As the name implies, incentive plans are Pay-for-Performance, which is the only type of design we recommend. (Note: if your organization gives a “Christmas Bonus” be careful it is not positioned as an incentive payment).
Incentive plans are often built with significant complexity that includes too many KPIs (Key Performance Indicators), a host of thresholds and tiers upon tiers. Sadly, many times, participants in the lower tiers do not know what they specifically did, or can do, to earn the incentive. Our rule: keep incentive plans simple. Just because an incentive plan is not complex does not mean it is not effective.
Annual incentive plans have the purpose to drive specific behaviors, which may be disconnected from earnings growth. For example, expansion of infrastructure (such as building branches or IT infrastructure) and increasing earnings at the same time is not a likely scenario. So be realistic with what you want to accomplish under incentive plans and realize that other components of compensation will help incentivize the executives on building long term, franchise value of the bank – which will include higher profitability, over time.