Definition
The term incentive compensation refers to the portion of an employee's salary that is related to performance, and not a guaranteed payment. Incentive compensation is additional money, or other rewards of value such as stock options, that are supplementary to base salary.
Explanation
This form of compensation goes by the term "incentive" because payment is usually contingent upon performance of the company, the employee's department, the employee, or combinations thereof. This means the employee has an incentive to perform at a high level, and be rewarded for the effort.
Incentive compensation programs aim to motivate individuals to act in a way such that the money is a reward for the employee's contribution to the success of the business.
The structure of incentive compensation programs is such that employees may have "at risk" a certain percentage of their salaries. When a "cash" incentive is used, it is typically offered as a percentage of the employee's base salary. For example, an employee with a base salary of $100,000, and 10% incentive compensation, is eligible for an additional $10,000 as part of that program.
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