Bonus Plans As stated earlier, bonus compensation is the fastest growing element of total compensation and often the

largest part. A wide variety of bonus pay plans can be categorized according to the three key aspects: The base of compensation, that is, how the bonus pay is determined. The three most common bases are (1) stock price, (2) cost, revenue, profit, or investment unit-based performance, and (3) the balanced scorecard/ Compensation pools, that is, the source from which the bonus pay is funded. The two most common compensation pools are earnings in the managers own unit and a firmwide pool based on the firms total earnings. Payment options, that is, how the bonus is to be awarded. The two common options are cash and stock (typically ordinary shares). The cash or stock can either be awarded currently or deferred to future years. Stock can either be awarded directly or granted in the form of stock options.

Base for Bonus Compensation The base of a choice comes from a consideration of the compensation objectives, as outlined in the succeeding figure.

Advantages And Disadvantages of Different Bonus Compensation Bases Relative To Compensation Objectives Motivation Right Decision Fairness Stock Price (+/-) Depends on (+) Consistent with (-) Lack of controllability whether stock and shareholders interests. stock options are included in base pay and bonus (+) aligns management compensation with shareholder interests Strategic Performance (+) Strongly motivating (+) Generally good (+) Intuitive, clear and Measures (cost, if noncontrollable measure of economic easily understood revenue, profit and factors are excluded performance (-) Measurement issues: investment measures) (-) typically has only a differences in short-term focus accounting conventions, (-) if bonus is very high, cost allocation creates an incentive for methods, financing inaccurate reporting. methods and so on. Balanced Scorecard (+) Strongly motivating (+) Consistent with (+) If carefully defined if noncontrollable managements strategy and measured, critical factors are excluded (-) can be subject to success factors are (+) aligns management inaccurate reporting of likely to be perceived as compensation with nonfinancial factors fair shareholder interests (+) potential measurement issues as above Key: (+) means the base has a positive effect on the objectives (-) means the base has a negative effect on the objectives

Bonus Compensation Pools A unit-based pool is a basis for determining a bonus according to the performance of the managers unit. A firmwide pool is a basis for determining the bonus for all managers through an amount set aside for this purpose. The succeeding figure summarizes the advantages and disadvantages of each approach to bonus pools.

Advantages and Disadvantages of Different Bonus Pools Relative to Compensation Objectives Motivation Right Decision Fairness Unit-based (+) Strong motivation (-) Provides the (-) Does not separate for an effective incentive for individual the performance of the manager the upside managers not to unit from the managers potential cooperate with and performance. (-) Unmotivating for support other units manager for when needed for the economically weaker good of the firm. units Firmwide (+) Helps to attract and (+) Effort for the good (+) Separates the retain good managers of the overall firm is performance of the throughout the firm, rewarded- motivates manager from that of even in economically teamwork and sharing the unit. weaker units of assets among units (+) Can appear to be (-) Not as strongly fairer to shareholders motivating as the unitand others who are based pool concerned that executive pay is too high. Key: (+) means the base has a positive effect on the objectives (-) means the base has a negative effect on the objectives