlement? Do rewards have long term value? Are they forgotten the next week? Do you have to reward everybody? Do you have to reward every year? If you do, do they become an entitlement and degenerate into a bonus?

These are all questions you should ask yourself. You should have clear convictions and expectations in setting up a variable compensation program. As a proponent of intentional leadership, I posit that at a minimum, having clarity of intent and purpose creates intentionality.

Balaji Krishnamurthy

Chairman, –Think.Shift. has been recognized by TIME,CNN, Wall Street Journal and other national publications for his unique and innovative style of corporate leadership. TIME magazine included him in their list of 25 Global Business Influentials for his influence on corporate leadership. Unlike most consultants, he is an operating executive with 30 years of experience as a corporate leader in both large and small corporations, during which he has personally modeled his innovative leadership principles. Food for Thought is our way of sharing interesting concepts on corporate leadership and management with others who might find it useful. The thoughts offered are intended to be controversial and thought provoking. They are intended to help our readers intentionally realize their potential, what we call Potentionality.

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Chairman, –Think.Shift. has been recognized by TIME,CNN, Wall Street Journal and other national publications for his unique and innovative style of corporate leadership. TIME magazine included him in their list of 25 Global Business Influentials for his influence on corporate leadership. Unlike most consultants, he is an operating executive with 30 years of experience as a corporate leader in both large and small corporations, during which he has personally modeled his innovative leadership principles. Food for Thought is our way of sharing interesting concepts on corporate leadership and management with others who might find it useful. The thoughts offered are intended to be controversial and thought provoking. They are intended to help our readers intentionally realize their potential, what we call Potentionality.

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Last modified: February 19, 2014

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