Profit sharing refers to various incentive plans introduced by businesses that provide direct or indirect payments to employees that depend on company’s profitability in addition to employees’ regular salary and bonuses. In publicly traded companies these plans typically amount to allocation of shares to employees.
The profit sharing plans are based on predetermined economic sharing rules that define the split of gains between the company as a principal and the employee as an agent. For example, suppose the profits are x, which might be a random variable. Before knowing the profits, the principal and agent might agree on a sharing rule s(x). Here, the agent will receive s(x) and the principal will receive the residual gain x-s(x).
Profit Sharing Plans
Profit Sharing Plans are designed to allow employees to share in company profits. They give the employer considerable flexibility in determining the amount of annual contributions – from 0% to 25% of covered compensation. Contributions may be allocated to the participants in proportion to their compensation, integrated with Social Security, or utilize age, service and employment position to leverage the allocation to specific groups of individuals.
At a Glance: Profit Sharing Plans
Provide a visible, valuable employee benefit
Offer a tax deduction for the employer contributions
Provide a vehicle for employer profit sharing
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