What Is a Performance Bonus?

A performance bonus is a form of compensation by a company to an employee that is made outside of the normal wage or salary that is paid. There are several different types of performance bonus payment methods, as well as several reasons for making the payments. Typical bonus payments often come at the end of a fiscal year and are rewards for an employee's individual and group-related labor for the company exceeding expectations. Aside from the standard year-end bonus, executives are often given additional compensation in the form of the employee stock option or a lucrative retirement plan known as a golden parachute. These types of executive bonuses are among a category known as camouflage compensation that is often made by corporations when they want to conceal from investors and the government the actual quantity of monetary compensation going to senior staff.

The annual performance bonus has become a staple method of compensation at many levels of management across various industries because of statistical validation as to its benefits over other types of compensation. Research in 2006 revealed that giving employees a 1% raise boosted their quality of work on the job by an average rate of 2%. By instead increasing compensation at the same rate with a lump sum bonus tied to the employee's exceptional level of contribution, the increase in job performance rose by a factor of 20%.

A difficult aspect to maximizing increased employee contributions to a company is determining what levels of performance at which to set the bonus pay. If the level is too easily obtained, then the bonus won't hold much meaning as most employees will obtain it, and, if it is too difficult to obtain, then employees won't work towards it as it will seem unrealistic to reach such goals. Where a performance bonus fails to get paid out due to invalid goal setting, companies will often issue discretionary bonuses at year's end to avoid negative feedback from a failed performance-based system.

A standard tiered approach to the performance bonus involves a minimum bonus payment when an employee is within 80% of company targets for productivity, a standard bonus when the employee is at a 100% level of performance, and a maximum company bonus when the employee exceeds expectations by having a 120% or higher level of productivity. These bonus levels, however, are only offered in most cases to management and executive staff who are paid salaries, with ordinary wage-earners in a company often not receiving any performance bonus incentives at all. As of 2011, the typical scale for performance bonuses as a percentage of the yearly salary for an employee in the US ranged from 10% for the very lowest level of managers on up to 60% to 100% of a year's salary for top level officials in firms.

Where camouflage compensation comes into play, the actual value of performance bonuses can be hard to track. These types of payments can fluctuate based on market conditions, such as a stock appreciation right (SAR), which is a bonus tied to the increased value of the company's stock during an arbitrary period of time. Another performance bonus that is an element of the golden parachute idea is the supplemental executive retirement plan (SERP), which offers retirement benefits far beyond those offered to other employees in a firm through standard individual retirement accounts (IRAs) and so on.

The nature of the performance bonus has come under increasing scrutiny and attempts at new legislation to restrict the practice by the US government in the wake of the financial crisis that ensued in 2008. In 2009, performance bonuses given out to banking and Wall Street-based executives exceeded many past records, despite the fact that the firms paying them either lost money, went out of business, or received large amounts of federal bailout funds provided by taxpayers in order to stay afloat. Billions of dollars in bonuses went to staff at failed insurance giant AIG or firms that posted record losses such as Merrill Lynch, totaling $18,400,000,000 US Dollars (USD) in bonuses paid by US firms in 2009 alone.