Page 389 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 7. Short-Term Incentives 375

emerge. The first states bonuses should only be paid for outstanding performance
(described as attainment of the specified objective; less means no bonus). This binary
approach of either “hit” or “miss” makes a bonus program simple to administer, but top
management will have a hard time calling a very near miss a zero. In addition, while such a
program adequately differentiates in pay between outstanding and less-than-outstanding
performers, one must question whether or not it adequately differentiates between poor and
adequate performers.
The second approach states that there are degrees of success and failure, and bonuses
should be structured accordingly. This second view requires the outlining and subsequent
weighting of each defined goal. Assume that one of five goals for a division is to increase net
earnings from 15 percent to 18 percent. This goal was given a weighting of 30, instead of
an unweighed 20 (i.e., a total of 100 divided by five goals), as shown in Table 7-23. With 18
percent being the normal target, it is possible to build values above and below this number
to reflect easy or difficult targets. Note that it is even possible to relate attainment in frac-
tions of a point, if such were desirable (e.g., attainment of net earnings in the amount of
18.5 percent would translate to 32.5 points).

Percent Points
21.0 and up 45
20.0 40

19.0 35

18.0 30
17.0 25
16.0 20

15.0 and lower 15
Table 7-23. Point schedule vs. EPS attainment

An important point is that although numbers may be used to determine the size of
the division fund by the measurement of goals and objectives, it is imperative to realize that
this is not a magic numbers show. The weighting scale, especially in the measurement of
qualitative goals, is only as good as the judgment of the evaluator.

Other Ways of Allocating Funds
Corporate Own Unit. Another basic approach to allocating funds is shown in Table 7-24.
In addition to the handful of top executives (whose fund is determined only by corporate
success), there are three types of divisions: support staff (e.g., finance, legal, personnel), cost
centers (e.g., production), and profit centers (e.g., sales/marketing). In this example, two-
thirds of the normal fund for support staff is based on corporate success and one-third on the
attainment of their objectives; for cost centers, the split is 50-50 between corporate success
and divisional success; profit centers have two-thirds of their normal fund determined by
their own success or failure and one-third by corporate success.