Page 391 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 7. Short-Term Incentives 377

Corporate Group Division Individual

CEO/president and staff VPs 100 — — —
Operating group VPs 50 50 — —

Division president 25 25 50 —

Division VP — — 50 50
Table 7-25. Allocation of bonuses: corporate, group, division, and individual

The manner in which divisional and corporate portions are structured will reinforce a
particular behavior. For example, placing the entire payout on divisional performance (ignor-
ing group and corporate) will encourage a division manager to take actions that are self-
benefiting regardless of long- or short-term impact on the rest of the organization. In this
illustration, the division head realizes that half of his or her bonus will come from outside
the division. Thus, the person must be responsive to actions beneficial to the group and
corporation as well as the executive’s own division.

Impact of Minimum Performance on Divisional Funds. However the guideline bonus
fund is generated, the plus and minus variations from desired payout must be in the desired
relationship. To illustrate: Employing the concept advanced in the earlier discussion on fund
formulas, assume it is desirable to pay nothing below a minimum growth rate. Thus, we could
express actual growth (e.g., income before corporate allocation) in terms of expected mini-
mum to determine a divisional bonus relationship, as in Table 7-26. Note the problem with
a projected loss situation.

Division Minimum Actual Relationship

A $10,000,000 $9,000,000 0.90
B 2,000,000 2,000,000 Infinity
C 16,000,000 20,000,000 1.25

D 15,000,000 16,000,000 1.07
Table 7-26. Performance vs. target for four divisions

However, by introducing targeted growth, we can express the relationship of actual to
targeted versus minimum in a manner that cancels out the problems of negative values. Note
that the formulas will always generate a positive number as long as target is greater than
minimum (a logical requirement) and actual is greater than minimum (when it is less, there
is no bonus pool).

Actual minimum
Relative performance —————————
Target minimum