Performance-Related Pay, does this approach still work?

 

One of the most, arguably the most, used and at the same time controversial approach to contingent pay is definitely represented by performance-related pay (PRP). A survey conducted in 2009 by e-reward revealed in fact that 84% of respondents having recourse to contingent pay schemes had implemented a performance-related pay programme.

 

 

Essentials of PRP

The mechanism of PRP is essentially based on linking individuals’ pay increases directly to the outcome of their performance and the results these yield. This approach clearly takes as axiomatic that two specific activities can be and are hence performed:

a) That managers discuss and agree with their reports the objectives these should meet (CIPD, 2012);

b) That these targets can be objectively measured over a pre-identified period of time, usually corresponding to one year (Torrington et al, 2008).
 

The pay increases eventually granted on the basis of the outcome of performance appraisals can either be consolidated into base pay in the form of pay progression or awarded by means of non-consolidated lump sums, that is to say bonuses (CIPD, 2012).

 

Making the case for introducing PRP

By reason of the several objectives these arrangements potentially enable employers to achieve, performance-related pay actually appears to be a particularly attractive approach to manage the organizations reward budgets. As suggested by Torrington et al (2008), PRP can in fact help businesses to:

- Attract and retain good performers;

- Increase the level of individual and organizational performance targets;

- Clarify individual roles and tasks;

- Identify and agree with individuals their possible development plan;

- Reward employees averting to necessarily offer them grade increases.

 

Despite Torrington et al (2008) also list the enhancement of staff motivation amongst the benefits offered by the PRP approaches, the provision of this effect as directly linked to the introduction of a PRP programme cannot be indeed taken as axiomatic; the CIPD (2012), for instance, considers establishing such a direct link questionable. As it will be further discussed later, analysing this approach from the empirical point of view, research has produced over the years conflicting results. These pay arrangements, nonetheless, can reveal to be particularly effective for helping employers to foster and embed in their corporate culture the concepts of high-performance, equity and fairness (CIPD, 2012).

 

According to Arrowsmith et al (2008) and Marginson et al (2008), performance-related pay schemes, reinforcing the communication of the organizational aims and making it easier for managers monitoring strategic objectives, can also enable employers to produce positive results in terms of performance management. The Authors also stress the significance of the role played by these pay arrangements to help employers to curb the personnel costs. Whether developed in association with low-base-pay-based schemes in fact the variable element of pay, and thus the overall individual pay, can be managed and adapted by employers according to the profit eventually made by the organization.

 

One of the consequences habitually associated with the introduction of PRP schemes is the reinforcement of the individual employment relations to the detriment of the collective relations (Torrington et al, 2008). The introduction of these schemes is in fact likely to weaken the unions’ bargaining power within an organization.

 

Essentially based on meritocracy, that is to say a principle according to which better performers should receive more generous reward packages vis-à-vis those who have contributed less to the attainment of the organizational objectives, these pay arrangements should represent the most sought approach by both employees and managers. It could hence be contended that directly linking salary to performance should ultimately represent the most widely acknowledged and universally appreciated approach to reward.

 

As claimed by Behn (2004), it is actually hardly imaginable linking pay to a different variable, let alone could that variable be identified with the length of service, or employee “longevity”, which is traditionally typically used by the public sector employers. Regardless of the method financial recognitions are granted to individuals, these should be invariably offered to the best performers, rather than to the individuals who, for instance, have worked for an organization for a longer period of time. This being the case, the employer would seriously risk putting in place “the wrong incentives” (Behn, 2004).

 

The main tenet at the basis of this approach could then be considered inspired by the glaringly obvious and it could hardly be argued that this approach should not be pursued by organizations aiming at enhancing their overall organizational performance. As suggested by the CIPD (2012), PRP actually represents a proper means to effectively link individuals reward to the business aims and objectives; it essentially enables employers to “ensure that organizational priorities become individual priorities” (Torrington et al, 2008).

 

The role played by managers, as usually happens during the execution phase of every type of strategy and practice, is clearly of paramount importance. According to the tasks performed by each individual within the organization, as far as applicable, these need to assign to their direct reports objectives which essentially enable the organization to attain its own objectives and strategy. Such an approach should in turn enable employers to drastically improve the chances of attaining their intended results and hence the desired level of organizational performance (Torrington et al, 2008).

 

Mismatch between PRP designing and execution

Despite in theory the PRP approach should represent the most effective means to reward people within organizations, it is usually considered the cause of dire troubles and difficulties when implemented in practice. It is indeed by reason of all the problems it is supposed to cause that PRP has attracted fierce controversy ever since it was originally developed and introduced within organizations.

 

The controversy surrounding these types of arrangements is mainly based on the mismatch usually identified between their theoretical development and their practical implementation (Torrington et al, 2008). Armstrong (2010) maintains that the effectiveness of this approach can be considered questionable in that, especially when it was firstly introduced, it failed to fulfil the expectations it had created, to wit: to strongly and successfully support the implementation of cultural change. As anticipated above, the main problem occurs during the schemes execution, rather than during their design and development. In many circumstances, nonetheless, failure has also been directly caused by the application of the wrong approach under the wrong circumstances.

 

So interesting this approach appears to be, as to having attracted the interest of the public sector employers too. The debate about the effectiveness of PRP within the public sector exploded anew in the UK at the end of the last decade, when it was suggested to apply these arrangements to the teachers of public schools (Torrington, 2008).
  

 

Arguments against performance-related pay

PRP approaches are essentially underpinned by the idea, which actually also represents a mandatory prerequisite for its successful introduction, that individual performance can be objectively, accurately and fairly measured, which in practice habitually reveals to be a sorely difficult feat to perform.

 

As a consequence of this theoretical assumption, the worth of the reward offered to the different employees should be justified on the basis of objective grounds, that is, on the basis of the results yielded by each individual, which should be in turn reflected in the level of pay each of them receives. All of that makes sense as far as it could be taken as axiomatic that individuals are willing to go the extra mile and increase their level of performance in exchange for a more attractive financial reward package (Armstrong, 2010).

 

The preconditions for the successful implementation of a PRP scheme are to some extent self-explanatory and essentially expounding why what has been even carefully designed and planned in theory is likely to fail to achieve the intended results when implemented in practice. With the exception of the cases in which the results yielded by a working activity can accurately, qualitatively be measured, a fair and objective assessment of the result produced by individuals usually reveal to be an absolutely tricky feat to perform in practice, especially when the calculation of pay increases and supplements is directly depending on these assessments.

 

It should not be neglected that individual performance is, or rather, should be assessed by Line Managers who, for different reasons, may be unable to fairly evaluate their direct reports performance. The first reason for this could be represented by managers showing, albeit inadvertently, bias or partiality; it is clearly unlikely that LMs could actually be able to fairly and equitably assess their direct reports work whether they have prejudices against some of them. Yet, in some circumstances LMs could be urged to deliberately manipulate their direct reports appraisal for “political reasons.” More specifically, LMs according to the effects they feel performance appraisal is likely to have on their direct reports could be tempted to tailor their judgements accordingly. Under such circumstances, low and high ratings are craftily avoided in that likely to impact interpersonal relations within the unit or group (Torrington et al, 2008). Boddy (2008), for instance, reports the case of a voluntary sector organization where, as a consequence of the introduction of a PRP scheme, performance appraisal scores tended to be “on the overly generous side.” This surely had an evident impact on the organization’s personnel budget; on the other hand a not equally evident improvement was recorded in employee motivation and in individual and organizational performance.

 

Also the LMs lack of capabilities and specific training, in addition to their lack of authority, can seriously jeopardize the successful implementation of these programmes. In some cases, even exactly determining who has to make the final decision about individual pay can turn to be rather tricky. Despite as a general rule every employee should have a manager, in some cases, especially when individuals work in teams and projects, some employees might have more than one superior, with the “official manager” possibly having little or no direct knowledge about the performance of their direct reports. In such cases properly assessing individual performance, and hence its impact on pay, may reveal virtually impossible (Behn, 2004).

 

The rating assigned by LMs to their reports performance in some cases may be also affected by budgetary limitations. Under these circumstances, to curb the impact which the implementation of PRP schemes has on the business budget, LMs deliberately underrate the results yielded by the excellent performers (Torrington et al, 2008). Despite in this case LMs act just as mere executors of the directives issued by the organization top management, these appear to their staff as those who are treating individuals unfairly.

 

Budgetary constraints can also emerge in a different way, for instance, by limiting or reducing the number of individuals whom can be considered eligible for pay increases. In those cases in which the number of people genuinely deserving a pay increase or a bonus should exceed the limit dictated by the top management, the effects produced by this type of measure would definitely be, to put it mildly, counterproductive (Behn, 2004).

 

Considering the impact which these pay arrangements can have on individual motivation, with specific reference to the main features associated with the expectancy theory, that is, “expectancy”, “valence” and “instrumentality”, research has produced mixed and contrasting results. In those cases in which objectives were clear and compensation adequate PRP schemes produced valuable results, whereas in the majority of the cases investigated the underpinning elements of the expectancy theory remained unsatisfied at large (Perry et al, 2009).

 

“Valence”, that is to say the worthiness of reward and the importance individuals attach to it, clearly also plays a role so that the pay increase of 3 percent habitually granted to employees in association with the implementation of these pay arrangements can hardly be considered attractive (Armstrong, 2010). This conclusion has been confirmed by an empirical study conducted by Heinrich (2007), which revealed that financial reward premiums associated with PRP schemes are usually too small to be considered appreciable and valuable by employees. By contrast, in those situations in which the amount of financial incentives is considered significant by individuals, the implementation of PRP approaches may prompt individuals to focus more on the aspects of their job which are most closely related to the monetary aspect, whilst neglecting the others (Torrington et al, 2008).

 

Individual PRP schemes can actually risk fostering an individualistic approach to work, to the detriment of teamwork. Employees will clearly tend to focus more on the activities enabling them to earn more considerable reward packages, to the detriment of cooperating and teaming up with their peers.

 

It has not be overlooked that the expectancy theory is based on the pivotal assumption that individuals have different wants and differently value results (Boddy, 2008); this consequently implies that at best pay increases do not attract all the employees in the same way.


 

An additional flip side of these arrangements is represented by the counterproductive effects on motivation these might produce the moment LMs unveil their staff ratings. Those who receive higher or satisfactory ratings would obviously feel happy for the recognition they receive. This does not necessarily exclusively relate to the financial aspect of PRP, but also to the “mere” circumstance of having been positively rated. Vice versa, those who have received unsatisfactory ratings clearly feel disappointed for their work not having been considered valuable, the fact of receiving or not receiving additional cash would just contribute to make things harder. Yet, these employees could also disagree with their LMs for the rating they have received, which they could consider biased and unfair especially vis-à-vis those given to their peers.

 

 

 

To avert such circumstances to occur and consequently to be managed, all too often LMs prefer avoiding to propose low or even no financial recognitions for their direct reports. The consequence of such behaviour is obviously considerably detrimental for two different reasons. Firstly, this approach would clearly lead to a situation in which best performers and worst performers are rated within a very narrow scale; occurrence which produces in turn two negative subsets of effects: on the one hand worst performers consider pointless going the extra mile, in that they already receive the same, or nearly the same, pay increases or bonuses received by those who have achieved better levels of performance; on the other hand such management behaviour is perceived as unfair by best performers which consequently lose faith in their management and in the way they treat their reports.

 

 

 

Secondly, this managers’ approach will surely remarkably impact the organizations personnel budget. Employers would find themselves in a situation to spend more with little, if any, justification for a better ROI.

 

 

Nowadays businesses are nearly constantly involved in the implementation of change so that in many circumstances the attainment of individual objectives can be affected by it. What can be considered as an organization’s priority and main aim today might not be considered important tomorrow or even later today. Differently from what suggested by Torrington et al (2008), nonetheless, this should not have a considerable impact on the appraisal of individuals’ performance. This for two different reasons: the fact that organizational objectives, and hence individuals’ objectives, change does not entail that individuals performance may not be properly assessed and evaluated; secondly, albeit organizational change may lead to amend individuals objectives, this not necessarily prevent organizations to attain theirs, at least in part. Once organizational objectives have been subject to adjustments, these may be in turn changed to individuals. This process might reveal not to be so straightforward; notwithstanding, change should not represent a particular barrier to the successful implementation of PRP schemes. Change is becoming increasingly frequent within organizational settings so that managers need to learn to get along with it and be ready to face the side effects this is likely to have.

 

One of the most negative effects of PRP, nevertheless, is associated with individual growth and development. When performance levels directly impact employees’ salary, individuals tend to minimise and conceal their feebleness during the appraisal meetings (Torrington et al, 2008). This clearly prevents employees and managers to have an open dialogue and hence to properly determine the individual training needs and identify the appropriate plan of action for improvement. This detrimental effect can be averted keeping separated pay review and performance assessment from development and growth planning, essentially performing the two activities in completely different and separate occasions.

 

The criticism attracted by PRP schemes sorely depends on its underpinning assumption that individuals are all motivated or mostly motivated by cash. It would seem that the cash factor invariably is at the centre of the employees’ attention, insofar as to influence, control and guide their activities and behaviour, which cannot be indeed taken as axiomatic and considered as a universal rule. This is actually the main reason why in many occasions PRP schemes have failed. By contrast, when designed and developed in presence of the right circumstances and in combination and synergy with other initiatives these programmes can produce truly valuable results.  

When PRP approaches can actually work

Performance-related pay approaches are beset with downsides, criticism and past and present implementation failures. Notwithstanding, some studies carried out by Brown and Armstrong (2000), the IRS (2005) and the IDS (2005) show that PRP approaches can also successfully be introduced and implemented within firms. As these studies suggest, PRP is likely to work only whether a few fundamental preconditions are met:

 

a) It is properly managed and implemented;

b) It is introduced only in presence of the right and suitable circumstances;

c) The implementation process is carefully prepared and sufficient time is allowed prior of its practical introduction (Brown and Armstrong, 2000);

d) It is implemented in combination with the other reward initiatives implemented by an employer in that its successful or unsuccessful execution can impact, negatively or positively, the other actions eventually co-ordinated by an employer to motivate staff (Brown and Armstrong, 2000);

e) It is regarded as part of a reward system formed by both financial and non-financial rewards (de Silva, 1998).

 

 

 

The disgrace of PRP is in part due to it having been in the past depicted as a universally effective and powerful approach, capable of invariably producing dramatic effects on individual motivation irrespective of the circumstances, which is clearly far from being the case (Torrington et al, 2008).

 

 

 

PRP is not and cannot be considered as an effective one-size-fits-all approach, but rather as an additional tool employers can have recourse to, whether and when appropriate, in order to try and influence employee motivation. As a general rule, this type of programmes can actually reveal to be effective in those cases in which:

 

- Individual performance can objectively be measured;

- Individuals have a complete control of the results produced by their work and a precise cause–effect relationship between these can be clearly identified;

- Neither teamwork nor cooperation with other colleagues has significant effects or impact on the results yielded by an individual;

- The introduction of these pay arrangements is supported by a rather individualistic organizational culture (Gomez-Mejia and Balkin, 1992).

 

 

 

Whether an employer fostering a culture based on teamwork and collectivist principles should introduce these pay arrangements, this move would immediately be interpreted by employees as sorely inconsistent and lacking of integrity.

 

 

 

Research has revealed that PRP approaches are more likely to be effective and successful in those organizations where objectives are clearly shared and understood by staff, compensation is considered adequate and organizational culture supports merit-pay schemes (Greiner et al, 1977). According to de Silva (1998), also the existence within the organization of a performance management process, nonetheless, represents a mandatory requirement. The PM process should ensure that some crucial activities have been prepared and performed (IDS, 1997); amongst these gains a particular significance organizational planning, meant as the definition of the objectives and the identification of the main skills required to effectively attain these. The targets clearly need to be set according to the overall organizational strategy and aims, and should be openly and appropriately communicated to the individuals concerned. The identification of the performance measurement and ratings, on the basis of which salary increases and bonuses will be offered, is clearly of paramount importance, too. In order for PRP schemes to be successfully implemented performance management should also take into due consideration and wisely balance the individual aspirations and wants with those of the employer.

 

 

 

As discussed earlier, the line managers’ importance and full involvement in the process is clearly crucial. LMs should be appropriately and thoroughly trained and ready to take responsibility to conduct performance management.

 

 

 

The existence of a PM process relying on these pillars can actually reveal to be particularly useful to enable employers to successfully implement PRP schemes. Their failure is more often than not due to the employees’ lack of understanding and acceptance of both the pre-set objectives and the method performance and results will be measured. Yet, performance appraisal systems directly linked to performance pay and PRP approaches exclusively relying on financial rewards are amongst the most recurring causes for these programmes failure (de Silva, 1998). Providing individuals opportunities for personal growth, training and involvement, in addition to obviously enhance employees satisfaction, would indeed enable these to acquire additional skills and capabilities, become more confident and hence perform better and more effectively contribute to the attainment of the organizational objectives.

 

 

 

The findings of an empirical study carried out in the Netherlands (Gielen et al, 2006) revealed that the introduction of PRP schemes has a robust and direct positive impact upon labour productivity (+9 percent). The study (which involved organizations with more than 100 employees) also revealed that this increased level of productivity did not cause any contraction on the businesses recruitment activities; by contrast, a 5 percent long term employment growth was reportedly due to the introduction of these programmes. The Authors also report a substantial increase of PRP popularity amongst Dutch firms, albeit not related to a widespread confidence amongst employers of the positive role played by these programmes upon productivity (Gielen et al, 2006). The rate of Dutch organizations having recourse to PRP schemes has actually increased from 29 percent in 1995 to 51 percent in 2001, with the most remarkable growth recorded within the construction sector organizations (+55 percent).

 
 

Longo, R., (2012), Performance-Related Pay, does this approach still work?, HR Professionals, Milan [online].



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