What Is a Bonus?

A bonus is a financial compensation that is above and beyond the normal payment expectations of its recipient. Bonuses may be awarded to both entry-level employees and to senior level executives. Bonuses may be dangled as incentives to prospective employees and can also be distributed to a company's shareholders.

While bonuses are traditionally given to exceptional workers, employers are increasingly doling out bonuses company-wide to stave off jealousy among staffers.

Understanding Bonuses

In workplace settings, a bonus is compensation given to an employee that complements his or her fixed wage or salary. A company may use bonuses to reward achievements, to show gratitude to employees who meet longevity milestones, or to entice not-yet employees to join a company's ranks.

Key Takeaways

  • A bonus is a financial compensation that is above and beyond the normal payment expectations of its recipient.
  • Bonuses may be awarded by a company as an incentive or to reward good performance.
  • Bonuses may be paid in cash, but also stock or stock options for employees.

Incentive Bonuses

Incentive bonuses include sign-on bonuses, referral bonuses, and retention bonuses. A sign-on bonus is a monetary offer that companies extend to top-talent candidates, to entice them to accept a position—especially if they are being aggressively pursued by rival firms. In theory, paying an initial bonus payment will result in greater company profits down the line. Sign-on bonuses are routinely offered by professional sports reams attempting to lure top-tier athletes away from competitive clubs.

Referral bonuses are presented to employees who recommend candidates for open positions, which ultimately lead to the hiring of said candidates. Referral bonuses incentivize employees to refer to prospects with strong work ethics, sharp skills, and positive attitudes.

Companies offer retention bonuses to key employees, in an effort to encourage loyalty, especially in downward economies or periods of organizational changes. This financial incentive is an expression of gratitude that lets employees know their jobs are secure over the long haul.

Performance Bonuses

Performance bonuses reward employees for exceptional work. They are customarily offered after the completion of projects, or at the end of fiscal quarters or years. Performance bonuses may be doled out to individuals, teams, departments, or to the company-wide staff. A reward bonus may be either a one-time offer or a periodic payment. While reward bonuses are usually given in cash, they sometimes take the form of stocks, gift cards, time off, holiday turkeys, or simple verbal expressions of appreciation.

Examples of reward bonuses include annual bonuses, spot bonus awards, and milestone bonuses. Spot bonuses, which reward employees who deserve special recognition, are micro-bonus payments, typically valued at around $50. Workers who reach longevity milestones—for example, 10 years of employment with a given firm—may be recognized with additional compensation.

Some businesses build bonus structures into employee contracts, where any profits earned during a fiscal year will be shared amongst the employees. In most cases, C-Suite executives are awarded larger bonuses than lower-level employees.

Bonus Inflation

While bonuses are traditionally issued to high performing, profit-generating employees, recent studies indicate that nearly 25% of all North American managers issue some type of bonuses to lower-performing employees as well, even though businesses that do this tend to grow more slowly and generate less money.

Still, many businesses resort to distributing across-the-board bonuses in an effort to quell jealousies and employee backlash. After all, it's easier for management to pay bonuses to everyone than to explain to inadequate performers why they were denied. Furthermore, it can be difficult to accurately assess performance success. For example, an employee who fails to make his quota may be a very hard worker, who happens to be encountering unavoidable production delays.

Bonuses in Lieu of Pay

Companies are increasingly replacing raises with bonuses—a trend that vexes employees because although employers can keep wage increases low by pledging to fill pay gaps with bonuses, they are under no obligation to follow through. But because employers pay bonuses on a discretionary basis, they may keep their fixed costs low by withholding bonuses during slow years or recessionary periods. This approach is much more viable than increasing salaries annually, only to cut wages during a recession, which rarely happens.

Dividends and Bonus Shares

In addition to employees, shareholders may receive bonuses in the shape of dividends, which are carved from the profits realized by the company. Furthermore, a company can issue bonus shares to investors.