The purpose of short-term incentives, which are typically annual incentives 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 is often expressed as a multiple of the CEOs annual salary. Most annual incentives include a three-tier structure: a “threshold” level, below which no award is earned, 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.