Most companies make some version of the claim that their most important asset is the people who work there. Thus, it follows that when the company succeeds, those workers should benefit, over and above the simple matter of employment continuity.
Profit sharing is a policy or process that gives a company’s employees additional benefits or compensation in accordance with, and as a result of, that company’s success. It may be deployed as a motivational tool and/or a retention tool, or more simply as a reward to people who helped to make positive things happen. Profit sharing is intended to motivate employees to care about the success (or lack thereof) of a business by giving them a pay element that is contingent on the company meeting certain financial goals. It is sometimes meant to help retain them by giving them a deferred profit that vests at a future date.
Profit sharing may be an effective motivational tool for small businesses, where employees can see a direct relationship between their own activities and overall outcomes. For larger businesses, targeted bonus schemes related to specific goals are generally more effective. However in some industries broad-based bonus programs are an expected element of overall compensation, and tying these to corporate profits is a common and defensible practice. After all, if there are no profits, then it’s easy to understand why there might be no bonus. (C-level executive bonuses are another matter entirely, best addressed elsewhere.)
Small companies may choose to share profits via parties and other morale-building events. Having people celebrate successes together is generally the best way to get an immediate return. A one-time 'Christmas bonus' payment, separate from formal compensation, may also be given.
Larger companies, or growth-oriented ones, may choose to use some form of stock options as incentives. These are not normally considered to be profit sharing; rather they are performance-based rewards and/or retention strategies.
For most employers, profit sharing is preferable to a pension plan. With profit sharing, any departing employees take their plan elements with them, and are responsible for future management. That is, the granting company has no ongoing fiduciary duty to manage the funds. Pension management, by contrast, is an ongoing and potentially onerous commitment.
To participate in a profit sharing plan, an employee must usually be a full-time worker who has at least one full year of continuous service with the company. In some plans, the percentages that can be earned may ramp up as you ascend the corporate hierarchy, and can be very high percentages near the top of the heap. For larger companies with registered plans, a profit-sharing plan must provide real benefits to the majority of the rank-and-file employees; not merely to a select group of managers.
As a veteran of a large organization with a profit-sharing plan, I was grateful for it in the years it paid out (it didn’t always happen). I can testify that it didn’t really motivate me to strive harder, since I and my teams felt like our contributions were either unlikely to meaningfully affect the bottom line, or would not produce results until a future financial period. But it did act as a retention aid, since as the payout day approached the employees would try to stick around to make sure they got their cut. Of course, on the days after the payout, there was sometimes a spike in voluntary departures.