Executive bonus payments may be getting a bad press these days but a well defined bonus scheme is still an effective component of compensation strategy.

Bonus payments seem to be a contentious issue these days. Not a week goes by without a shareholder group objecting to the size of a Chief Executive's latest bonus award. In the wake of the economic conditions and corporate scandals of the past few years, shareholders are monitoring the actions of their respective companies with renewed and concerned interest. It has reached the point where bonuses in general seem to be increasingly viewed in a negative light, whether as the subject of shareholder revolt or of employees gossiping around the water cooler.

Bonuses however are not a bad thing if awarded appropriately. A bonus should be a key component of a well structured performance related compensation programme. Indeed, over the past couple of decades the implementation of bonus schemes has become more and more prevalent and the majority of employers now recognise that a well-designed programme can have a positive impact. In a recent survey of compensation practices among hotel companies in Europe, HVS found that the vast majority of companies have a bonus scheme in place for executives at hotel department head level upwards. The grant of a bonus however should not be based merely on job on title or an employee's seniority. Bonuses should be viewed as an incentive, not an entitlement. In our opinion, the most appropriate manner in which to reward an employee is through a performance linked incentive bonus. Incentives strengthen the link between an individual's performance and that of the company, and overall business performance improves as a result. When designing a bonus plan it is worth bearing the following points in mind.

A successful bonus plan does not stand alone but is part of a larger, integrated reward scheme and Human Resources strategy. Before implementing a bonus scheme an organisation or department must carefully define the goals of the scheme, how it fits into the overall HR strategy, and how much weight the bonus carries in the overall reward package. There is no one-size-fits-all bonus scheme. Rather, each company must tailor its bonus strategy to its corporate culture and operating philosophy. For example, an assertive, rapidly growing company many decide to pay a low base salary with a high bonus potential component. A conservative company however may prefer to pay a high base with a minimal bonus element.

By their nature, bonus plans are typically aimed at rewarding short-term performance, i.e. less than twelve months. An effective scheme needs appropriate, significant and measurable performance targets. In addition, the plan needs to be simple to comprehend and easy to communicate. We typically recommend that a company's bonus programme contains two to four criteria upon which performance targets are based, although a company can have as many as it feels appropriate. Financial criteria can include measures such as EBITDA, Department or Company Profit, Earnings per Share (EPS), and Revenue Growth. Additionally, recognition should be given for the achievement of personal objectives, such as winning a new contract for the company, or the implementation of a new training programme.

These measures can be weighted accordingly for each position. For example, in a public company where EPS is a key measure for all executives, it may represent a larger part of the CEO's bonus potential than of the Chief Technology Officer's. This would then reflect appropriately the contribution of each individual to the company's EPS.

In a recent consulting study on behalf of one of our clients we recommended the following weighting:

Performance MeasureChief Executive OfficerChief Technology OfficerEarnings Per Share3015%Achievement of Budgeted Revenue10%10%Personal Objective10%15%Maximum Bonus50%40%
One of the benefits of having two or three criteria is that it still rewards employees in a year when one of the measures may have suffered through external influences. For example, if EPS are down due to factors outside of a company's control, such as the performance of the stock market, then the employee still has an incentive to excel against the other two measures.

Qualification for bonus award should be clear and straightforward. Once goals are met then a bonus is paid. The threshold for qualification of bonus is typically around 95% achievement of goal. In cases where goals are exceeded, a company can introduce an override bonus to reward the superior performance. For example, if an employee exceeds his department profit target by 10% then his related bonus component increases by 2%. A company can then introduce a cap which corresponds to the maximum percentage as determined in the overall bonus plan.

Bonus plans based on immeasurable criteria, such as 'being a jolly good chap who has put in 20 years service', are to be avoided and will no longer be tolerated by investors. Well implemented, performance linked bonus schemes however are to be encouraged and should be regarded in a positive light. They motivate staff, lead to improved business results and are based on measurable targets rather than on someone's whim.

Christopher Mumford is Managing Director of HVS Executive Search in London and specializes in sourcing talent for the hospitality industry throughout Europe, the Middle East and Africa.