A revenue incentive can reward an executive for signing a large contract that produces little margin, burdens delivery, or never pays in full. The target may be met exactly as written while the organization receives a result it did not intend to reward.
The drafting issue is the relationship between the measured event, the executive’s control over it, and the value the organization expects.
“Revenue” is not a complete definition
Consider a hypothetical contract with a stated value of $1 million, only $200,000 of which is collected during the award period. An award based on signed contract value, recognized revenue, or cash collected can produce three different outcomes. Discounts, refunds, cancellations, and pass-through costs can change the comparison further.
Contract value may reward sales effort promptly. Collections may better reflect cash received but expose the executive to billing and collection decisions made by others. Margin can discourage unprofitable growth, but the definition must address which costs are allocated to the business. There is a tradeoff to decide before the numbers are known.
A measurement period can move the behavior
A year-end target can encourage discounts to bring a contract into the current year. A short retention period can reward a hire who leaves soon after the measurement date. A transaction bonus can reward closing a sale while leaving integration performance outside the award.
Adding another metric is not always the answer. An award with too many moving parts can become difficult to understand and administer. The useful design identifies the result that matters and the most consequential behavior the formula could unintentionally reward.
Discretion and an earned entitlement are different promises
A board may want discretion to account for exceptional circumstances. The executive may expect a payment once a formula is satisfied. If the agreement promises both without resolving the relationship, the dispute arrives when the board tries to reduce a result the executive believes was earned.
The agreement needs a coherent treatment of adjustments, interpretation disputes, changed roles, leave, and departure during the measurement period. Applicable wage law can also limit the treatment of earned compensation. Calling an award discretionary does not settle every issue.
Changing the payment date can create a separate problem
Deferred compensation may implicate Section 409A. A change that seems administratively convenient, such as allowing an executive to choose a later payment date, can have consequences beyond the incentive formula. The IRS’s discussion of nonqualified deferred compensation identifies the additional tax consequences of noncompliance.
Before promising an award, the organization needs to understand what earns it, what changes the amount, and when payment becomes due. Those answers should support the same business objective.
See the Executive Agreements and Compensation Guide for the surrounding employment and approval decisions.
