How to value a bonus when evaluating a job offer?

Question

If I have two job offers, one for £X and one for £Y + n% performance related bonus where the bonus is only paid annually, how should I compare them?

The employer making the offer is being simplistic and simply adding n% onto their offer and claiming it's a "package value". That's obviously not the case otherwise they could just pay that salary.

Assuming I am judged as an individual, and confident of hitting my goals (i.e. I will get the full n%) how should I value the future bonus when comparing it to straight salary?

Answer 1

I see four key differences.

Usually a bonus is paid as a lump sum at the end of the year -- maybe a calendar year, maybe the anniversary of you starting with the company. I'll assume this is the case for purposes of discussion. So let's compare job A, which will pay, say 1000 foobars a month, with job B, which pays 900 foobars a month and a 1200 foobar bonus at the end of the year.

In both cases, the total pay is the same: 12,000 foobars for the year.

But:

One: You don't get the bonus until the end of the year, so you have to wait for your money. It's almost always better to get money sooner. Then you can buy that new toy or whatever and enjoy it now rather than waiting. If you have no immediate use for it, you can invest it and make some additional income.

Two: If you quit in the middle of the year, you do not get the bonus. No job lasts forever. If a significant percentage of your pay comes as an end-of-year bonus every year, then the year you quit or are laid off, you get zero bonus. So in job A if you leave after 6 months, you get 6,000 foobars. In job B you get only 5,400.

Three: There is often uncertainty about a bonus. It may depend on you meeting certain goals set by the employer, or the company making a certain profit level. Often bonuses are totally at the whim of the boss. I once had a job where I was promised a substantial percentage of my pay as an end-of-year bonus, and when the time came, the boss told me the company wasn't doing well and he didn't have the money. You may be promised a bonus your first year, but the next year they give a smaller or no bonus. Etc.

Four: Pay raises are often calculated as a percentage of base pay. Like if the company says that this year everyone will get a 5% raise, in job A that means an extra 50 foobars a month. In job B it probably means an extra 45 foobars a month. The bonus may or may not be increased. Yes, my example is over-simplified because most companies don't give a blanket x% raise to everyone. But most companies do have a range: raises this year will be 1 to 3% or whatever. Even if each employee's pay is considered on an individual basis with no fixed percentages, the employer tends to think in terms of what percentage raise is appropriate, almost always calculated just on base pay.

Answer 2

There really are multiple aspects to this.

The calculatory time value aspect: Assuming that job X and Y will in total pay you the same amount, the time value of the salaries in job X are higher because job Y pays a large part only in the end of the term. In practice, you can dismiss this pretty much since short term interest rates are, currently, close to nil.

The risk aspect: Even if you are confident you will hit your targets, you might not do so. You might get sick, or in some other form distracted so that you just can't reach your goals no matter how much you'll try. So, if job X and Y in total pay the same, it would be a lot wiser to take the one with the regular higher salary.

Here again, in practice, it usually just doesn't matter so much. The job offering the higher salary will have a higher implicit target expectation. If you don't deliver, you will have a higher risk of losing your job than in company Y where a large part of the salary is performance based.

My advice: if you are confident that you will constantly outperform your goals and thus make a lot more money than the regular salary would amount to, you should definitely go for the performance bonus. If you feel you will always "just" reach targets, go with the regular salary.

Edit to include a valid comment:

There is a possibility that you will quit or be dismissed before the yearly bonus payout. In most companies, this will mean that you lose your bonus. This really depends on your specific contract, though.

Answer 3

One other thing to consider. You may be assigned to a project where some of the teammates are not capable/motivated/ enough. The project suffers and you get 0 foobars as your bonus.

Answer 4

What are all conditions of bonus payout? A few jobs ago my employer had a quarterly bonus of 10-25% of nominal salary based on position; then a range of 75-125% of that based on performance metrics and "360 review" which is a kind of pay based on popularity calculation. In the Bush recession, the quarterly bonus started to be delayed until the bulk of new sales were closed in Q4. I moved on shortly.

One cautionary note: after several consecutive quarters of suspension my ex-manager appealed to family court to adjust the cash amount of alimony and child support to be the percentage x actual earnings rather than percentage x projected earnings. The court declined.

Answer 5

My experience with every position I had where an annual bonus was including in the compensation package, the bonus was based not only on my performance, but also of performance of either the company or the division of the company I was part of. The term you may hear is the amount of funding the bonus pool has, and is typically based on the overall performance of the company/division, over which you likely have much less control. Be sure to understand how the bonus pool is funded in order to determine the likely payout. It may also be useful to know the level of bonus pool funding over the last several year.