Posts Tagged ‘pay for performance’

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The question of how to reap the benefits from providing rewards to employees and how to “make them tick” belong to the most delicate and strategically important issues that organizations need to deal with. “In whatever way a performance management system attaches rewards to performance, it has an impact on the entire relationship. It is not, then, just a narrow question of motivation, but its effect on the culture of the organisation and its sub-cultures” (Hendry at al. 2000 cited in Bento and Ferreira, 1992). Thus, performance related pay (hereinafter referred to as “PRP”), can have either positive or detrimental effects on employee motivation and on individual and organizational performance, depending on a given context.

To date, a vast body of literature on compensation has been developed that explores how to motivate, attract and retain employees. More case studies dealing with this subject in different contexts of public and private sectors would definitely be welcome. When observing opposing views on this issue, some authors see PRP as “panacea” that cures all workforce problems, others think it is destructive, discriminatory, can motivate counterproductive behaviours, create a climate of mistrust etc. Baron (1999: 245) recognizes the complexity of its implementation and defines PRP as “a delicate set of motivational tools that can be powerfully effective in one setting and utterly dysfunctional in another”.

Positive aspects of PRP

Milkovich and Wigdor (1991: 58) believe that “because there is a solid rationale [psychological and economic theories] behind merit pay, and because it is possible to put it into practice, merit pay may be desirable for many organizations”. These theories suggest that linking pay to performance should have a positive incentive effect on performance.

One example where PRP has demonstrated beneficial effects is Safelite Glass with its piece-rate system. (Baron 1999: 243-44, 271-75) The reason why PRP worked so well for this company is that, according to five-factor analysis, all appropriate conditions were met (simple technology; no ambiguity in the task; easy to monitor; well-suited and non-diverse workforce; value placed on individual effort – rewards for hard work and/or skill, the economic environment supportive of low-cost strategies). When Stanford economist Ed Lazear studied Safelite, he found that there was a 44% increase in the number of pieces installed per day per worker (Pfeffer 2006). The reason for this was that individual employees worked more; furthermore, the company managed to retain and attract better employees and get rid of the least productive people by creating wider gaps between best and worst performers with variable incentives.

Another successful example of the implementation of piece-rate incentive is Lincoln Electric. An employee incentive programme was implemented to gain competitive advantage. Production workers are paid according to the number of pieces they produce, they also get a year-end bonus based on their performance – their base pay is increased by an average of 75%, and they are evaluated twice a year (Kleiman 2004). LE also provides stock options. Additionally, Milkovich and Newman (2008: 260) mention that the employees think “part of the success comes from other forms of reward, including the strong commitment to job security”. Unfortunately, the company did not take into account any alternative scenarios. When it experienced lean times because of some unsound management decisions, it decided to omit the bonus since it was tied to the company’s earnings. Workers felt that something they are entitled to was taken away from them.

What about negative effects of PRP?

One of the “loudest” opponents of PRP, Alfie Kohn, specifies five core reasons why rewards fail: they punish (“carrots” and “sticks” both contain an element of control), rupture relationships (cause rivalry, suspicion, hostility), ignore reasons, discourage risk-taking (knowing exactly what is necessary to receive a reward) and they undermine interest (extrinsic rewards weaken intrinsic motivation). In his opinion, rewards have “a peculiarly detrimental effect on the quality of our performance” (Kohn, 1993: 49). Though, it has to be mentioned that he is not against payment in general; he is against turning payment into a reward for better performance. In his opinion, people then forget about their job and only concentrate on the reward. Another important point is that employees can be offended if they are treated like pets, especially if they feel strongly about their job (e.g. teachers, nurses), and this also has a negative effect on their performance.

One example that highlights the negative effects of PRP can be seen in the case of consultants in the NHS. According to the NHS paper, this is an especially sensitive area of PRP implementation since in the medical field, pay often relies on things unrelated to clinical performance such as rational prescribing, meeting waiting lists targets etc., whereby patients’ welfare may become neglected.  In addition (according to Abel and Esmail 2006: 1), a significant number of consultants feel discriminated against on the basis of race, gender, speciality and degree of management contribution (above all, women and non-white consultants). “Where there is doubt about the fairness [of awards], performance related pay may be divisive and de-motivating” (Boyce et al. in Abel and Esmail 2006: 5). The issue of fairness (in relation to distributive and procedural justice) is extremely important and has been widely discussed in the literature on rewards. Another important issue are appraisal systems.  “Without proper appraisal mechanisms, PRP systems fail, and often achieve the exact opposite of what their proponents claim for them – namely the creation of resentment, ill-feeling and demotivation of the workforce” (Abel and Esmail 2006: 5). The NHS paper concludes, “a much deeper problem with the current NHS scheme is that it is still attempting to assess and reward individual performance, when the NHS and many private sector workplaces rely on the activities of teams”.

Another case study (Marsden and Richardson 1994), that has shown that PRP did not have a significant positive motivational impact on employees (12% said it did have, 76% said it did not have), describes the introduction of the PRP scheme into the Inland Revenue in 1988, and the opinions of the reporting officers confirmed this result. However, a demotivating element seems to be present there, since a certain minority of employees was strongly against PRP, possibly because of the feeling of unfairness and favouritism. Additionally, a significant percentage of workers agreed that the scheme undermined morale, caused jealousies among them and made them less willing to help one another. The reason for motivational failure was ascribed to the fact that not all conditions of expectancy theory were met (employees must feel able to change their behaviour, they must be sure that this change would bring the reward, they must value the reward enough to justify the change). Among other findings it is mentioned that the amount awarded is less important than the way it is allocated. The PRP scheme was also deemed responsible for undermining the established appraisal system because it had a corrosive effect on relationships between employees. The second theory, also mentioned in the study, that could assist in understanding the motivational response of the Inland Revenue workers is the goal-setting theory, which “predicts improved performance if goals are set more clearly, as long as the goals are agreed and believed to be achievable” (Marsden and Richardson, 1994: 256). The surprising fact was that the management still thought of its strategy to be successful because they were only considering financial savings and ignoring non-material costs. According to updated information (Marsden et al. 2001), Inland Revenue has made significant changes in the appraisal system, moving away from evaluation against a standard uniform set of criteria towards individual objectives harmonised with general organisational objectives.

A newer case study from 2001 based on the first large scale survey of ordinary employees conducted to establish the effects of PRP on employee motivation and work relations across the British public services and on workplace performance (Marsden et al. 2001) has shown that above-average PRP has an incentive effect for significant numbers of employees, however, it can be diminished by measurement difficulties and unfair performance evaluation. One of the most important conclusions of the study was that, for ordinary employees, PRP is not as important as goal setting and appraisal. Even more, it has been established that the way employees are divided between different performance grades by means of appraisal and goal setting is crucial for the success of PRP. Improved goal setting may help to clarify work goals on the one hand and enable management to negotiate higher levels of performance on the other. Another thing worth mentioning here is organisational commitment. It can seemingly stabilise some negative effects of poorly conducted appraisals and boost confidence in incentives, at least temporarily.

Several studies have concluded that the impact of PRP on performance is limited or even negative. Its impact on motivation is not clear – it seems to motivate a minority, but fails to motivate a majority (Inland Revenue, 1994). The question is why PRP continues to be introduced, if it has so many negative effects? The OECD research of PRP for government employees (Landel and Marsden 2005) recognizes one of the key reasons: it is because of its role in facilitating other organisational changes such as effective appraisal and goal setting, clarification of tasks, acquisition of skills, improved employee-manager dialogue, more team work and increased flexibility in work performance. Purely financial rewards may have a demotivational effect. Armstrong (1993: 151) suggests “The mix of financial and non-financial rewards [that] can only be achieved by the careful and continuous analysis of the circumstances of the organization and the needs of its members”. Hence the real value of PRP in improving performance is not in its financial element but rather in its secondary effects.


The issue of rewards is very delicate and complex, and there is no best recipe for the implementation of PRP; however, its effects can be used as an incentive means for the implementation of wider management and organisational change. Changes always involve risk-taking and a fair amount of investment at all levels. Nevertheless, blind risk-taking and overuse of financial incentives is senseless and can cost companies dearly. A mere adoption of a certain pay-for-performance plan/reward management plan will not bring desired results, unless “the changes make sense within the total pay system, the personnel system, and the broader organizational context” (Milkovich, Wigdor 1991: 101). A pay system should also not be considered as something fixed; organizations should form them in such a way that it can adapt to the challenges of a constantly changing business environment at any given moment. To sum up: where performance relies on the activity of teams, teams should be assessed and rewarded rather than individuals; goal-setting and appraisal are more important than PRP; the real value of PRP is in its secondary effects.


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