Advanced Performance Management · Performance and reward

Executive Reward: Bonuses, Share Options and LTIPs

Updated 11 October 2026 · Fact-checked

Executive reward links directors' pay to performance. Cash bonuses reward short-term targets. Share options give the right to buy shares at a fixed price. LTIPs award shares or cash if long-term targets are met. In APM, you assess each scheme's motivation, goal congruence, risks and drawbacks against the scenario.

Understand Executive Reward: Bonuses, Share Options and LTIPs

Executive reward exists because of the agency problem. Shareholders (principals) own the company, but directors (agents) run it. Directors may pursue their own interests. Pay schemes try to align the two by tying reward to results shareholders value.

A cash bonus is paid when a target is met, usually for one year. It is simple and easy to understand. The risk is short-termism. Directors may boost this year's profit by cutting R&D, training or maintenance. They may also manipulate figures or choose easy targets.

A share option gives the holder the right, not the obligation, to buy shares at a set exercise price after a set date. It has value only if the share price rises above the exercise price. It links pay to shareholder wealth. But share prices move with the whole market, not just effort. Options can pay out for luck. They have no downside for the holder if the price falls, which may encourage excessive risk-taking. Directors may also focus on lifting the share price in the short run, or on dividend and buyback policy, rather than on sound strategy.

A long-term incentive plan (LTIP) awards shares or cash if performance conditions are met over a multi-year period, often three years or more. Conditions may include total shareholder return, earnings per share or return on capital. Awards usually vest only if the director is still employed. This encourages retention and a longer view. Drawbacks are complexity, difficulty setting fair conditions, and the chance that directors still target the measures chosen.

The key difference: an option rewards any rise in share price above the exercise price. An LTIP normally depends on meeting stated performance conditions, and often delivers shares even if the price has fallen. Good schemes mix fixed salary, bonus and long-term elements, use several measures, and are overseen by an independent remuneration committee.

Key rules to remember

Intrinsic value of a share option at exercise: Gain per option = Market price − Exercise price (if positive, otherwise 0); The holder will not exercise if the market price is below the exercise price.
Total option gain: Total gain = Number of options × (Market price − Exercise price); Ignores tax and any cost of financing the purchase.
Bonus as percentage of target: Bonus = Bonus rate × Measure above threshold (or a fixed sum if target met); Use the scheme rules given in the question. Check for caps and thresholds.
Total shareholder return (TSR): TSR = (Closing price − Opening price + Dividends) ÷ Opening price; A common LTIP condition, often compared with a peer group.

How to solve Executive Reward: Bonuses, Share Options and LTIPs questions

Use this method for any question asking you to evaluate or criticise a reward scheme.

1Read the requirement. Note whether you must explain, evaluate, criticise or recommend.
2Identify the scheme types in the scenario: bonus, options, LTIP, or a mix.
3State the objective of each scheme: usually aligning directors with shareholders and retaining talent.
4Apply to the scenario facts. Ask what the measure is, the time horizon, the target and who controls the outcome.
5Explain the behavioural effects: short-termism, manipulation, risk-taking, focus on measured items only.
6Give the drawbacks: market luck, controllability, complexity, cost, fairness and ethical issues.
7Recommend improvements: longer horizons, several measures, clawback, independent remuneration committee, shareholding requirements.
8Finish with a clear conclusion that answers the requirement, in the format asked.

Quickest way: Scheme, behaviour, fix

When to use it: Use when time is short or when a 5 to 10 mark requirement asks you to criticise a scheme.

Name the scheme and its measure in one line.
Write the behaviour it will encourage, using a fact from the scenario.
Write the harm: short-termism, risk, manipulation or unfairness.
Add one fix for each point.
Check each point uses scenario detail, not just theory.

Common mistakes in Executive Reward: Bonuses, Share Options and LTIPs

Treating options and LTIPs as the same thing.
Both pay in shares and both are long term.
Fix: Say options depend on the share price rising above the exercise price. LTIPs depend on stated performance conditions over a period and usually vest as shares.
Listing generic pros and cons with no scenario link.
Students memorise lists.
Fix: Tie every point to a fact: the target, the measure, the time period or the director's behaviour in the case.
Saying share options always motivate directors.
They seem to align with shareholders.
Fix: Point out market luck, no downside risk for the holder, and the pull towards short-term share price gains.
Ignoring controllability.
Students focus on size of reward.
Fix: Ask whether the director can influence the measure. Share price and group profit may be outside a divisional manager's control.
Criticising without recommending.
The requirement says criticise, so students stop.
Fix: Add practical improvements such as multi-year targets, balanced measures, clawback and a remuneration committee, unless the question rules this out.
Forgetting ethical issues and professional skills.
Students focus on technical content.
Fix: Mention manipulation and fairness. Use a clear, professional tone and give a reasoned recommendation.

Worked examples

Example 1

A director holds 40,000 share options with an exercise price of $3.50. The share price at exercise is $5.20. Calculate the director's gain and state one behavioural risk of the scheme.

Show the solution

Gain per option = $5.20 − $3.50 = $1.70.
Total gain = 40,000 × $1.70 = $68,000.
Behavioural risk: the director gains if the price rises but loses nothing if it falls, so may take excessive risks or focus on short-term price gains.

Answer: The gain is $68,000. The scheme has no downside for the holder, which may encourage excessive risk-taking.

Example 2

Zeta plc pays its finance director an annual cash bonus if profit before tax exceeds budget. Results show profit just above budget, achieved after cuts to staff training and delayed maintenance. Criticise the scheme and suggest improvements.

Show the solution

Identify the measure: one-year profit before tax against budget. It is a single, short-term, financial measure.
Behaviour: the director gained by cutting training and maintenance, which lift current profit but harm future performance. This is short-termism.
The budget may have been set low or negotiated, so the bonus may reward easy targets. Profit can also be influenced by accounting choices, which raises manipulation and ethical concerns.
The cliff-edge target ('just above budget') encourages managing results to land just over the threshold.
Improvement: add an LTIP with three-year conditions such as TSR or return on capital.
Improvement: add non-financial measures such as staff development and asset condition, and consider clawback if results are later restated.
Improvement: have an independent remuneration committee set challenging targets and review them.

Answer: The scheme rewards short-term profit, so it encourages cuts that damage long-term value and possible manipulation. Use a mix of long-term and balanced measures, set targets independently and include clawback.

Exam tips

Use the scenario. Marks go to points linked to the case facts, not to textbook lists.
When asked to criticise, always cover behavioural effect, then drawback, then improvement.
Distinguish clearly between options and LTIPs. Examiners often reward precise comparison.
Link to agency theory and governance in one sentence, then move on to application.
Write in the format requested, such as a report or email, to earn professional skills marks.

Practice questions from Performance and reward

Executive Reward: Bonuses, Share Options and LTIPs: frequently asked questions

What is the difference between share options and an LTIP?

A share option gives the right to buy shares at a fixed price, so it pays only if the share price rises above that price. An LTIP awards shares or cash if set performance conditions are met over a multi-year period. LTIPs can pay out even if the share price is flat, provided the conditions are met.

How do I criticise an executive bonus scheme in APM?

Look at the measure, the time period and the target. Explain the behaviour it encourages, such as short-termism or manipulation, and the harm that follows. Then suggest improvements like multi-year targets, several measures and clawback.

Why do share options not always motivate executives?

Share prices are affected by market conditions that executives cannot control. Options have no downside if the price falls. Executives may also lose motivation if options are far out of the money.

Why are LTIPs seen as better than annual bonuses?

They cover a longer period, so directors are less likely to damage future results for short-term gain. They also often require the director to stay employed until the award vests. They are not perfect, as they can be complex and directors may still target the chosen measures.