Rewarding Key Employees: How to Retain Top Talent

In the business world, rewarding key employees is critical for sustaining a motivated and engaged workforce. Yet, while financial incentives such as bonuses, stock appreciation rights, or phantom stock plans are often seen as straightforward solutions, their effectiveness is increasingly called into question. Despite their widespread use, financial rewards may not always yield the desired long-term behavioral changes or cultural benefits within an organization. Here, we explore why financial incentives might fall short and what alternatives businesses can consider.

The Limitations of Financial Incentives

Short-Term Behavioral Changes

Financial incentives can temporarily influence employee behavior, but studies and anecdotal evidence suggest they rarely lead to sustained improvements. Employees often revert to their usual patterns of work, regardless of monetary rewards. This is because behavior is more deeply influenced by intrinsic factors like values, habits, and character than by external rewards.

Gaming the System

Formula-based bonuses, while designed to incentivize specific outcomes, can inadvertently encourage employees to “game the system.” For instance, a bonus tied to individual revenue generation might reward an employee who meets sales targets but neglects teamwork or fosters a toxic work environment. Such systems often fail to recognize broader contributions that enhance company culture or team cohesion.

Complexity and Costs

Setting up financial incentive programs, particularly those tied to company performance, can be complex and costly. Plans like stock appreciation rights or phantom stock require regular company valuations, which can be expensive and challenging, especially for privately held businesses. These costs may outweigh the perceived benefits, particularly if employees view the rewards as insubstantial or insincere.

Lack of Meaningful Impact

Financial rewards are often seen as transactional rather than transformational. Employees may appreciate the extra compensation but may not feel a deeper sense of loyalty or connection to the company. This lack of meaningful impact can undermine the very goals these programs aim to achieve.

Non-Monetary Alternatives to Consider

Recognition and Encouragement

Non-monetary rewards often hold greater value than financial incentives in creating a positive workplace culture. Recognizing employees for their contributions—whether through verbal praise, awards, or public acknowledgment—can foster a sense of belonging and appreciation that monetary rewards cannot.

Career Development Opportunities

Investing in employee growth through coaching, training, and mentorship shows a genuine commitment to their future. Employees who see a clear path for personal and professional development are more likely to remain loyal and engaged.

Creating a Positive Work Environment

The atmosphere and culture of a workplace play a crucial role in employee satisfaction. By addressing workplace annoyances, promoting teamwork, and fostering a supportive environment, employers can enhance overall job satisfaction and productivity.

When Financial Rewards Do Work

While financial incentives may not always be the best solution, they can still have a place in a well-rounded reward strategy. For instance:

Discretionary Bonuses: These allow management to reward extraordinary contributions with the benefit of hindsight. By recognizing employees who go above and beyond, companies can ensure fairness and celebrate exceptional efforts.
Hybrid Approaches: Combining formula-based rewards with discretionary elements can balance structured incentives with the flexibility to recognize broader contributions.

The Bigger Picture: Fair Compensation and Good Hiring Practices

The key to rewarding employees effectively often lies in hiring the right people and compensating them fairly from the start. Employees who align with the company’s values and culture are more likely to contribute positively without needing constant incentives. Fair and transparent pay ensures employees feel valued for their ongoing efforts, reducing the need for gimmicky reward systems.

Conclusion

While financial incentives may seem like a straightforward way to reward employees, their limitations often outweigh their benefits. Instead, focusing on non-monetary rewards, fostering a supportive culture, and investing in employee development can yield more meaningful and lasting results. By prioritizing intrinsic motivation over external rewards, companies can build a workforce that is not only productive but also deeply engaged and committed to the organization’s success.

Video Transcript

Rewarding Key Employees

How can you reward your key employees? You’ll get the answer to that question today. As well as other questions like, what are stock appreciation rights? What is a stock appreciation plan? What is a phantom stock plan? What is a bonus plan? What is a bonus based on a formula? What is a discretionary bonus and do financial rewards actually change employee behavior? I’m Aaron Hall, an attorney representing business owners and entrepreneurial companies.

If you’re a business owner, these videos are for you to help you spot issues to discuss with your attorney to avoid legal problems and to grow a great company. If you haven’t yet downloaded the seven common legal mistakes made by new businesses, it’s a free cheat sheet I have available. It’s yours if you’re an entrepreneur or you’re a business owner, just go to www.aaronhall.com/free. It’s a free download that I’ll email to you. I’ll also send you some other valuable educational resources.

Ways to Reward Employees

Non-Monetary Recognition

How can your company reward key employees? Well, first off, you have the recognition, encouragement, the atmosphere, the vibe, the culture that you create. That’s kind of what I call non-monetary recognition, and I think that’s really valuable. Perhaps more valuable than monetary. But today, I’m gonna talk about the different types of monetary recognition.

Stock Appreciation Rights

All right. The first one is stock appreciation rights. What are stock appreciation rights? Stock appreciation rates are generally in large companies where once the employee starts, whatever the stock is priced at on that day, the employee gets the financial benefit as the stock price increases during the employee’s time at the company. So to the extent, the stock appreciates in value. The employee has a right of financial benefit. From that appreciation, it can be set up a lot of different ways, but that’s the gist of it.

Stock Appreciation Plan

What is a stock appreciation plan? Typically that is a company-wide plan that provides stock appreciation rights to employees. In other words, the company has set up a plan so that when employees start whatever the price of the stock is on that day, the employee benefits from increases to that price during the course of the employee’s employment. As you can probably tell though, all company stock appreciation rights are kind of difficult to figure out because in a small company you don’t have a daily stock value like you would with a publicly traded company. Yes, you could go get a private valuation, but there is so much fluctuation and private valuations are just between different appraisers that it’s very difficult to do a stock valuation for a small company for stock appreciation rights. So for that reason, it’s fairly rare in a private company.

Phantom Stock Plan

What is a Phantom stock plan? Well, as you can imagine, if a person came to the company and they started working there and they bought 5% of the shares of the company, then when they leave the company, they might have an option to sell those shares back and they get any sort of benefit in the appreciation or increase in value of those shares. A phantom stock plan is kind of like that, but it’s phantom, meaning it doesn’t actually exist. You’re not actually getting stocks. A phantom stock plan is a contract with employees that you will essentially give them a bonus based on how the value of the company increases over time. So in a way it’s kind of like stock appreciation rights, but it’s set up in a different way and it’s meant to mirror ownership in a company without giving over actual ownership.

Pros and Cons of Phantom Stock Plans

All right. What are the pros and cons of a phantom stock plan? The perceived benefit to the owner is that employees who are part of a phantom stock plan would have greater sense of ownership in the company, a greater sense of caring. They might work harder or be more frugal with the company’s resources, but a lot of companies have found that that doesn’t pan out, and here’s why. A lot of employees are going to behave how their internal system is wired, regardless of any potential financial benefit.

Second, a lot of employees see through the fact that it’s not actual stock ownership. It’s phantom stock ownership, which means it’s just a contract. The other problem with it practically is, in order for an employee to be compensated under a phantom stock plan, the stock has to be valued and valuation of a privately owned company can be very difficult and expensive because you have to hire a private appraiser to value the company so that’s the problem with Phantom stock plans.

Bonus Plans

So you’re a company owner, you want to reward your key employees. What’s another way to do it? You could do a bonus plan. What is a bonus plan? Well, it’s simply a plan to give them additional compensation over and above whatever their salary or hourly rate is and this bonus plan might apply to individuals, a segment of employees or all the employees. The bonus plan might be confidential and only available to those who know about it, or it might be known by all of the employees, but that’s what a bonus plan is. Now, bonus plan can be based on a formula or can be discretionary.

Formula-Based Bonus Plans

What is a bonus plan based on formula? That is a bonus or additional compensation that the company will give to the employees based on a specific formula that you could put in a spreadsheet, or perhaps it might be based on certain scores or ratings that the employee or department, or a team gets over time.

What’s an example? An example of a bonus plan based on a formula might be if the company hits certain revenue goals, then every employee will get a 3% bonus based on the value of their salary. So a person making a $30,000 salary, would get a 3% bonus of $30,000 or they would get a bonus of 3% of $30,000. A person making $100,000 would get $3,000 if it’s a 3% bonus.

Another example might be based on the individual employee’s performance. The problem with these formula-based bonuses is first, they can be hard to calculate, but let’s say you figure that out. Second, they can be easy to game. In other words, employees can game the system. They can be terrible, but they do exactly what’s needed to get their bonus, and now you find that you are giving a bonus to an employee who’s terrible in most regards to the job, but not in the specific metrics that are being rewarded in the bonus formula.

Example of a Potential Pitfall in Formula-Based Bonuses

What’s an example? Let’s say you have a bonus that says to attorneys, “You will get a percentage of the company’s profits based on certain billable revenue that you bring into the company.” Seems like a great idea. We wanna encourage revenue. Why not reward the attorneys who bring in more revenue and hit certain goals with a little bonus at the end of the year?

The problem is you might have an attorney who is faithful and loyal and positive, who shows up early, who helps their coworkers, but none of those things are part of the formula. And then you have another attorney who shows up late, has a bad attitude, gossips, doesn’t help coworkers but does actually bill more and that attorney is gonna get rewarded. Which employee in this case provides more value and reinforces a positive culture? The one that didn’t get the bonus.

So that’s why you can see formulas can be really counterproductive because they highly incentivize certain behaviors and they don’t recognize other behaviors. Now, you might say, “Well, let’s just do a formula that looks at all sorts of factors.” The problem is now you’re getting complicated. It’s a lot of data to track and having too many factors can dilute employees’ attention.

In other words, if the employee is trying to focus on everything it takes to get that raise, they might feel like, “You know what? It just takes everything.” And that diminishes the goal of a compensation plan, which is to drive certain behaviors and get employees to stay focused on what matters most.

Discretionary Bonus Plans

All right. So what a lot of employers say is, “All right, in light of all those problems with stock appreciation rights or a phantom stock plan or formula bonus system, what are we gonna do?” Well, you can do a discretionary bonus plan.

What is a discretionary bonus plan? It’s simply a plan that a company has to give bonuses at management’s discretion to employees who have contributed in extraordinary ways to the company above and beyond. What that does is it allows the management to determine who really has contributed in ways that perhaps we hadn’t contemplated when the year started, but we have realized that person has gone over and above what they were expected to do.

Maybe that person, when there was a real conflict in the company, they brought peace. When there was strife, they brought people together to help them see at the other side of different concerns. Maybe they were positive, maybe they were encouragers, maybe they spent a lot of additional time helping teammates with their projects. Discretionary bonuses allow companies to look with the benefit of hindsight back at the year and say, “How do we want to reward people who truly contributed to the company?”

So the company may still set aside a bonus pool or a compensation pool, but instead of telling all the employees in advance what criteria will be used, the company reserves some discretion.

Combining Bonus Approaches

Now, by the way, you can use a hybrid of all these. Of course, it gets more complicated when you do that, but you could use formula and discretionary bonus. That’s a way to say, “Hey, we wanted to reward these factors, but we also want the discretion to reward people who’ve done something that wasn’t identified in the criteria in advance.”

Do Financial Rewards Change Employee Behavior?

All right, well, what should you do? I think it comes down to you answering one important question and that is, do financial rewards actually change employee behavior? There’s a lot of data indicating that although financial rewards might temporarily change employee behavior, employees often revert back to their standard practices and patterns, fears, anxieties, and tendencies.

In other words, look at your employees right now. Certain people always do the right thing and they work hard and they do what’s best for the company on a regular basis even though you may not have any additional compensation for them or any particular incentives for that behavior. Other people, they’re just problematic employees. They make decisions based on what’s in their best interests. They’re not self-disciplined, they cause other problems and then you have a variety of people in between.

The Long-Term Effectiveness of Financial Incentives

The question is from a psychological standpoint, do these financial incentives actually create long-term employee behavioral changes? Anecdotally, I have come to the conclusion that they don’t.

In other words, it’s best to pay people who are doing well for the good work they’re doing, not necessarily hold a bonus over their head. A person who is doing what they’re supposed to do often is not gonna be changing behavior based on a bonus long-term behavior. Likewise, people who are problems or don’t have good habits and don’t have good routines or good character or a focus for what’s in the best interest of the company, often we find that those employees don’t actually change long term.

Final Thoughts on Employee Rewards

What they might do is try to game the system to get some sort of bonus, but it doesn’t produce long-term meaningful change contributing to the company.

So a lot of business owners who have looked at all these different ways to reward key employees have said, “You know what the key is finding good people and then compensating them fairly for their contribution on an ongoing basis.”

The idea of a delayed bonus or reward may work in a discretionary manner just to bring fairness to the situation so a person is fairly compensated for extraordinary effort. But most business owners who have gone through this and have really spent the time have determined these little incentives turn out to be ineffective gimmicks essentially.

Non-Monetary Rewards for Long-Term Success

So I’ve shared with you my opinion on how you can reward key people in your company. I think it’s great to focus on the non-monetary rewards. That’s encouragement, recognition, coaching, training, looking out for their best interests, thinking about their career, making sure that you find out what work is meaningful to them, what annoyances they have, and do what you can to help make that job better.

But this idea of some sort of monetary bonus down the road, most of the time I’ve seen it just doesn’t create long-lasting behavioral changes in the employees and it actually is fairly distracting and expensive to set up. And then of course, the compensation that’s required for that is an expensive part of the budget as well.

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