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Whether used proactively to influence behaviour or retrospectively as part of a reward package, bonuses and incentives can carry a number of benefits for organisations and employees. The success of any bonus or incentive scheme, however, is based on an understanding of the context in which they operate and an appreciation of how individuals may respond differently to the same stimulus.
This factsheet explores the various types of bonuses and incentives, the trends in the application of bonus and incentive schemes, and the benefits and potential drawbacks of bonuses, cash and non-cash incentives. It provides an insight into how different schemes suit a variety of contexts and what to consider when designing and operating such schemes.
While money can influence employee behaviour, it may also encourage the wrong types of actions. Therefore, any financial-based scheme needs to be designed carefully and tailored to align with an organisation’s own culture and needs. To be effective, bonus and incentive plans need to operate as part of an integrated reward strategy closely linked to business objectives, and corporate governance and ethical standards. The use of non-cash incentives can similarly be effective in motivating employees within the context of a wider reward strategy that is closely aligned with the business strategy. The success of all such schemes will depend on how effectively performance is defined, managed and ascribed, requiring effective communication and engagement on the part of both employees and line managers.
What are bonuses, cash incentives and non-cash incentives?
Bonuses and cash incentives are a form of variable pay based on the use of cash lump-sum payments linked to individual, collective or organisational performance (or some combination of these). They are not consolidated into base pay.
Non-cash incentives are a means of encouraging higher performance among employees by awarding prizes or ‘gifts’, such as merchandise, travel or retail vouchers, associated with some performance measure (such as sales volume).
It's important to draw a distinction between the cash incentives and bonuses, although the two terms are interlinked and often used interchangeably by the media.
Incentives aim to influence future employee behaviour or performance, usually through the use of targets: if a specific target is met, the employee will receive a cash payment.
Bonuses cover a wider range of purposes and can be discretionary or non-discretionary. Like incentives, they may be used in an attempt to influence employee performance or behaviour to meet pre-set objectives, but they could also be used on a more ad hoc or retrospective basis to reward past achievements.
It's also helpful to differentiate between:
Non-cash incentives (sometimes known performance improvement plans) which are forward-looking, formal schemes and which aim to affect directly employees’ future performance.
Employee recognition schemes which are retrospective (as they recognise past performance rather than incentivising future efforts) and may be informal and discretionary. Such schemes may be inter-linked with non-cash incentives.
Our report Show me the money! The behavioural science of reward examines recent thinking on how individuals respond to various kinds of incentives.
Background and rationale for bonuses and cash incentives
The trend to incorporate bonus and incentive plans into reward packages has been driven in part by the influence of the ‘new pay’ philosophy. This advocates that ‘guaranteed’ basic pay should comprise a small element of the overall reward package, with a shift towards strategic reward linking employee performance and pay to the wider business strategy.
There's also been a move in certain sectors towards market-based pay, whereby an employee might only receive a pay increase if the market rate for the role had increased: in this scenario, individual contribution could be recognised via a bonus instead of a pay rise.
For the employer, the advantages of bonuses/cash incentives over consolidated salary increases include:
- ongoing motivation as bonuses have to be re-earned
- lack of impact on certain employer on-costs that are linked to basic salary levels, such as overtime rates.
- capacity for maintaining market pay competitiveness without necessarily inflating the annual pay bill
- flexibility through, for example, the ability to reduce or even halt payments during economic downturns.
For the employee, the main benefits are:
- greater control over own levels of remuneration
- higher payments are potentially possible.
But the downside for employees includes that:
- non-consolidated payments must be re-earned and may not count towards pensionable pay
- payments may be unpredictable or lower than expected if targets cannot be met.
Types and coverage of bonuses and cash incentives
The payment of bonuses and cash incentives is generally linked either to the quality and/or quantity of work, on an individual or collective basis, or to some measure of company performance such as profit levels (or both).
Schemes may be broadly divided into the following categories although definitions vary, may overlap or be linked.
Individual-based - payment of the bonus/incentive is calculated by some measure of individual performance, hence there should be a considerable incentivisation effect. Sales commission could be included within this category (although this may be regarded as a distinct form of remuneration in its own right).
Schemes driven by business results often use company profit levels as a measure to help determine bonuses.
Team-based - link the bonus with some measure of team performance, often with the aim of fostering effective teamworking.
Ad hoc/project based - might be used when a particular deadline is important, for example to reward construction workers for completing a building project on time, although such schemes may be open to manipulation.
Department/site-based - payments which could be used to reward, for instance, factory workers who attain productivity improvements in one particular plant of a firm.
Gainsharing - based on the idea that employees should be able to share in financial gains achieved through improved performance (particularly enhanced productivity).
Combination - based on a combination of two or more of the above programmes.
There're also more specialised bonuses for example Christmas, attendance and retention bonuses.
According to our Reward management surveys many employers operate some form of cash-based bonus or incentive plans. However, such schemes are far more common in private sector than in the public or voluntary sectors. The most popular arrangements include individually based plans (for example, personal performance or commission), plans driven by business results (such as profit) and combination schemes.
Payment levels and recent developments in the use of bonuses
Levels of payments
If they are to impact on employee behaviour or performance, bonus or incentive payments need to be ‘worth having’, that is, set at a sufficiently high level to have an effect, and take into account, though not driven by, market practice. By contrast, caution needs to be taken in setting bonuses at very high levels to avoid driving undesired behaviours or outcomes, such as the crowding out of non-financial motivation.
An important factor in calculating any incentive is that it's kept simple. Ideally, employees in the plan should be able to measure progress against targets and carry out the calculation themselves so they know how they're progressing and what payment level they might achieve.
Employers need to decide the way they'll set bonus payments, including whether to make use of a formula and how to express payments (for example as a salary percentage or a flat-rate payment).
Information tracking specific breakdowns of UK bonus payments over time (by gender, for instance) can be found in the Office for National Statistics' Annual Survey of Hours and Earnings.
Following the recent recession, bonuses have become a highly contentious issue with their whole nature and operation questioned. The Financial Services Authority (FSA) considered that remuneration practices were a ‘contributory factor to the market crisis’. Practices in investment banking in particular tended ‘to reward short term revenue and profit targets’ and, in so doing, ‘gave staff incentives to pursue unduly risky practices’.
A range of measures have been introduced, with further proposals anticipated, to regulate remuneration in the finance sector, particularly for senior pay. The latest development is the EU’s Capital Requirements Directive known as CRD IV that requires that bonuses in the finance sector should be limited to 100% of base pay, or 200% with the approval of at least 66% of shareholders. The regulation covers senior banking employees irrespective of their location, so those staff working for a European firm but based in Asia would be subject to the same cap.
Many reward specialists believe there’s a need for a continuing clear link between high levels of performance and the payment of bonuses, but without rigour in applying this principle, bonuses may reward less-than-robust performance or incentivise inappropriate behaviour. One example of inappropriate behaviour is corruption, which according to a Transparency International report Incentivising ethics: managing incentives to encourage good and deter bad behaviour, can include fraud, trading in influence, anti-competitive practices and the offering, promising or payments of bribes. They argue that for incentives to work as intended and to avoid perverse and distorted outcomes, employers should ensure they have an open and ethical culture in which staff are encouraged to do the right thing and feel able to challenge management decisions or targets they think are unethical or dysfunctional. See more in our factsheet on business ethics and the role of HR.
There’s also the danger that if bonuses have too many checks and balances their complexity may fail to motivate.
Background and rationale for non-cash incentives
It’s sometimes argued that cash may not be the most effective means of motivating employees as it doesn’t necessarily motivate them to ‘go the extra mile’ in their current role. Non-cash incentive schemes, based on the receipt of a gift or prize, are arguably more memorable and exciting, and therefore have greater impact.
Typically found in customer-facing industries, non-cash incentive schemes may be based on the use of a single prize to be won by the highest-performing individual employee or encompass a range of awards recognising different levels of achievement.
The benefits of using non-cash incentives include:
Affordability - such programmes may be more affordable than alternatives such as cash bonuses.
Simplicity - it is easy for a sales employee to understand that, say, selling so many phones will result in them receiving whatever the latest gadget is.
Psychological impact - it's acceptable for employees to speak openly with pride about the winning of gifts in a way that would be considered by many to be socially unacceptable it they were seen to be ‘bragging’ about their cash bonuses.
On the downside, drawbacks may include:
Lack of credibility - such prizes may not be taken as seriously as cash.
Lack of employee awareness - employees may be less conscious of the value of non-cash incentives over ‘hard cash’, especially when living standards have fallen significantly.
The incentivisation industry is more highly developed in the USA. Although it’s growing in popularity in the UK, according to our 2013 Reward management survey, non-cash incentive schemes were operated by only a minority of UK employers and are most commonly found among private sector and larger organisations.
Designing and operating non-cash incentive schemes
Types of non-cash incentives
The main types of non-cash incentives may be broadly divided into:
- merchandise such as tablets, mobile phones or watches
- activities/special events such as meals out, hotel spa accommodation/treatments or a trip to a sporting event.
- travel for example an all-expenses paid trip
- retail vouchers which are often obtainable at a discount to ‘face value’
- awarding points that may be converted into a range of awards.
It’s worth noting that the last two of these categories might not be strictly regarded as ‘non-cash’ items.
Selecting a supplier
Numerous suppliers of non-cash incentives exist. Such organisations often provide a wide-ranging service encompassing not only employee non-cash incentives but also other employee schemes such as recognition and team-building activities. More information on suppliers can be found in the journal Incentive and motivation.
Employers need to consider the tax implications of implementing a non-cash incentive scheme as they can be subject to income tax over a certain level. It is possible for employers to arrange payment of any tax or national insurance owing on behalf of employees. Information on the UK tax implications of non-cash awards can be found in guidance from HM Revenue and Customs.
ARMSTRONG, M. (2015) Armstrong's handbook of reward management practice: improving performance though reward. 5th ed. London: Kogan Page.
INCOMES DATA SERVICES. (2012) Bonus schemes. HR studies. London: Incomes Data Services.
INCOMES DATA SERVICES. (2010) Employee recognition schemes. HR studies. London: Incomes Data Services.
PERKINS, S.J. and WHITE, G. (2016) Reward management: alternatives, consequences and context. 3rd ed. London: Chartered Institute of Personnel and Development.
ROSE, M. (2011) A guide to non-cash reward. London: Kogan Page.
Visit the CIPD and Kogan Page Bookshop to see all our priced publications currently in print.
DIFONZO, S. and KNESL, R. (2014) What you need to know about designing effective incentive compensation. Workspan. Vol 57, No 6. June. pp40-44.
MCMULLEN, T. and PETERSON, T. (2013) The business impact of recognition systems. Workspan. Vol 56, No 11, November. pp21-24.
MOYNIHAN, D.P. (2013) Long-term incentives: best practice vs best fit. Workspan. Vol 56, No 5, May. pp58-62.
PARK, S. and STURMAN, M.C. (2012) How and what you pay matters: the relative effectiveness of merit pay, bonuses and long-term incentives on future job performance. Compensation and Benefits Review. Vol 44, No 2, March/April. pp80-85.
SHAW, J. and GUPTA, N. (2015) Let the evidence speak again! Financial incentives are more effective than we thought. Human Resource Management Journal. Vol 25 No 3, July. pp281-293.
TAYLOR, T. (2010) The challenge of project team incentives. Compensation and Benefits Review. Vol 42, No 5, September/October. pp411-419.
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Members and People Management subscribers can see articles on the People Management website.
This factsheet was last updated by Charles Cotton.
Charles Cotton: Performance and Reward Adviser
Charles directs the CIPD's performance and reward research agenda. He has recently led research into: how employers can help improve their employees’ understanding of their personal finances; how front line managers make and communicate reward decisions to their employees; how employers manage the risks around reward; how private sector employers can build the business case for workplace pensions; how employees form their attitudes to pay; and how the annual pay review process can become more strategic.
He is also responsible for the CIPD’s public policy reward work and has given evidence to select committees on banking pay, redundancy awards as well as responding to various consultations, such as on pensions, retirement and MPs’ expenses.
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