It's that time of year again: appraisal season is upon us, and discussions about raises and compensation are buzzing everywhere. One crucial component of compensation is the bonus. In addition to base pay and benefits, job seekers and employees may receive raises, stock options, and bonuses. Depending on the industry, there may be other forms of compensation such as overtime, on-call pay, compensation for special projects, and investment opportunities. Bonus pay, in particular, is additional compensation on top of one's base salary or hourly wage. 

For HR professionals, it's essential to have a comprehensive understanding of all forms of compensation and how employees receive them. Let's delve into this by starting with a detailed exploration of bonuses.

What is a bonus?

A bonus is a type of compensation that is not guaranteed and is typically paid out after the completion of a specific event. There are various types of bonuses, which we'll discuss in more detail later, but generally, they are performance-based. This means that companies distribute bonuses based on how well an employee or group of employees contributes to team or company goals, often tied to revenue targets. 

However, some bonuses are discretionary, meaning that managers have the discretion to decide who receives a bonus and the amount, rather than it being based on specific criteria like performance or quotas. As a result, bonuses can be a complex topic for both companies and employees.

Why should companies provide bonuses? 

When organisations of similar size, industry, or location offer bonuses to their employees, it creates pressure for other companies to do the same in order to attract top talent. For instance, sales roles commonly come with a bonus structure because it's expected in the industry. 

Moreover, bonuses help companies attract top talent, who are driven to perform well. When there's a reward tied to output, it tends to attract motivated individuals who are willing to work hard to help the company succeed. 

This incentive structure encourages employees to strive for higher performance levels, whether they're directly involved in revenue generation, like sales, or indirectly, such as in marketing or executive leadership roles. 

Additionally, bonuses align employee interests with company success. Employees who have the opportunity to earn more based on company performance are more likely to be invested in achieving positive outcomes. 

Conversely, if a company underperforms, employees with bonus structures may experience reduced compensation, unlike those with fixed salaries who receive the same pay regardless of company performance

What types of bonuses are there, and how do they work?

There are various types of bonuses, each with its own structure and eligibility criteria. Here's a breakdown of the most common types:

Discretionary bonuses: These bonuses are awarded at the employer's discretion and are not guaranteed. They are not specified in employment contract and are typically based on factors like individual or team performance, company profits, or other qualitative measures. Milestone bonuses are one example of discretionary bonuses.

Nondiscretionary bonuses: Unlike discretionary bonuses, nondiscretionary bonuses are outlined in employment contract and are part of compensation package. These bonuses are usually tied to specific goals, targets, or performance metrics. If an employee meets the criteria specified in their contract, they are entitled to receive the bonus. 

The frequency and structure of bonuses can vary, with some being distributed quarterly, annually, or as one-time payments. Additionally, the eligibility for bonuses may depend on factors such as employee level within the organisation and their contribution to achieving company objectives.

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The most common bonuses:

Profit-sharing

Organisation often utilise profit-sharing plans to instil a sense of ownership among employees. With profit-sharing, a portion of the company's quarterly or annual profits is distributed to employees, typically based on their annual salary. This distribution may come in the form of cash payouts or contributions to retirement plans. 

Spot bonus

Spot bonuses are given by companies to employees for demonstrating specific company values or behaviours. These bonuses are usually of relatively low value and are often awarded by managers or supervisors.

Noncash bonus

A noncash bonus is any reward or prize that lacks monetary value. For instance, it could be an additional day of paid time off or a coveted parking spot in the employee lot. Typically, noncash bonuses are linked to programs like "Employee of the Month," and companies often grant them to employees who meet specific criteria.

Sign-on bonus

A sign-on bonus is a payment agreed upon when starting a new job. Companies often use this nondiscretionary bonus to attract highly qualified staff, fill positions with high turnover rates, or compensate for a salary reduction or loss of guaranteed bonuses from a previous job. Some companies provide signing bonuses as a lump sum, while others spread them out over a year to retain employees for a specified period. 

Milestone bonus

Milestone bonuses, also referred to as task or mission bonuses, are directly linked to employees work performance. These bonuses are awarded by companies when certain metrics or goals are achieved. The company establishes the milestone in advance, providing a clear goal for teams or individuals to strive towards in order to earn the bonus payment.

Annual bonus

Annual bonuses are typically awarded by companies following a successful year. While some companies guarantee annual bonuses, the amount may vary from year to year based on the organisation's profits. Other companies distribute annual bonuses only after particularly prosperous years.

Retention bonus

Retention bonuses are offered by some companies to encourage current employees to remain with the organisation. Often, these bonuses are communicated in advance so that employees are aware of the amount they will receive if they stay with the company for a specified period. Companies may also provide retention bonuses during periods of significant organisational change, such as mergers or acquisitions, to maintain staffing levels through the transition.

Referral bonus

A referral bonus is provided to employees who refer talented individuals to join the organisation. Referral programs vary across companies, with some offering a flat payout rate for any position, while others provide higher rewards for referring candidates for hard-to-fill or executive-level roles.

Holiday bonus

Some companies offer a holiday bonus to their employees towards the end of the year. Typically, this bonus is a percentage of each employee's annual pay. While this practice is not common in many firms, there are companies that provide holiday gifts as a gesture of gratitude for their employees' efforts, regardless of business profits or work performance.

Stock options

Stock options grant employees ownership in the company, allowing them to purchase shares at a predetermined rate and benefit from the company's success through stock value appreciation. Instead of directly granting shares, organisation offer employees the option to acquire a specific number of shares at a discounted rate. While stock options may not have a straightforward value like a signing bonus, they can still significantly impact an employee's financial situation.