The purpose of the annual incentive 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 expressed as a percentage of the CEOs annual salary. Most annual incentives include a two-tier structure: 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.