Whether used proactively to influence behaviour or retrospectively as part of a reward package, bonuses and incentives can have various benefits for organisations and employees. However, the success of any bonus or incentive scheme is based on an understanding of the context in which it operates and individuals may respond differently to the same stimulus.
This factsheet explores the types of bonuses and incentives, trends in their use, and their potential benefits and drawbacks. It looks at how bonuses and cash or non-cash incentives suit a variety of contexts, and what to consider when designing and operating such schemes.
What are bonuses, cash incentives and non-cash incentives?
Bonuses and cash incentives are a form of variable pay based on lump-sum payments linked to individual, collective or organisational performance (or some combination of these). They are not consolidated into base pay, though in certain situations (such as due to cost constraints) they can be given as part of, or instead of, a pay rise.
It's important to draw a distinction between the cash incentives and bonuses, although the two terms are interlinked and often used interchangeably.
Incentives aim to influence future employee behaviour or performance, usually using targets: if a specific target is met, the employee will receive a cash payment, typically of a specific size.
Bonuses cover a wider range of purposes and can be discretionary or non-discretionary. Like incentives, they may be used to influence employee performance or behaviour to meet pre-set objectives, but they could also be used to reward past achievements.
It's also helpful to differentiate between:
Non-cash incentives, sometimes known as performance improvement plans, are forward-looking, formal schemes. They aim to affect directly employees’ future performance by awarding prizes or ‘gifts’, such as merchandise, travel or retail vouchers, associated with some performance measure, such as sales volume.
Employee recognition schemes are retrospective as they recognise past performance rather than incentivising future efforts. They may be informal and discretionary. Such schemes may be linked with non-cash incentives.
Our report Show me the money! The behavioural science of reward examines recent thinking on how individuals can respond to various kinds of incentives.
The purpose of bonuses and cash incentives
The desire to incorporate bonus and incentive plans into reward packages has been driven in part by the ‘new pay’ philosophy. This advocates that ‘guaranteed’ remuneration (basic pay and benefits) should comprise a smaller proportion 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 rise 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 employee, the main benefits of bonuses/cash incentives over consolidated salary increases are:
- Greater control over their level of remuneration.
- Higher payments are potentially possible.
But the downside for employees includes:
- Non-consolidated payments must be re-earned and may not count towards overtime pay.
- Payments may be unpredictable or lower than expected if targets cannot be met.
For the employer, the advantages include:
- Ongoing motivation as bonuses must be re-earned.
- Lack of impact on certain employer on-costs that are linked to basic salary levels, such as pension contributions.
- 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.
There are also challenges for employers. While money influences behaviours, it may encourage the wrong types. So, any financial-based bonus or incentive scheme must be designed carefully and align with an organisation’s business objectives, corporate governance and ethical standards as well as the views of key stakeholders, such as employees, donors or customers. However, this can lead to a proliferation of checks and balances, such as malus or clawback, which then reduces the motivational impact.
The success of these schemes also depends on how effectively performance is defined, managed and ascribed, requiring effective communication and support for both line managers and employees.
Types and coverage of bonuses and cash incentives
Payment of bonuses and cash incentives is generally linked 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 seen as a distinct form of remuneration in its own right).
Schemes driven by business results - Company profit levels or customer satisfaction may be used as measures to help determine bonuses.
Team-based - Links the bonus with some measure of collective performance, often with the aim of fostering effective teamworking.
Project-based - Might be used when a 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 that could be used to reward, for example, workers who attain productivity improvements in one factory.
Gainsharing - Employees share in financial gains achieved through improved performance (particularly enhanced productivity).
Combination - Two or more of the above schemes.
There are other more specialised bonuses, for example at Christmas or for attendance.
Our 2019 Reward management survey found that may employers use some form of cash-based bonus or incentive plan. 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.
CEO bonuses and incentives
Despite the growth of interest in environmental, social and governance investing, most FTSE 100 executives’ bonus and long-term incentive plans are weighted towards financial measures of company success. By contrast, non-financial measures, such as workforce ones, play a minor, albeit growing, role. See our CEO pay and the workforce report for more.
Payment levels and inappropriate behaviour
If they are to impact on employee behaviour or performance, bonus or incentive payments need to be ‘worth having’. That means they must be set at a high enough level to have an effect, and consider (though not be driven by) market practice. By contrast, setting bonuses at very high levels need caution to avoid encouraging 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).
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 ethical practice 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.
While money influences behaviours, it may encourage the wrong types. So any financial-based bonus or incentive scheme must be designed carefully and tailored to align with an organisation’s business objectives, corporate governance and ethical standards as well as the views of key stakeholders, such as employees, donors or customers.
The success of such variable pay plans depend on how effectively performance is defined, managed and ascribed, requiring effective communication and supports for both line managers and employees.
The purpose of non-cash incentives
Because cash may not be the most effective means of motivating employees as it doesn’t necessarily encourage them to ‘go the extra mile’, non-cash incentive schemes, based on the receipt of a gift or prize, could be more memorable and exciting, and therefore have greater impact.
Typically found in customer-facing industries, non-cash incentives may be a single prize won by the highest-performing employee or team, or a range of awards recognising different levels of achievement.
The benefits include:
Affordability - They may be more cost-effective than cash bonuses.
Simplicity - It's easy for a sales employee to understand that, say, selling so many phones will result in them receiving whatever the latest prize is.
Psychological impact - It's acceptable for employees to speak openly with pride about the winning of gifts in a way that may be considered by many to be socially unacceptable it they were seen to be ‘bragging’ about their cash bonuses.
Drawbacks can 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’.
Lack of value - People value the same non-financial reward, such as a trip to a sporting event, differently, so what might be an incentive to one person might not to another.
The incentivisation industry is more highly developed in the USA than in the UK where, according to our 2019 Reward management survey, only a minority of employers have non-cash incentive schemes.
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.
Books and reports
ARMSTRONG, M. (2019) Armstrong's handbook of reward management practice: improving performance though reward. 6th ed. London: Kogan Page.
PERKINS, S.J. and WHITE, G. (2020) Reward management: alternatives, consequences and context. 4th ed. London: Chartered Institute of Personnel and Development.
Visit the CIPD and Kogan Page Bookshop to see all our priced publications currently in print.
COTTON, C. (2020) CEO pay: complex solutions for complex problems. CIPD Voice. Issue 26. 16 November.
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.
CIPD members can use our online journals to find articles from over 300 journal titles relevant to HR.
Members and People Management subscribers can see articles on the People Management website.
This factsheet was last updated by Charles Cotton.
Charles Cotton: Senior 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.