Do retention bonuses pay off?

Published 8 February 2023 | 5 min read

Ultimately retention bonuses can be an effective short-term tool for senior and hard-to-replace roles.

The use of retention bonuses — cash payments offered to employees as an incentive to stay on the job through a specified date or upon achievement of a specific milestone — is at an “all-time high,” with almost 60% of organisations making the investment, according to a recent study by World at Work.

But is it money wisely spent?

Tom McMullen, rewards expertise leader at Korn Ferry, says that retention bonuses are typically offered to employees who are in a key role and who have shown outstanding performance. They can be useful in certain cases, for example, to encourage employees to stay through a merger or acquisition or through the completion of a key enterprise project.

Retention bonuses can also be a useful tool to keep employees during a hot talent market. “The pattern is tied to the macroeconomic environment,” says Jacqueline Welch, executive vice president and chief human resources officer at The New York Times Company. McMullen agrees, noting that companies use retention bonuses when they receive a market signal that they could lose talent, such as high turnover in a certain job function.

Remote work might be another factor possibly driving the rise in the use of stay bonuses. In the wake of the Covid pandemic, corporate culture and professional friendship ties have weakened. McMullen notes this may have made such payments seem more necessary.

However, there are some risks to be aware of when offering retention bonuses. There’s no evidence they increase engagement or long-term loyalty. It’s for this reason that Tracy Winton, senior vice president of human resources at Iovance Biotherapeutics, uses them sparingly. “It moves the employee/employer relationship away from the ideal partnership state and towards the transactional,” she explains, noting that when she has offered retention bonuses, 90% of those employees left anyway.

“Employers need to understand the employee perspective,” says Randi May, an employment counsel in New York City. “Once the payday hits, they’re out of there. They will start their job search around the end date.” Retention bonuses make employees think, “These are the only dates they want me.”

Some organizations use retention or sign-on bonuses to procure talent and match competing job offers. But this short-term strategy risks alienating current employees and can wreak havoc when it comes to pay equity.

And one more argument against retention bonuses: “You’re essentially paying people to do what you’re already paying them to do,” observes Erika Duncan, a human resources advisor based in New Jersey.

A More Effective Way to Use Retention Bonuses

In most organisations, retention bonuses are left up to management discretion. Fewer than one-third of companies have formal guidelines and eligibility criteria, according to the World of Work study. Used mainly for senior and hard-to-replace roles (like sales, IT, and technical staff), the bonuses are paid in cash, in a lump sum. About a quarter of organizations use a periodic payout at regular time intervals or upon achievement of project milestones. Many contracts have clawback provisions, whereby the employee must pay back the bonus (or a pro-rata portion) if they leave before the stipulated time period. Length of service is usually not a criterion for eligibility.

To use retention bonuses more effectively, experts recommend the following four steps:

1. Think strategically.

When you offer a retention bonus, you are essentially offering the employee an end date. So you need to ask yourself: What’s driving the risk of the employee’s departure? Will retention payments lower that risk? And how will you measure success?

If you are experiencing turnover due to below-market base pay, for example, retention bonuses are not the solution. You need to raise base pay. If you want to recognize exceptional results and effort, give the employee a one-time spot bonus. To retain senior executives, it may make cash-flow sense to explore restricted stock grants that vest over time.

Retention bonuses can be a creative way to slow growth and exits if you only need people short-term. “You can design a ramp-down program with a graduated scale, such as four months, six months, and so on,” explains Erika Duncan.

2. Spell out program eligibility and offer managers guidelines on how to use them.

This is valuable for two reasons. First, companies that don’t provide governance are likely to run the risk of an open checkbook. Second, more than 25% of companies that pay retention bonuses relied on management discretion and therefore could not identify how they were calculated, according to World at Work.

Having an explicit policy also ensures that your company’s approach towards retention bonuses is more fair. Total management discretion, without any oversight, risks favoritism, equity, and morale issues.

3. Put your offer in writing.

Include dates of eligibility, payout provisions, and the rationale for the bonus. Where applicable, define qualifying project milestones. Consider whether to include a clawback provision, ineligibility in case of termination for cause, and payment contingent upon a release of claims. Contractual language should be easily understood — no legalese.

4. See if it passes the “public printer” test.

Ask yourself: If a copy of the retention bonus program was discovered sitting on a printer by an unsuspecting employee, would it pass the fairness test? “The program should be such that if it were communicated to all employees, they would understand the strategy,” says Welch.

If you are going to use retention bonuses widely, consider communicating the program. People may not like it, but they will trust and respect you more if they hear about the program from the company leaders and are trusted with the rationale, rather than through employee rumor mill.

Welch shared an example of what this looks like in practice. One of her prior employers was renowned as a good developer of a specific job role. Like clockwork, at 12 to 18 months, clients would come to poach this talent.

With turnover for the position leaping from 10% to 25%, her company created a retention and development strategy. They were candid with employees in this role, informing them that clients would attempt to hire them away after a year. They educated them on the reasons to stay, explaining the career ladder and promotion opportunities. When possible, they promoted these employees on a shortened timeline. When people were not quite promotion-ready, they used retention bonuses as a stop-gap solution to incent them to gain the necessary skills to get to the next level.

A final word to the wise: Don’t pay jerks to stay. Open the exit door for top performers who threaten to leave and are toxic to the work environment. Let them go, no matter how great their results are. “Don’t allow yourself to be held over a barrel,” Welch says. Winton agrees. “I tell managers whenever you make a compensation decision based on fear, it doesn’t work.”

And if your organisation can’t afford a bonus program, you can reward key employees with career development opportunities and specific, appreciative feedback. There are many nonmonetary ways to retain staff.

When used surgically, retention bonuses are an effective short-term economic tool for organisations. Long-term retention and loyalty aren’t necessarily about the money, but are dependent on the priceless relationships managers build with their team members.

Click here to read the article by HBR.