Earning A Bonus

Should an entry-level employee earn a bonus that is based on company performance?

In my formative years at Lands' End, entry-level employees earned a bonus based on company performance. As a statistical modeler, I did have an impact on the company. If I built a model that improved sales by 1%, that resulted in $7.5 million in demand, maybe $2.5 million in EBIT. So the bonus was important to me. I eagerly watched our financial results. I learned how my work contributed to the success of the company.

Maybe more important, I felt valued at Christmas when I received half my bonus check, and again in March when I received the other half. I still felt valued when the bonus check was tiny.


I've experienced the opposite effect.

I once led a group of individuals in a division of a company that offered bonuses. This division merged with another division. The other division did not offer bonuses. As a result, the combined division would not offer bonuses.

Take an employee who earned a salary of $40,000 per year, with a bonus range of between 6% and 15% (not the actual percentages used at this company). The bonus could vary between $0, and $6,000.

In this case, the employees earned 15% bonuses each of the past two years. Their division performed well above expectations, they deserved to share in the success.

The decision makers did not have the courage to tell the employees of this decision. My directors and I had to communicate this message to my employees.

I recall being in an Executive meeting, where about ten of us were discussing the consequences of this decision with Human Resources. I was the only person who spoke up. And oh my, did I speak up. I detest when big companies step on tiny employees making entry-level salaries.

Let's go back to our employee earning $40,000 per year. Each of the past two years, this employee earned $46,000. This coming year, the employee could do a great job. The employee would earn $40,000 (though some received a very small salary adjustment, maybe 1% or 2%).

You can imagine the grim looks the employees wore on their faces when we communicated this decision to them.

The harsh feelings lasted for years. Employees quit. Some became downright bitter, less productive. Some resented me. I recall one individual, tears in her eyes, faulting me for letting her down, faulting me for not doing my job, for failing her.

There are many incentives for employees. When a business matures, and grows at a standard 5% to 10% per year, bonuses give employees a first-hand understanding of the ups and downs of a mature business, as well as an incentive to drive profit increases.

Take that incentive away from an employee, and you damage a fickle relationship between employees and employer.


Two questions for you, the loyal reader.

First, should entry-level employees receive an annual bonus based on company performance?

Second, what should have been done for the $40,000 per year employee I described in this article? If a bonus is to be taken away from this employee, what (if anything) should be done for this employee?

Executive Compensation

A few months after the end of the fiscal year, publicly traded multichannel businesses are required to share Executive Compensation with the public.

It is always easy to pick on Executive Compensation. There are hundreds of examples of leaders being rewarded, while employees are downsized, or shareholders struggle to receive an adequate return on investment.

Compensation works in different ways, depending upon where an employee stands in a multichannel company.

The vast majority of employees are placed in "salary bands". These bands are determined by competitive reviews of comparable jobs at similar companies. Once an employee is "banded", s/he will earn an annual salary increase that is roughly similar to the increase in the cost of living over the past year. Outstanding performers may earn a bigger increase, employees at the bottom of the salary band may earn a bigger increase.

Executive Compensation is more complex.

Take a CFO at a multichannel company. Her compensation is comprised of at least three components:

• Annual Salary. Let's say her annual salary is $350,000 per year.
• Performance Bonus. The bonus is usually based on the company achieving sales and profit objectives. This bonus might vary between 0% and 100% or more of her salary. During an average year, the bonus might be 50% of base salary --- maybe $175,000, paid after the close of the fiscal year.
• Stock Options. If the business is publicly traded, the employee is granted shares that can be redeemed. The employee might be granted 100,000 shares at a price (say $10 per share). The shares usually vest in increments, so that they are fully vested in four years. After four years, the share price should have hopefully increased enough to please investors. Say the share price, after four years, is $20. This employee could earn in 100,000 * ($20 - $10) = $1,000,000 in four years. The brand may elect to grant new shares each year, at the current price of the shares of stock.

So, the humble Executive can earn maybe $1,000,000 a year, about a third is guaranteed, about twenty percent is variable on annual performance, and close to half is based on market performance.

In a bad year, the CFO earns the base salary of $350,000.

In a good year, the CFO earns $350,000 base salary, $350,000 bonus.

If the business has numerous good years, the CFO can earn $350,000 base salary, $350,000 bonus, and $1,000,000 in stock options.

So, we established that about 2/3 of the Executive's salary is "variable", highly dependent upon company performance.

Now, let's go back to the base salary. Compensation Committees like to review "peer" businesses. In other words, the Compensation Committee will look at the salary of the CFO, and compare it with the salaries of CFOs at major competitors.

Let's assume that company performance is "average", compared with the peer group.

Let's also assume that this CFO is "under-compensated", from a base-salary standpoint, verses CFOs within the peer group. In other words, maybe the average CFO in the peer group earns $420,000.

Here's the situation: You like to pay your leaders at the mid-point of your peer group. Do you increase the salary of the CFO to $420,000 a year, so that your CFO is compensated at a "fair" level, compared with other CFOs?

• If your answer is "no", why? Do you risk losing your CFO to a peer company that pays a better base salary, and if you do lose your CFO, what is the risk to your company?
  
• If your answer is "yes", why? What kind of message do you send to your garden-variety employees, who are earning $50,000 a year, and are struggling to pay bills with their 3%, $1,500 cost-of-living increase? What kind of message do you send to your hourly staff, who are earning $25,000 a year, and are really struggling to pay bills with a 3%, $750 cost-of-living increase?