Employee Bonus Plans: Consequences and Best Practices

Introduction

Employers are constantly looking for ways to attract qualified employees, and bonus plans have been a driving force in the business world. The implementation of bonus plans is often used by employers in an effort to attract and retain qualified employees. In recent years, the consequences of such plans have been carefully scrutinized. The purpose of this discussion is to examine some of the consequences that companies face when they decide to implement bonus plans, as well as the steps that can be taken to avoid those negative consequences. The paper begins by discussing what bonus plans are and why they are needed.

Bonus plans are reward systems given to employees to encourage loyalty and ensure good performance (Amsler et al., 2002). According to an article in the Journal of Managerial Issues, most bonus plans are based on merit — meaning that the compensation received is tied to an employee's performance (Amsler et al., 2002). These plans are often used by employers to increase the productivity and morale of their workforce. As one source notes:

What Are Bonus Plans and Why Are They Needed?

"Many U.S. business owners are finding that turning to incentive programs — in which pay is linked to performance — is a good way to spur sales, boost productivity, and improve employee morale. These non-traditional reward programs, which can include gain-sharing, pay-for-knowledge, and small group incentive/lump-sum bonus plans, are becoming increasingly popular as the traditional merit increase becomes a taken-for-granted, ineffective stimulus." (Freeman)

Bonus plans are needed because "bonuses give employees an added incentive to complete projects on time and to seek out upcoming projects they can work on" (Bowers, 2003). Many large companies are well known for the types of bonus plans they offer, which range from monetary rewards to travel giveaways. In any case, the use of bonus plans has become deeply embedded in American business culture.

A study published in the Journal of Managerial Issues and conducted at a large service corporation examined the impact and consequences of bonus plans. In this study, merit bonus plans were the focus. The authors explain:

"Under a new pay system implemented by the Corporation, all exempt employees were to be compensated by a two-component plan. The first component consisted of base salary and the second component consisted of a merit pay bonus, which would be allocated to employees based upon their rated performance in relation to preset goals. The merit bonus was designed to make a portion of employees' pay variable; this portion was to be contingent upon job performance. Therefore, total compensation theoretically could vary significantly with current performance. As a part of the pay plan, individual goals were established, with employees and their supervisors agreeing on the range and scope of the tasks to be performed by the employees during the annual rating period. Employees' bonuses were then determined by supervisory ratings of the degree to which preset goals were met. The maximum possible bonus available to an employee who achieved the highest performance rating was 20 percent." (Amsler et al., 2002)

Consequences of Bonus Plans

The participants in the study came from different departments and held various levels of responsibility within the corporation. The study suggests that those in top positions benefit most from bonus plans and report higher levels of job satisfaction. The study also notes that bonus plans must be presented to employees in a manner that is proportional to the hard work they have displayed, relative to their individual skill levels. When managers fail to properly compensate employees, diverse consequences can result — including decreased morale, animosity among workers, lower productivity, and poor employee loyalty. When such consequences arise, the impact can be devastating and difficult to recover from (Amsler et al., 2002).

There is an overwhelming consensus that one of the worst consequences of bonus plans is that they sometimes reward people who have not earned a bonus. Many argue that bonus plans often backfire because they reward employees even when performance is poor. According to an article entitled "Bonus Plans: Why Most Fail," when an employee is unable to perform a skill at a high standard, offering that employee a bonus will not enhance their ability to perform that skill (Porter, 2003). The article explains that "if an employee cannot perform a certain skill, then rewarding their performance will not help. For example, if a salesperson is poor at selling, then paying a commission will not teach them to be a good salesperson" (Porter, 2003). Although managers do not aim to reward poor performance, many bonus plans — especially those not based on merit — inadvertently do so (Porter, 2003).

According to the article "Bonus Plan Rx: First Aid for Short-Term Incentive Plans," there are several additional consequences of bonus plans (Dalik and Goldman). These include:

1. Bonus plans that are unaffordable for the firm — In many cases, managers overlook the financial aspects of creating a bonus plan and find themselves unable to meet the financial obligations it requires.

2. Insufficient stakeholder support — The stakeholders in a firm need to support a bonus plan if it is to be properly implemented.

3. The absence of bonuses or "windfall" bonuses resulting from factors outside the employee's control — Once a bonus plan has been implemented, employers must honor their commitments and ensure that external factors do not interfere with plan execution.

4. Employees' unwillingness to alter their performance to align with the firm's business strategy — This occurs when bonuses are not awarded on the basis of merit, leaving employees with little incentive to change their behavior.

5. Unreasonable focus on a few business strategies — Companies that implement bonus plans must consider the firm's overall strategy, not only the strategies that directly affect the bonus plan.

6. Poor performers receiving too many bonuses and strong performers receiving too few — This consequence can have a profound impact on productivity and employee loyalty.

7. Workers who are unaware of the link between bonus rewards and their performance level — There must be a clear understanding of why an employee is receiving a bonus; without that understanding, work performance is likely to remain stagnant.

8. Exclusive plans that disenfranchise lower-level employees and reinforce inappropriate hierarchical structures — Employers must avoid showing favoritism to senior employees and must recognize that workers at every level contribute to the firm's success.