The purpose of the annual incentive is to compensate executives for achieving the
company’s short-term business strategy. Thus, it is based on achieving a number
of goals specified for the company by the company's Board of Directors.
The nature of these goals varies depending on the business, company strategy and
other conditions. Annual objectives can include such items as:
- increasing revenue or market share
- improving profit margins
- implementing a new corporate strategy
- development of new products
- expanding to a new market, and completion of a critical project
Typically, the annual incentive is paid in cash and often can be up to twice the
CEOs annual salary.
Most annual incentives include a two-tier structure: a "target" level, which is
the executive’s normal expected performance, and a "stretch" component, meaning
that the company would have to obtain extraordinary results for the maximum incentive
to be paid. This is done to encourage executives to achieve superior results. Board
compensation committees can be very creative in structuring annual incentives to
reward achievement of company-specific objectives.