The lower and upper performance thresholds in the typical bonus plan are routinely based on the outputs from the firm's annual budgeting process. Almost all firms go through an annual budget cycle in which CEOs, executives and lower-level managers submit budgets for targeted outputs in the following year. The budget projections are reviewed and negotiated with higher levels in the hierarchy, resulting in a final budget target for the firm, division, or department. As I pointed out earlier, the lower and upper performance thresholds in the bonus plans are often based on the budget target with the lower threshold often set at 80% of the targeted or budgeted performance and the upper threshold set at 120%.

1. Are bonuses tied to performance measured relative to the budgeted performance target?
2. Speculate about the unintended consequences that can arise from tying bonuses to budgeted performance.