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

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.

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

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

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.

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

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

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.