Building a Better Bonus Plan

For many gaming executives, bonus checks are coming soon. The annual bonus is an indispensable motivator, which can tie executive pay to the financial performance of the company. That being said, it is often surprising that many companies do not have a bonus program that is clearly stated, with performance parameters that are comprehensible. In fact, questions about how to calculate, and administer a bonus program are among our most frequently asked.

Being staunch proponents of pay-per-performance compensation models we have assisted numerous firms’ in constructing a bonus plan that has measurable performance goals customized to fit the “line of sight” of each executive position. We decided that this would be a good time to offer a basic guideline for a bonus program that can be structured to reward executives when performance meets, and exceeds established goals, while it also ties their fortune to the success of the company.

The Philosophy

A sound bonus program is one part of a well researched and articulated company compensation philosophy that is generally established by the Board of Directors compensation committee. Typically in language that states that the companies compensation program is designed to attract, retain, and motivate key employees to achieve certain professional objectives, the committee will set levels for base salaries by surveying a peer group of its’ competitors or similar businesses, then set target levels for the “at risk” components of the compensation plan, in this case the bonus program. The same survey conducted can help to set targets, as a percentage of base salary that the firm will pay as bonuses when company, and individual executive goals are met. As an example:

  • Company targets base salaries to be set at the median of the peer group
  • Annual bonus targets will be at 40% of base, and will be paid at target when all goals are met

The percentage of base salary that is set to be in the “at risk” part of an executives’ total compensation can range from 10% to 100% and allows the firm to decide how much of the key employees total potential cash compensation will be leveraged.

Key Value Drivers

The bonus program will contain “value drivers” for each position eligible to receive a bonus that coincide with the firms’ financial goals. There should be at least two quantitative measures, and can be as many as the company feels are directly in the executives line of sight. Ideally these measures should be a blend of the firms’ performance, and individual performance factors. Each of the measures can be weighted as part of the target for that position to reflect the amount of responsibility the employee has for its’ outcome. As an example, the companies E.P.S. (earnings per share) may very well be used as a measure for each executive position in the plan, but to a greater, or lesser degree depending upon how much that given position has a direct ability to impact E.P.S. In the case of the company’s CEO this may represent 75% of their total bonus potential as their efforts, and decisions will have a greater impact on E.P.S. than those of any other key executive in the firm. So the CEO’s program might look like this:

CEO – bonus target at 100% of base salary

  • Meeting forecasted EPS targets = 75%
  • Other value drivers = 25%

On the other hand, it may be felt that the companies V.P. of Human Resources has less ability to directly impact the E.P.S., and other metrics will represent a higher percentage of their achievable bonus target. If the V.P. human Resources is working on projects like company training programs, manuals, etc., the completion of those large tasks may be set as metrics for any given year so that their program may look like this:

VP Human Resources – bonus target at 40% of base salary

  • Meeting forecasted EPS targets = 40%
  • Completion of company-wide training program = 40%
  • Complete revision of company manual = 20%

This allows the company to set the benchmarks to be achieved for each position, and still allows the individual some level of control over their bonus potential. Bonus programs that have too few measures, or measures over which many of the plans participants do not have direct control can be de-motivating and should be avoided.

Targets and Caps

Implementation of the program should be as simple, and straightforward as possible. When goals are met bonuses will be paid at target levels. If goals are exceeded, other metrics can be applied to pay greater than the target. For example, if E.P.S. is exceeded by $.03 the company might pay an additional bonus percentage for each point over the target. This can then be capped as the firm desires to pay up to a maximum percentage that has been predetermined as part of the plan. The same type of metrics can be applied if goals are not met, deducting a given percentage of the target bonus for each measure of unmet goal. This allows the company to truly reward performance, and not reward a failure to perform. We would stress here again the need for having at least two quantifiable measures, so that a bad year in E.P.S. for example, did not put any type of bonus payment out of reach.

Let’s Get Back to Work

This is a rough sketch of the way a bonus program can be structured, and the actual value drivers, and compensation philosophy will, of course differ with every firm’s needs. Our hope is that it will help to de-mystify the process of constructing a bonus plan that will serve the needs of your company, and its’ key employees.