Human Capital & Careers

Incents and Betterments: Dispelling the Myth of Short-Term Incentives

Does delinking bonuses from budgets improve employee performance? Some CFOs say yes.
Marie LeoneDecember 1, 2001

The traditional short-term incentive plan may be destined for the dustbin if an alternative adopted by a handful of companies is successful enough to win more adherents.

The conventional plan limits cash bonuses and links them to annual budgets, with the aim of meeting quarterly objectives. But while it may not fail at that, critics suggest that this type of arrangement also encourages employees to manipulate budgets in ways that hurt long-term performance. In that sense, say some consultants, the idea that bonuses linked to budgets are the best form of short-term incentive pay is actually a myth.

However, such companies as SPX Corp. and Briggs & Stratton Corp. have uncapped bonuses and decoupled them from short-term budget goals, instead linking payouts to stock performance. And that, asserts G. Bennett Stewart, a senior partner at the consulting firm Stern Stewart & Co., should discourage employees from gaming the system by, for instance, cutting funds for research and development to hit short-term earnings targets.

SPX, for one, swears by its plan. Chuck Bowman, director of corporate finance at the Muskegon, Mich.-based auto-parts maker, says the company hasn’t seen any “sandbagging and negotiating of budgets” since it implemented the plan five years ago. Before that time, he says, bonus games at the company were the rule.

But the jury is still out on its ultimate success. SPX’s shares have gained an average of 29.3 percent a year since 1996, compared with only 20.6 percent for the Standard & Poor’s midcap index. In contrast, the companies that make up the S&P electronics and components index returned an average of 34.1 percent during the same period.