Bonus

A bonus is pay given in addition to base wages or salary, usually to reward performance, retention, or a specific outcome.

A bonus is compensation paid on top of regular wages or salary, often to reward performance, retention, profit targets, or completion of a specific task.

Why firms use bonuses

Bonuses are part of incentive design. In principal-agent terms, a firm wants worker effort, quality, or retention, but it cannot observe everything perfectly. Variable pay can help align worker behavior with the firm’s objective.

Common bonus structures include:

  • individual performance bonuses,
  • team bonuses,
  • profit-sharing,
  • signing and retention bonuses.

Economic trade-offs

Bonuses can improve effort when performance is measurable, but they can also create problems:

  • workers may focus only on rewarded tasks,
  • risk is shifted onto employees,
  • poorly designed targets can encourage gaming,
  • strong bonus culture can widen pay dispersion inside firms.

So the economic question is not whether bonuses are good or bad in the abstract. It is whether the metric being rewarded matches the behavior the firm actually wants.

Labor-market context

Bonuses are especially common where output can be measured clearly or where firms compete hard for scarce labor. In other settings, fixed wages may work better if performance is hard to verify or teamwork is central.

Knowledge Check

### What distinguishes a bonus from regular salary? - [x] It is additional compensation tied to a rule, event, or performance measure - [ ] It is always paid weekly - [ ] It is never taxed - [ ] It cannot vary across workers > **Explanation:** A bonus is extra pay beyond base compensation and is usually conditional in some way. ### Why might a firm prefer bonuses to higher fixed wages? - [x] To strengthen incentives without permanently raising base pay - [ ] To remove all worker risk - [ ] To guarantee perfect performance measurement - [ ] To avoid all compensation costs > **Explanation:** Variable pay lets firms reward outcomes while keeping part of compensation contingent. ### What is a common downside of poorly designed bonuses? - [x] Workers may game the metric rather than improve true performance - [ ] Productivity becomes impossible to measure - [ ] Firms can no longer hire skilled workers - [ ] Wages stop affecting effort entirely > **Explanation:** Incentives can distort behavior if the target is narrow, manipulable, or disconnected from broader firm goals.