Profit-sharing bonus – what, why, and does it work? How?

One common bonus to find in the American market is the profit-sharing bonus. Do you know what it is? Are you wondering if it could work for your company?

This article will explain what a profit-sharing bonus is, how it works, and who is likely to obtain it. It will also summarize its pros and cons. 

What is a profit-sharing bonus?

A profit-sharing is compensation received over a set period of time, usually once a year. It represents a percentage of the company’s pre-tax profits. For this reason, the profit is only applied when the company has benefits.

The percentage assigned to each individual may depend on their salary, their seniority, etc. Anyway, the “reasoning” behind the percentage distribution must be transparent to employees. 

This bonus can either be monetary or in the form of stocks and bonds.

Different kinds of profit-sharing plans

Profit-sharing plans are primarily divided into three categories:

Current profit-sharing plan: it is paid in cash or stocks, and it is paid whenever it is assigned. It provides instant gratification. However, the total amount is taxable as regular income.

Deferred profit-sharing plan: the bonus withdrawal time is set at the time of retirement, death, or termination of employment. This increases employee retention, and the bonus amount is not taxable, but it does not have immediate effects on employees’ performance.

Hybrid profit-sharing plan: it is a combination of the above two plans. A proportion of the bonus is saved as a retirement plan, and the rest is encashed. It joins the advantages of the two other kinds of plans.

Who is likely to receive a profit-sharing bonus?

Some insights about profit-sharing bonuses:

• It is mainly used in the United States (more than 95% of these bonuses are located in the States).
• 66% of the time, they happen in a business services company. The second most common sector is the financial industry, with 20%.
• Not everyone gets it. Usually, it is assigned to senior professionals and leads.
• The average salary of recipients of a profit-sharing bonus is 54,000€ annually. It means that people with high salaries are likely to be the ones assigned profit-sharing bonuses.
• This practice is extended to companies of all sizes.

Why is it beneficial?

As with every bonus, the main point is to motivate and incentivize employees. It will result in an increase in their effort and in their satisfaction too. The profit-sharing bonus specifically is also a boost to their feelings of ownership and loyalty.

Profit-sharing is a bonus specifically beneficial to companies. That is because the costs of this benefit are proportional to revenue. Organizations do not need to worry about setting it too high or too low since it is adaptable to each year’s results.

What are its inconveniences?

There are two main disadvantages of profit-sharing.

The first one is that employees could prioritize profitability over quality. This will give good economic results in the short term, but in the long term, reputation will be damaged. So to say it another way, profit-sharing could encourage bad behavior.

The other inconvenience is that there will be many free riders: employees that do not perform well but rely on others’ work. Since what you receive depends on the total profits of the company, your own results do not matter if the overall results are really profitable. Employees who contribute less will still receive a share of profits, regardless of their relative contribution. This is because there is no difference based on merit or performance. 

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