The most common incentive plan mistakes made by privately held companies #2: Bonuses based purely on the owner’s judgement

In this series of articles, we’ll review some of the most common mistakes that privately held companies make in approaching the question of incentives, before looking at a sketch of what I have seen work well.

#2: Bonuses based purely on the owner’s judgement

Work out a sum to share with managers and divvy it up based on how you think they’ve performed during the year. Its simplicity is appealing, but there are a few problems with this approach.

First, people talk, leading to sibling-like rivalry: ‘Why did he get more than me?’ The amounts no longer matter, if what gets paid differs due to a subjective assessment, someone is going to feel hardly done by. The business ends up aggravating their staff and making them more vulnerable to poaching. And paying for the privilege.

Second, discretionary bonuses like this discourage open and frank discussions about personal performance. When the employee knows that his boss’ impression of his performance makes the difference between a holiday for his family to Dubbo or Disneyland, the incentive plan encourages him to hide problems, rather than discuss them.

Third, the value of discretionary bonuses is discounted by employees because they know that there is no guarantee of delivery, no matter how good the results they achieve. In the market for talent, a $50,000 bonus opportunity decided on discretion is not worth as much as one objectively determined, except of course, to those skilled at creating the impression of good work.

Finally, the day-to-day behaviour encouraged by discretionary bonuses can be damaging to the performance of the company. Imagine two sales people, one on a discretionary bonus and one on a flat 10% commission. It pays the former to spend time in the office ensuring the boss knows just what a good job he is doing, it pays the latter to get out of the office and make the next sale.

In our next article we’ll look at the dangers of linking incentives to budgets.