There are three main reasons why employers and employees disagree over performance bonus entitlements. From the least common to the most:
3. The employer is mistaken. In this situation, the written requirements for payment of a performance bonus are clear and the employee’s performance objectively meets the requirements for payment of a of a bonus in a certain amount and at a certain time. The employer refuses to pay or pays a lesser amount for the employer believes a good reason, such as the bonus amount came in much larger than expected or the company had a bad year and payment of the full bonus amount will place a strain on the business. Sometimes an employer resists paying a bonus amount because the employee, while hitting the specific bogies necessary to earn the bonus, has otherwise conducted himself in a disruptive, costly or otherwise less than satisfactory manner. In such cases, management’s recourse is to hold its nose and rewrite the plan.
2. The employee is mistaken. In this case, the employee believes that his or her performance warrants a bonus under the terms of the plan but is mistaken. The Dunning Kruger effect is fully in play. Akin to the self-enhancement bias (the tendency to describe oneself as better than average) or, more colloquially, the Lake Wobegon effect (where “all the women are strong, all the men are good-looking, and all the children are above average”), the Dunning-Kruger effect occurs when a person’s incompetence at a task prevents them from realizing that they are incompetent. Employees often overrate their own level of performance and they lack the insight to see that they have failed to meet the level of performance required for the bonus.
1. The Bonus Plan is Unclear. This seems to be the most common cause of performance bonus disputes. The criteria for earning a bonus are vague or can be interpreted more than one way. The triggers for entitlement to the bonus are not clearly stated. The bonus plan may include subjective bonus entitlement criteria and failed to expressly state that entitlement to the bonus, in the end, is entirely up to the employer’s discretion.
For these reasons, bonus plans must be in writing and must be written clearly in a way that leaves no room for interpretation. If the bonus is performance based, clearly state manner in which bonuses are determined and to the extent possible, use objective criteria and calculation measures. The vesting provisions must be clear (e.g., the employee must be an active employee on December 31, on the date the bonus is due to be paid, or some other clear time trigger.) Any contingency, adjustment or clawback provisions must be clearly stated. As with any contract, clarity is critical.