Why do we need short-term AND long-term incentives – a behavioural explanation

There will be a number of factors as to why a business does or does not offer “variable pay” – a.k.a annual bonuses and/or long-term incentives.

These can include cultural choices, size and affordability.

Often, businesses will just choose an annual bonus OR a long term incentive – with the most common choice being for annual bonuses.

From a “behavioural economics” perspective, incentives influence behaviour. We would very much consider that the award of an annual bonus has the most powerful immediate effect – a well-constructed annual bonus plan being a tool that can bring about both behavioural change and business success in the short-term.

Importantly, the behaviours that are influenced by remuneration which is short-term focused are different from those that are influenced by long-term incentives.  Whilst sustained business success depends in part on achieving short-term goals, it is also dependent on strategic thinking and the achievement of longer-term strategic objectives. However, we see companies often just trying to replicate the structure of short-term incentives over a longer period – rather than creating something different which will encourage other behaviours and mindsets.  For example, annual bonuses focus on short-term outlooks and achievements – which are different from the more thoughtful behaviours required over the longer term

The successful design of remuneration packages therefore needs to be based on a firm understanding that the behaviours you wish to encourage in the short term may be different from those you wish to encourage in the long term and the art behind the design is to (1) establish what behaviours are required and (2) work out how they can be balanced effectively.

Finally, even if you are a business which is deliberately conserving cash and therefore may think you are only able to pay “in paper” – there are ways to structure the award of equity/options such that both short- and long-term incentive structures can be created.

If the above matters resonate and you would like to discuss how MM&K could assist you with developing your approach to incentive structures – please contact Stuart James (stuart.james@mm-k.com) in the first instance.

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