Why performance pay fails to deliver?

Rethinking Performance Pay

One of the more difficult areas of human resource management is the area of employee motivation. The methods for motivating employees differ dramatically and the effectiveness of these different motivation tools is often called into question. One of the most controversial areas of motivation is pay-for-performance systems (PFP) which are tools using pay or financial reward to increase or motivate employee behavior. The problem with PFP is it typically does not produce increased effort and productivity but instead short-term gains in these areas. The problem with PFP is typically shortsighted and mainly take into account extrinsic forms of motivation such as increased payroll bonuses, merit pay, and other financial gains. Research shows a more robust view of PFP is needed which considers both intrinsic and extrinsic motivational forces.

According to Artley and Stroh (2001) performance management is the utilization of performance data to improve business operations. Performance management needs to measure outcomes for objectives to which consistent standards have been placed. This measurement provides management with a decision-making tool which allows leadership to prioritize activities and utilize resources more effectively. Through the performance management process, managers can determine deficiencies in operations and can make the necessary adjustments in programs to increase efficiency. Typically, performance is managed using data and placing performance enhancers in place such as PFP. These PFP have limited enhancement ability for two important reasons. The first reason is that PFP seem to provide no long-term motivation for employees. In studies of merit and bonus pay systems the results showed that these systems often only moderately successful in motivating higher performance. In a 2012 study of merit pay systems the results showed that PFPs were not very successful.

A survey of senior compensation professionals in 72 organizations was conducted to examine the effectiveness of merit pay in achieving organizational objectives. The results indicate that merit pay is seen as being “marginally successful” in influencing employee attitudes (e.g., pay satisfaction) and behaviors (e.g., performance) which represents a decrease in effectiveness compared to a survey conducted 10 years ago where merit pay was seen as moderately successful (Eskew, 2012).

The second reason that PFP have limited enhancement results is due to the fact that they have limited connection to company objectives and goals. By designing compensation plans that focus on organizational performance and growth, this methodology overlooks the individual employee. The individual employee and his or her goals and values must be aligned with the organization for any PFP to have success. By aligning goals and objectives in this manner the culture of the organization is transformed and focused towards improving itself. According to Noe, R. A., Hollenbeck, Gerhart, & Wright, (2007),

It focuses decision-making and behavior on goals — including goals relating to environmental, safety, diversity, and other social performance measures — consistent with overall business strategy, Reinforce a pay-for-performance culture through a balance of fixed and incentive pay opportunities, and allows the company to attract and retain employees with the skills critical to its long-term success.

A PFP that ties company objectives with employee objectives also provides the company with an accurate way to measure the effectiveness of an employee since performance goals are tied in with corporate goals and objectives. In order to make this form of PFP possible, the system must be designed with intrinsic as well as extrinsic compensation.

Designing a PFP system that takes into account both intrinsic and extrinsic rewards can be complicated because the needs and desires of workers can vary. One important concept with the design of this type of system can be found in the public sector. One of the ways to ensure high performance with extrinsic rewards and maintain a motivation which is not completely monetarily motivated is to make sure that financial (extrinsic rewards) are not connected to ‘quotas’ or volume of customers. The reasoning for this design is to ensure that customer needs are not undermined by employees motivated by rewards (Coulson, 1991).

The extrinsic rewards system should be designed in a general fashion surrounding the ideas of job performance. Areas of performance analysis would include absenteeism, lateness, professionalism, diligence to work, and client satisfaction. These areas would be objectively based results relying upon factual data such that employees would not believe that the results were arbitrary or the result of favoritism (Gunn, 1993).

The intrinsic strategy of rewards management will be based upon employee recognition of attributes and deficiencies. The supervisor would maintain a personal level of recognition by pointing out quality of work and weaknesses in area of work. For example, when a supervisor notices that an employee has completed his or her work in a very timely fashion then the employee should be made aware of this quality in his or her work progression. Pointing out quality work is vital to employee happiness and satisfaction (Mahaney and Lederer, 2006).

Intrinsic rewards can increase employee interest by showing employees that his or her job is important and that they are working in a self-developing environment. This occurs as a result of supervisors recognizing when an employee does a good job, or assigning special tasks that may interest the employee. In the human services field the most important intrinsic reward is that the employee feel that he or she’s job has importance. Through the careful tracking of employee mistakes a supervisor will see the strengths and weaknesses of the individuals in his or her charge. Supervisors will thus be able to give timely oral and written compliments and admonishments for job performance. According to Kettner (2002), the top nine performance enhancers are filled strictly by intrinsic rewards. This fact shows how important the design of PFP is to their success.

The argument for more robust systems of PFP can be seen in studies of the most successful companies. The most successful companies design and implement performance management systems that serve the purpose tracking performance as well as providing the means to improve it. According to Mahaney, & Lederer, (2006) a well-planned performance pay plan with both intrinsic and extrinsic rewards built in, can increase productivity and make a company more competitive. Other indirect improvements were also cited such improvements to cash flow and earnings.

It was also discovered that performance pay created the best results when utilized in specific ways. For instance, the performance bonus should cover small periods (one to three months) or longer periods (a year or more) and the performance bonus should be based on an employee’s performance and the performance of the company. When used in this manner, bonuses were found to more effective than when used for short periods of (time less than three months) and when both employee and company performance were not considered (Mahaney & Lederer, 2006).

In further evidence of the need to rethink how PFP are designed and defined, in a study of 217 manufacturers it was found the intrinsic motivations played a more significant role in increasing performance than did extrinsic rewards such as bonuses and merit pay.

As the main finding of the research, it has been determined that…intrinsic and extrinsic reward practice level is not high. Our analysis found that intrinsic reward practices of “regular expressions of appreciation by managers/ leaders to employees” “quality-based promotions” and “formal suggestion system” are used more than other intrinsic reward practices; and of the extrinsic rewards “pay for overtime hours work” and “quantity based performance appraisals” practices are more widely used than other extrinsic reward practices… The use of intrinsic reward practices exhibited a significantly positive effect on people results performance indicators. However, it has been determined that effect of extrinsic reward practices on people results is not significant (Özutku, 2012).

When one views the evidence that shows why PFP are not successful in motivating people, it is clear that these systems are not comprehensive enough of the employee’s needs and desires. If these systems were accurate in their ability to satisfy the employee then PFP would fare better in studies. The research shows that the traditional PFP system needs to be rethought and studied more to find ways of incorporating more intrinsic rewards in order to enhance performance. Studies should also be conducted to find what balance of intrinsic and extrinsic rewards work best in the design of PFP systems.

References

Artley, W., & Stroh, S. (2001). The performance-based management handbook a six-volume compilation of techniques and tools for implementing the government performance and results act of 1993. (1 ed., Vol. 2, pp. 3–12). California: Oak Ridge Institute for Science and Education.

Noe, R. A., Hollenbeck, J. R., Gerhart, B., & Wright, P. M. (2007). Fundamentals of human resource management (2nd ed.). New York: McGraw-Hill Companies.

Coulson-Thomas, C (1991).Developing tomorrow’s professionals today. Journal of European Industrial Training, 15(1)

Eskew, D. (2012). A survey of merit pay plan effectiveness: end of the line for merit pay or hope for improvement? Retrieved from http://www.questia.com /googleScholar.qst?docId =5000417081

Gunn, B (1993).Management systems and personnel evaluation. Management Decision, 31(4).

Kettner, P (2002). Achieving excellence in the management of human services organizations. Upper Saddle River, NJ: Allyn & Bacon, Inc.

Mahaney, R. C.& Lederer, A.L. (2006). The Effect of Intrinsic and Extrinsic Rewards for Developers on Information Systems Project Success, Project Management Journal, 37 (4), 42

Noe, R. A., Hollenbeck, J. R., Gerhart, B., & Wright, P. M. (2007). Fundamentals of human resource management (2nd ed.). Chapter 7 New York, NY: McGraw-Hill.

Özutku, H. (2012). The influence of intrinsic and extrinsic rewards on employee results: An empirical analysis in turkish manufacturing industry. Business and Economics Research Journal, 3(3), 23–47.

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