What is a Bonus?

January 14th, 2008 by Jim Cotterman

Some firms consider a bonus any payment in addition to base pay.  So a distribution beyond draw/salary made in accordance with a defined allocation is a bonus.  No attempt is made to distinguish performance from individual to individual; or for any one individual, from actual to expected contribution.  Such payments commonly arise out of point, percentage, tier and lockstep systems that align the distribution with the underlying pre-existing allocation for base pay. 

A slight variation of the above occurs when there is a pre-determined distribution allocation that differs from base pay allocation.  Sometimes there may be more than one such distribution tier.  For example, the first $1,000,000 is distributed on base pay, the next $1,000,000 is distributed equally, the next $1,000,000 on some other basis.  A variation of this for admitting new owners is properly examined in an upcoming post.

Sometimes firms use a bonus to reward extraordinary contribution.  When best done, extraordinary contribution is narrowly defined.  Recipients are few and the size of each bonus large.  Under this definition only about 2.5% to 5% of contributors would qualify for a bonus.  A large bonus exceeds 20% to 25% of base pay.

Other firms will award a bonus when an individual’s performance exceeds that expected for his/her base pay.  Usually the exceptional performance must warrant a bonus of at least 10% of base pay.  Under this definition many more individuals might qualify for a bonus.

Then there are the firms where a bonus may be awarded an individual who measurably outperforms his/her peer group.  This is generally more common in point, tier and lockstep systems that have a bonus modifier.  Here one must not only excel but excel beyond that of his/her peers.  Again the differentiable performance should probably warrant a bonus of at least 10% of base pay.

These are the most common bonus types.  If you have experienced a different approach, please join in with a comment.

The next question may very well be which method is best?  That largely depends on the underlying base pay program, the desired values and behaviors as well as the strategic intent of the organization.  There is one type of bonus system that the author has little regard for — small differentiated payments to nearly everyone.  That approach is likely to create more trouble than it is worth.  One might be better off running an extra payroll.  You are likely to accomplish much the same result with significantly less effort and less downside risk.

Another question typically asked is why minimum bonuses of 10% or 25%?  By setting a minimum bonus as a percentage of base pay the threshold automatically adjusts as pay increases.  For example, a $10,000 bonus for someone making $100,000 or less conveys something very different from that same amount for an individual with $1,000,000 in base pay.  Another reason is to recognize the lack of precision possible in pay decisions.

This entry was posted on Monday, January 14th, 2008 at 8:13 am and is filed under Partner compensation, Associate compensation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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