Incentives can be a useful way to reward performance but they need careful thought and robust guidelines.

Unlike a bonus – a discretionary, informal reward – an incentive is usually contained in a policy that indicates a certain reward will be paid if performance outcomes are achieved.

An incentive program aims to introduce rigour into the reward determination process, through budgeting and financial goal-setting. It also provides an employer-of-choice feature in a competitive labour market and helps to reinforce a success mentality (and, conversely, penalise failure).

A sound framework is needed to ensure success

In my experience, programs should be:

• Clear and simple.
• Take account of the shareholder/owner perspective.
• Focus on a small number of key measures.
• Be realistic.
• Include both financial and non-financial measures (weighted towards the financial).
• Recognise competitive realities.
• Align with agreed strategies, actions and budgets.
• Deal fairly with uncontrollable events.
• Encourage teamwork and cooperation.
• Consistent.

Management of incentive programs can be difficult

There can be disagreement about whether a result has been achieved and uncontrollable events may prevent payment. For example, listed companies may come under pressure from shareholders and choose not to pay certain incentives, or government cost-cutting may mean that senior executives miss out on expected incentives.

HR practitioners can overcome some of the issues by:

• Ensuring that targets are achievable so that the reward program is credible.
• Repeatedly communicating the progress of an incentive, not just at the beginning and end of a performance term.
• Setting performance budgets with a degree of stretch.
• Building in reward for over-achievement, provided that exceptional performance can be accomplished safely and without recklessness.
• Deciding whether over-achievement rewards will be prescribed or discretionary, according to business circumstances and board/CEO perspectives.
• Paying a reward in the same year as the performance period involved, so as to link performance and reward more easily in communications with shareholders. Understandably, this will require an estimation of performance and potentially some subsequent adjustment of reward (up or down) in the following year to respond to official calculations.

The bottom line is that a properly planned incentive program will meet corporate governance requirements, fairly reward employees and include provisions that help to ‘expect the unexpected’.