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.
Mistake #5: Payments made in full in one year
Because the financial calendar is 12 months long, it seems to make sense to tie bonus payments to annual performance. But most business owners will agree that one year is too short to get any real sense of the strength of a result. You need the perspective of three or more years to judge how sustainable and how repeatable the result was.
Yet, most bonus programs pay out in full each year and often with the benefit of hindsight, therefore, over pay.
Ironically, the consequence of this approach can be lower bonuses for managers, as owners are often reluctant to tie large amounts to single year performance, knowing what an unreliable indicator it is.
Next we’ll look at the final of our six most common mistakes, using the wrong performance measures.