Compensation Model: Should You Be Paying Bonuses?

A bonus is a payment that’s in addition to an employee’s salary. There are various types of bonus arrangements. Most common is merit-based — an individual earns a bonus based on performance. Sometimes, though, an incentive is based on how well the company is doing or a combination of the individual’s and the firm’s achievements.

Bonuses usually depend on certain criteria being met. You should be very specific and upfront with your bonus-eligible staff about what they need to accomplish for the incentive to be payable. Sometimes, a bonus is a contractual entitlement, but mostly the decision to pay is at the absolute discretion of the employer. Employers are under an obligation to exercise their discretion reasonably and fairly when deciding whether a bonus is warranted.

Let’s face it: If bonuses have always been paid for certain performance, then a legitimate expectation is created among employees. Your bonus program could be to give all employees a certain share of the company profits — which is known as profit sharing — regardless of the performance of individuals or teams. A bonus to the entire company based on the firm’s performance is an organization-wide bonus.

Other programs give incentives to individuals or teams to motivate them to perform above certain thresholds. In manufacturing companies, teams are able to share in gains from improvements to production and quality in their particular area. A variety of cash and noncash awards are possible for certain types of achievements in some firms — these are known as spot-bonus awards and noncash rewards. And sometimes a bonus is awarded if an employee recommends someone for a position for the company who is hired.

Profit sharing — Usually between 2.5 and 7.5 percent of payroll, but sometimes as high as 15 percent as a bonus on top of base salary. It can be based on the entire company’s profitability or from a given line of business. The purpose is to encourage employees to understand how their work affects the company’s performance and its profitability.

Gain sharing — Designed to reward productivity and improved performance. The incentive is often based on statistical improvements in production and quality on a quarterly or sometimes monthly basis. The award definitely provides a sense of excitement for participants.

Spot bonus — Special recognition, typically $50 and up, made by an immediate supervisor or any higher-level person. The math is in the employees’ favor: Spot bonus programs may equal about 1 percent of payroll. Expect to give out such bonuses to 25 percent of eligible. Employees can earn more than one instant bonus a year.

Noncash bonus — Instills pride and improves employee morale, and is often given to employees in front of a crowded room at a special ceremony. The certificate or trophy is thoughtfully and cleverly designed, and appropriate to the occasion. And it can be coupled with a token tangible award, such as a gift certificate, a bonus day off or a great parking space.

Sign-on bonus — Very popular when unemployment is low and top talent is hard to find. They establish goodwill. Many times these are offered when new employers need to buy out any compensation that’s left on the table from a previous employer (because the employee is forfeiting it to take the new position). Medium-to-large signing bonuses may be paid over a year to protect the company’s interests.

Whether you hand out year-end bonuses or give them to employees throughout the year, you want to create a bonus system that reflects an employee’s actual contributions to the company. Remember, it’s critical to let all employees know how you arrived at the bonus amount so that the compensation is seen as being fairly distributed.