What’s the Best Way to Allocate a Bonus Pool? Three Points

Situation: A company allocates 10% of pre-tax profit to a Bonus Pool. Employees qualify for quarterly bonuses based on company and group performance, and for semiannual bonuses based on individual performance. Last year not all funds were paid out of the pool because some employees failed to hit performance targets. What’s the best and fairest way to allocate the excess funds in the pool?

Advice from the CEOs:

  • Why not let the pool be the pool? Employees will or will not qualify for bonus participation based on individual and group performance. The company determines who qualifies at each level and these individuals become the pool participants, splitting the full pool in proportion to their level of qualification and their salary.
  • Not all companies will do this based on pay and bonus level policies. For these companies there are options on what to do with unpaid bonus funds in the pool:
    • Leave the funds in the pool for future distribution;
    • Shift unpaid bonus to Retained Earnings; or
    • Retain a percent of the funds in the pool and shift the rest Retained Earnings.
  • Another consideration is whether to use discretionary or metric criteria to determine bonuses. Some companies use only or primarily metric criteria, others use discretionary criteria, and some use a blend of metrics for one portion of the bonus with the remaining portion discretionary. The rationale behind discretionary criteria is to give managers the opportunity to recognize extraordinary contributions that fall outside the normal metrics.

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