June 19, 2025

The Growth Bonus Trap: Sales Pay Design is a Minefield

The article was generated from the video transcript and edited by Dr. Hermann J. Stern.

We've established the critical need to balance profit-focused incentives with growth metrics in executive compensation here: The Profit Problem: Why Focusing on Profit in Executive Pay Leads to Underperformance. However, the seemingly straightforward task of setting effective growth targets is fraught with challenges. As we explored in a recent lecture at the University of St. Gallen, even when armed with industry averages, the inherent ambition makes designing a motivating and fair bonus system surprisingly complex: The Target-Setting Trap: Why Growth Goals Are Often Set Too High (and Why It Matters).

To illustrate this, Dr. Stern conducted a simulation with the students, posing a common scenario: the industry average growth rate is 8%, and they needed to design a bonus system where this served as the target. The key questions were: where would they set the payout hurdle (the growth rate below which no bonus is awarded) and the payout cap (the growth rate beyond which the maximum bonus is achieved)?

While varied, the students' responses clustered around a floor of 7% (median 6%) and a cap of 12% (median also 12%). This seemed reasonable on the surface, centered around the 8% average. However, when we compared this range to the actual distribution of growth rates for the largest German companies over a ten-year period (encompassing 755 observations), a significant problem emerged.

The data revealed that only a third of these large companies experienced growth rates between 4% and 14%. This meant that a staggering two-thirds of the companies were either significantly above or below the students' chosen incentive range. Consequently, in two out of three cases, the bonus system would fail to incentivize growth effectively. Companies growing below the hurdle would have no motivation to strive for growth, while those already exceeding the cap would have no incentive for further expansion. This creates a substantial "no pay for higher performance" zone.

Ideally, as one astute actuary from SwissRe pointed out, we would possess perfect foresight into the growth distribution and design a payout curve that spans the majority of likely outcomes, perhaps from below 10% to above 25% for an industry averaging 8%. This would cover most scenarios and minimize the "no incentive" areas.

However, implementing such a broad range creates a different problem: credibility. Imagine telling executives that achieving a -10% growth rate already triggers a small bonus, while the maximum payout requires exceeding 25% in an industry averaging 8%. For large, established companies, these extremes often appear unrealistic and can lead to ridicule and a lack of buy-in.

The fundamental challenge is that the actual distribution of growth rates in the real world is often far wider than our intuitive estimations. This inherent variability makes it exceedingly difficult to design a sales growth component in a pay-for-performance scheme that effectively motivates across the spectrum of potential outcomes without appearing either too easy or impossibly out of reach.

This short video vividly illustrates the complexities of setting effective growth targets for executive compensation. Witness the student exercise and the stark contrast between their intuitive ranges and the real-world distribution of growth rates. Understanding this challenge is crucial for designing incentive systems that truly drive sustainable growth without creating unintended disincentives or losing credibility with executives. Click play in the video above to see the explanation and reconsider the next time you encounter seemingly straightforward sales growth targets in compensation plans.