Page 359 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 7

Short-Term Incentives

S hort-term incentives are designed to include both downside risk and upside
potential, rewarding the extent of accomplishment for the period. The period
measured typically is the business year. The amount of payment goes up and
down each year in relation to performance, thereby lowering costs to the
organization when performance is low while providing the executive an opportunity to attain
significant rewards for achieving or exceeding objectives. While a company may hesitate in
granting a $100,000 executive a 40 percent salary increase, since salaries are rarely reduced,
there is much less reticence in granting a $40,000 bonus (on the assumption that all, or a large
part, will not be granted the following year if performance drops). Short-term incentives are
therefore much more effective than salary for pay-for-performance objectives.

INTRODUCTION

Annual incentive plans came into being early in the twentieth century, when management of
companies shifted from owners to professional managers. The owners’ objective was to moti-
vate managers to act like owners. This was done by giving them a bonus for a portion of the
financial success achieved. Bethlehem Steel was among the first with such a plan.
While salary actions are typically based on individual performance and long-term incen-
tives on corporate performance, short-term incentives often include both. They may also
include “groups.” The number of groups will vary by organization and company size. Groups
may be defined vertically and/or horizontally. The vertical definition is by organization level
as one descends down through the company (e.g., corporate, sector, group, division, depart-
ment, and section). The horizontal definition is typically either by function (e.g., sales), by
type of business (e.g., aircraft engines), or by geography (e.g., Europe). It may also consist of
groups, sometimes called teams, made up of people from various parts of the organization.

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