cipd bonuses and incentives
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Bonuses and incentives
CIPD Factsheet Revised February 2012
What are bonuses, cash incentives and non-cash incentives?
Bonuses and cash incentives are a form of variable pay based on the use of cash lump-
sum payments that is, they are not consolidated into basic pay linked to individual,
collective or organisational performance (or some combination of these factors).
Non-cash incentives are a means of incentivising higher performance among employees
by the awarding of prizes or gifts, such as merchandise, travel or retail vouchers,
associated with some performance measure (such as volume of sales).
It is important to draw a clear distinction between the concepts of cash incentives and
bonuses, although the two terms are interlinked, and sometimes used interchangeably.
Incentives aim to directly affect future employee behaviour or performance, usually via the setting of targets: if a specific target is met, the employee will receive a
particular mandatory cash payment.
Bonuses encompass a wider range of purposes and could be discretionary or non-discretionary. Like incentives, they may be used in an attempt to directly influence
employee performance or behaviour to meet pre-set objectives but they could
also be used on a more ad hoc or retrospective basis to reward past performance.
It is similarly helpful to differentiate between the following:
Non-cash incentives (sometimes known performance improvement plans) which are forward-looking, formal schemes that aim to affect directly employees future
performance.
Employee recognition schemes which are retrospective (as they recognise past performance rather than aiming to directly incentivise future efforts) and may be
informal and discretionary. Although not directly covered by this factsheet, such
schemes may be inter-linked with non-cash incentive arrangements.
Background and rationale for bonuses and cash incentives
The increasing trend to incorporate bonus and incentive plans into reward packages has
been driven in part by the influence of the new pay philosophy which advocates that
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guaranteed basic pay should comprise only a relatively small element of the overall
reward package and shift towards strategic reward linking employee performance and
pay to the wider business strategy.
In addition, there has been a move in certain sectors towards market-based pay, whereby
an employee might only receive a pay increase if the market rate for the role (for example,
management accountant) had increased: in this scenario, individual contribution could be
recognised via a bonus instead of a pay rise.
For the employer, the advantages of bonuses/cash incentives when compared to
consolidated salary increases include:
ongoing motivation effect as bonuses have to be re-earned
lack of impact on certain employer on-costs that are linked to basic salary levels
capacity for maintaining market pay competitiveness without necessarily inflating
the annual paybill
lexibility through, for example, the ability to reduce or even halt payments during
economic downturns.
For the employee, the main benefits are:
greater control over own levels of remuneration
higher payments are potentially possible.
But the downside for employees includes:
in effect, the flip side to certain advantages for the employer, for example, that non-
consolidated payments must be re-earned or may not currently count towards
pensionable pay
payments may be unpredictable or lower than expected if targets cannot be met.
Types and coverage of bonuses and cash incentives
The payment of bonuses and cash incentives is generally linked either to the quality and/
or quantity of work, on an individual or collective basis, or to some measure of company
performance such as profit levels (or both).
Schemes may be broadly divided into the following categories, although definitions vary
and may overlap or be linked.
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Individual-based. Under these schemes, payment of the bonus/incentive is determined by some measure of individual performance, hence there should be a
considerable incentivisation effect. Sales commission could be included within this
category (although this might be regarded as a distinct form of remuneration in its
own right).
Schemes driven by business results. These schemes often use company profit levels as a measure to help determine bonuses.
Team-based. Such schemes link the bonus with some measure of team performance, often with the aim of fostering effective teamworking.
Ad hoc/project based. This arrangement might be used when a particular deadline is imperative, for example to reward construction workers for completing a building
project on time although such schemes may be open to manipulation.
Department/site-based. A variation on the collective bonus theme, payments could be pitched to reward, for instance, production workers who attain productivity
improvements in one particular plant in a manufacturing firm.
Gainsharing. An approach based on the idea that employees should be able to share in financial gains achieved through improved performance (particularly
enhanced productivity).
Combination. Bonus or incentive payments can be based on a combination of two or more of the above programmes.
There are also a number of more specialised bonuses that are beyond the scope of this
factsheet, for example the Christmas bonus, the attendance bonus and the retention
bonus.
According to our annual Reward management survey, the majority of employers overall
operate some form of cash-based bonus or incentive plans. However, such schemes are
far more common in private services and manufacturing than in the public or voluntary
sectors.
The most popular arrangements include individually based plans (for example, personal
performance or commission), plans driven by business results (such as revenue) and
combination schemes.
See more from our annual reward survey reports
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CIPD members can find more detailed information on how to design and implement bonus
plans in our practical tool.
Go to Bonuses and incentive plans: a development guide
Payment levels and recent developments in the use of bonuses
Levels of payments
If they are to impact on employee behaviour or performance, bonus or incentive payments
need to be worth having, that is, set at a sufficiently high level to have an effect. By
contrast, caution needs to be taken in setting bonuses at very high levels to avoid driving
undesired behaviours or outcomes. Market practice may also need to be taken into
account.
An important factor in the calculation of any bonus is that it is kept as simple as possible.
Ideally participants should be able to measure progress against targets and carry out the
calculation themselves so that they know how they are progressing and what payment
level might be achieved.
Employers need to decide the means to be used for determining bonus payments,
including whether to make use of a formula and how to express payments (for example as
a percentage of salary or as a flat rate payment).
Our 2010 Reward management survey includes a detailed examination of both target and
maximum bonus/incentive potential broken down by sector and occupation. More detailed
information tracking specific breakdowns of bonus payments over time (by gender, for
instance) can be found in the government-sponsored Annual Survey of Hours and
Earnings1.
See the results of our 2010 reward management survey
Recent developments
In the wake of the global banking crisis and structural upheaval in the financial services
sector, the use of bonuses has become a highly contentious issue with the whole nature
and mode of operation of bonuses called into question. Remuneration practices were
deemed to be a contributory factor to the market crisis in a report from the Financial
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Services Authority (FSA)2. Practices in investment banking in particular tended to reward
short term revenue and profit targets and, in so doing, gave staff incentives to pursue
unduly risky practices.
A range of measures has been introduced, with further proposals anticipated, in respect of
the regulation of remuneration in the finance sector, particularly affecting senior pay. These
include the bestowing of a duty on the FSA to ensure remuneration policies are consistent
with effective risk management3.
Essentially, many reward specialists belive, there is a need for a continuing clear link
between high levels of performance and the payment of bonuses, but with a need to avoid
the problems that may arise if a lack of rigour in the application of this principle means that
bonuses are in practice rewarding less-than-robust performance.
Background and rationale for non-cash incentives
Cash may not be the most effective means of motivating employees, it is sometimes
argued, as it does not necessarily motivate them to go the extra mile in their current role.
The use of non-cash incentive schemes, based on the receipt of a gift or prize, is arguably
more memorable and exciting hence the greater incentivisation impact.
Typically found in customer-facing industries, non-cash incentive schemes may be based
on the use of a single prize to be won by the highest-performing individual employee or
encompass a range of awards recognising different levels of achievement.
The benefits of using non-cash incentives include:
Affordability: Non-cash incentivisation programmes may be more affordable than alternatives such as cash bonuses.
Simplicity: It is very easy for a sales employee to understand that, say, selling so many insurance policies will result in the receipt of a new flat-screen television.
Psychological impact: it is acceptable for employees to speak openly with pride about the winning of gifts in a way that would be considered by many to be socially
unacceptable it they were seen to be bragging about cash bonuses.
On the downside, drawbacks may include:
Lack of credibility: such prizes may not be taken as seriously as cash.
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Lack of employee awareness: employees may be less conscious of the value of non-cash incentives over hard cash.
While the incentivisation industry is more highly developed in the USA, it is also growing in
popularity in the UK. According to our latest Reward management survey (see link above),
however, non-cash incentive schemes are currently operated by only a minority of
employers and are most commonly found among private sector and larger organisations.
Designing and operating non-cash incentive schemes
Types of non-cash incentives
The main types of non-cash incentives may be broadly divided into the following
categories:
merchandise, such as ipods, mobile phones or watches
activities/special events such as meals out, hotel spa accommodation/treatments or hot air ballooning trips
travel, for example an all-expenses paid trip to Australia
retail vouchers, which are often obtainable at a discount to face value
the awarding of points under a points-based systems that may be converted into a range of awards.
It is worth noting that under some stricter definitions, the latter two categories might not be
regarded as non-cash items.
Selecting a supplier
Numerous suppliers of non-cash incentives are in operation. Such organisations often
provide a wide-ranging service encompassing not only employee non-cash incentive
programmes but also other employee schemes such as recognition and team-building
activities. More information on suppliers can be found in the journal Incentive and
motivation4.
Tax implications
Employers need to consider the tax implications of implementing a non-cash incentive
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scheme as awards over a certain level are subject to income tax. It may be possible for
employers to arrange payment of any tax or national insurance owing on behalf of
employees. Detailed information on the tax implications of non-cash awards can be found
in guidance from HM Revenue and Customs (see Useful contacts below).
CIPD viewpoint
The use of bonuses and cash incentives, when carefully designed and tailored to align
with an organisations own culture and needs, can help to create and sustain high
performing workplaces. To be effective, bonus and incentive plans need to operate as part
of an integrated reward strategy closely linked to business objectives including long-term
goals and corporate governance standards. The use of non-cash incentives can similarly
be effective in motivating employees within the context of a wider reward strategy that is
closely aligned with business strategy. The success of all such schemes will depend on
how effectively performance is defined, managed and ascribed, requiring effective
communication and engagement on the part of both employees and line managers.
Useful contacts HM Revenue and Customs - incentives pages
References
1. OFFICE OF NATIONAL STATISTICS. Annual Survey of Hours and Earnings
[online]. Available at: http://data.gov.uk/dataset/
annual_suvey_of_hours_and_earnings
2. FINANCIAL SERVICES AUTHORITY (2009) Reforming remuneration practices in
financial services [online]. London: FSA. Available at: http://www.fsa.gov.uk/pubs/
cp/cp09_10.pdf
3. House of Commons Treasury Committee. (2009) Banking crisis: regulation and
supervision[online]. Fourteenth Report of Session 200809. HC 767 (2008-09)
London: House of Commons. Available at: http://www.publications.parliament.uk/pa/
cm200809/cmselect/cmtreasy/767/767.pdf
4. Further information is available at http://www.incentivemotivation.co.uk
Further reading
Books and reports
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INCOMES DATA SERVICES. (2010) Bonus schemes. HR studies. London: Incomes Data
Services.
INCOMES DATA SERVICES. (2010) Employee recognition schemes. HR studies. London:
Incomes Data Services.
PERKINS, S.J. and WHITE, G. (2008) Employee reward: alternatives, consequences and
contexts. London: Chartered Institute of Personnel and Development.
ROSE, M. (2001) Recognition for performance: non cash rewards. London: Chartered
Institute of Personnel and Development.
Visit the CIPD Store to see all our priced publications currently in print.
Journal articles
CARTY, M. (2009) IRS bonuses and incentive survey 2009: employers keep the faith in
bonuses. IRS Employment Review. No 920, 24 April. 10pp.
ELLIG, B.R. (2010) Annual incentive plan formula considerations. Compensation and
Benefits Review. Vol 42, No 4, July/August. pp222-230.
GRAY, R. (2010) The return on incentives. Human Resources. October. pp49-50,52.
HILL, B. and TANDE, C. (2009) Incentive pay: short-term change agent or long-term
success? Workspan. Vol 52, No 9, September. pp61-64.
HODGE, P. (2009) Splashing the cash. Employee Benefits. August. pp28-29.
TAYLOR, T. (2010) The challenge of project team incentives. Compensation and Benefits
Review. Vol 42, No 5, September/October. pp411-419.
CIPD members can use our online journals to find articles from over 300 journal titles
relevant to HR.
Members and People Management subscribers can see articles on the People
Management website.
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