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Performance-related pay, also known as pay-for-performance, is one of the most common compensation structures used in organizations. Some authors such as Baumann & Stieglitz (2014), describe this system as an effective tool for aligning the behavior of employees to organizational goals as well as attracting the best talent. Despite its popularity, it remains controversial as to whether it is the best approach for compensating personnel. Essentially, pay-for-performance entails establishing goals and means of measuring them, after which employees are compensated based on their achievement of the set objectives (Fang & Gerhart, 2012). According to Baumann & Stieglitz (2014), many organizations have embraced the mentioned compensation system; however, the bulk of these entities do not execute this approach properly. This compensation scheme has also been criticized for reducing the performance of a complex task to a simple, single performance measure. Therefore, the pay-for-performance system fails to take into consideration all factors likely to affect employees’ productivity (Baumann & Stieglitz, 2014). Additionally, using subjective performance measures also creates concerns among workers when this compensation scheme is used. This paper discusses how an organization can evaluate the effectiveness of its pay-for-performance plans, the disadvantages of using this compensation from both the perspective of an employee and an employer.
Measuring the Effectiveness of Pay-for-Performance Plans
There are numerous ways that an organization can use to assess the effectiveness of its pay-for-performance plans including reward alignment, effects on retention and recruitment, objectivity of performance measures, and productivity implications.
The first way entails determining the extent of reward alignment (Baumann & Stieglitz, 2014). As Zhang, Long, & Zhang (2015) explain, for pay-for-performance plans to be effective, the incentive or reward should be aligned with the organizational goals and strategies. This entails considering the overall performance objectives of the entity and reflecting them in the pay system. Other questions that the organization should ask itself when evaluating the effectiveness of its pay-for-performance plans include how employees are contributing to the achievement of these goals; whether it has the organizational culture that mediates the behaviors and attitudes of personnel; and the extent to which Human Resources (HR) policies further realization of organizational targets (Zhang et al., 2015). In sum, the entity should assess the level of both vertical and horizontal integration. The former is concerned with evaluating the extent to which the reward strategy is aligned with the priorities of the business strategy whereas the latter entails making sure that the pay-for-performance scheme is supported by the people management policies and practices adopted by the organization such as employee relations, rewards, and resourcing among others. The entity should ascertain the effectiveness of its pay-for-performance plan by determining the level of congruence between the aims of performance management and reward. For instance, an indicator of an ineffective pay-for-performance approach is when the productivity appraisal system places emphasis on pay while the reward (pay) scheme is based on performance (Fang & Gerhart, 2012). In such a case, an effective pay-for-performance plan should be characterized by reward method that is pay-determined, and the appraisal system emphasizing pay increases. Another important aspect of the reward alignment for pay-for-performance scheme that organizations should consider is employees’ interests (Ederer & Manso, 2013). The discussed plan is effective when it is aligned with workers’ and organizational interests.
The second approach that organizations can use to assess the effectiveness of their pay-for-performance plans is by measuring their effects on retention and recruitment (Weibel, Rost, & Osterloh, 2010). According to Ederer & Manso (2013), an effective pay-for-performance scheme helps in resolving organizational problems since it aligns the interests of employees and those of the entity. Moreover, DeCenzo, Robbins, & Verhulst (2010) assert that an effective pay-for-performance system is a tool for attracting top talent, which can subsequently enhance organizational productivity. Studies indicate that the discussed schemes can attract top performing employees and motivate existing personnel to put more effort in completing their tasks (Baumann & Stieglitz, 2014). Therefore, a pay-for-performance system that does not help in retaining workers and attracting top talent is not considered effective.
The third approach that an organization can use to measure the effectiveness of its pay-for-performance plans is to assess their productivity implications (Zhang et al., 2015). Essentially, the discussed system links pay to performance; thus, the ultimate objective is to increase the productivity of employees and that of the entity as a whole. Ederer & Manso (2013) point out that the pay-for-performance plan is primarily an incentive system that seeks to motivate workers to exert greater effort. Zhang et al., (2015) agree by stating that, when the pay-for-performance scheme is managed effectively, it can be an extremely powerful tool to motivate employees. Moreover, the justification for implementing the discussed approach is to improve organizational performance. Therefore, the productivity of employees subjected to this compensation plan can be used to gauge its effectiveness (DeCenzo et al., 2010). Studies have shown the positive productivity effects associated with adopting the pay-for-performance scheme (Weibel et al., 2010). For instance, organizations that switched from providing salaries to performance-based pay reported significant increases in productivity (Ederer & Manso, 2013). Similarly, Weibel et al. (2010) indicated that linking pay to productivity helps in motivating workers and is associated with high levels of employee motivation and productivity. A fundamental inference from these findings is that effective pay-for-performance plans are those that increase personnel performance and organizational productivity whereas those that do not affect the former aspect or reduce performance are considered ineffective.
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Another method of measuring the effectiveness of the pay-for-performance scheme is to determine the objectivity of the performance evaluation (Ederer & Manso, 2013). Various authors agree that the key to ensuring an effective pay-for-performance system is having an effective performance measurement. According to Zhang et al., (2015), the most common reason for the failure of the discussed plans is because they lack a good appraisal scheme. When developing a pay-for-performance system, Fang & Gerhart (2012), highlight the importance of managers and employees knowing the performance goals, the manner in which they will be measured, and how workers will be compensated based on their productivity. Moreover, managers should make sure that low and high performers are differentiated sufficiently. In the event that low performing employees are awarded with a merit increase, they might consider their performance satisfactory when it is not the actual case. By contrast, when high performing workers are awarded with a slight pay increase relative to the average performers, they are likely to develop perceptions that the organization does not consider their productivity as being important (Fang & Gerhart, 2012). Therefore, effective pay-for-performance system should be based on objective and accurate measure of outcomes. This requires the performance goals to be consistent. Moreover, it is imperative for the organization to clearly define the expected performance and develop objective methods for measuring it.
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Disadvantages of a Pay-for-Performance Plan from an Employee’s Perspective
The pay-for-performance scheme is not without disadvantages to employees. The first demerit is that this plan works well with top performing workers but not with the majority of personnel (Ederer & Manso, 2013). Zhang et al. (2015) described the pay-for-performance scheme as a zero-sum game, where there are winners and losers, and the latter comprise the majority. As Baumann & Stieglitz (2014) elucidate, in two thirds of organizations that implemented the discussed systems, there were significant improvements in employee engagement for low and average performing workers. Moreover, the pay-for-performance scheme has been criticized on grounds that it serves to reward high performers rather than maintaining equity in pay.
The second disadvantage of the pay-for-performance plan to employees is that it disregards other crucial factors likely to have an influence on their performance (Fang & Gerhart, 2012). This scheme places a lot of emphasis on rewarding staff members based on their outputs to an extent that it is likely to ignore other aspects that personnel may deem important when performing their work. There are numerous elements having a bearing on employee performance such as relationships with colleagues, supportive work environment and relationships with co-workers among others – all these factors are not taken into account in the discussed schemes (Weibel et al., 2010). In this respect, the pay-for-performance system has been criticized for ignoring the developmental needs of staff members solely focusing on providing financial rewards.
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Another disadvantage associated with the pay-for-performance plan for employees is that the bulk of the processes depends significantly on the supervisor’s or line manager’s judgment. This raises concerns regarding the objectivity of the productivity measurement procedure (Fang & Gerhart, 2012). Baumann & Stieglitz (2014) outlined a number of problems that are common during performance assessment processes, which include easy options, labels, and subjectivity. In terms of easy options, managers are hesitant of ranking employees either too low or high. The problem of labels denotes the influence that descriptive labels might have on the evaluation process (Baumann & Stieglitz, 2014). Subjectivity entails managers using their own measures for assessment of the performance of employees or applying standardized criteria inconsistently.
Disadvantages of a Pay-for-Performance Plan from an Employer’s Perspective
A number of disadvantages exist for employers when using the pay-for-performance plan. The first drawback is that this compensation scheme is detrimental to quality (Weibel et al., 2010). Pay-for-performance system can result in employees placing more emphasis on quantity when compared to quality, which is likely to result in quality deterioration (Fang & Gerhart, 2012). For example, when the sales volume is the performance metric used to determine pay, sales people are more likely to be preoccupied with making the highest possible number of sales and may ignore other details like ensuring the availability of the product in inventory prior to allowing the customer to fill an order and filling the needed paperwork (Weibel et al., 2010). This increases the possibility of customers receiving the wrong item or having to wait for longer periods for the delivery to be made. Deteriorating quality might result in detrimental outcomes with respect to the company’s bottom line such as losing customers, having a negative reputation, and experiencing a reduction in sales among others.
The second disadvantage of using the pay-for-performance is that it blocks teamwork in the organization. When employees attempt to achieve personal goals, they are less likely to be team players (Ederer & Manso, 2013). Using the pay-for-performance plan pits personnel against each other; thus, they may refrain from offering assistance to struggling colleagues since they perceive offering assistance as wasting time that they would otherwise use to enhance their individual productivity (Fang & Gerhart, 2012). Sometimes, lack of cooperation among employees escalates into conflicts or the view that one worker might be interfering with the efforts of others to realize their objectives. The pay-for-performance system creates a situation wherein personnel work for their personal rather than mutual gain, which is detrimental to relationships among staff members (Fang & Gerhart, 2012). Zhang et al. (2015) agree with this view by suggesting that forcing employees to compete against each other for rewards is destined to harm cooperation, and thus, organizational excellence. Additionally, when workers contest for limited rewards, they are likely to perceive their colleagues as adversaries who hinder their success.
The third disadvantage of pay-for-performance plans stems from the challenges of assessing performance (Baumann & Stieglitz, 2014). Except in situations where productivity measures are absolutely objective, like granting a bonus to a sales person for reaching a certain sales volume, it is often challenging to ascertain whether the performance of the employee warrants an increase in pay (Fang & Gerhart, 2012). As a result, supervisors are under intense pressure when appraising the performance of workers in order to ensure that they undertake an accurate evaluation of the results. Weibel et al. (2010) asserts that no method exists that can be used with 100 percent accuracy to distinguish employees’ performance and ascertain who deserves the merit pay most. Moreover, the most desirable personnel accomplishments are almost impossible to measure; thus, the opinion of the manager or the supervisor is the key factor that determines merit pay (Baumann & Stieglitz, 2014). When an organization utilizes only measurable elements of employee performance, there is the possibility that it is not taking into account the most crucial aspects of workers’ jobs.
The fourth disadvantage of the pay-for-performance scheme is that pay alone is an insufficient motivation (Fang & Gerhart, 2012). If employees consider the amount of pay offered as extremely low, the pay cannot offer the needed motivation to increase their levels of productivity (Ederer & Manso, 2013). Some authors maintain that there is no firm foundation for the presumption that increasing the pay for people is likely to encourage them to perform more or better (Fang & Gerhart, 2012; Zhang et al., 2015). Simply because low pay can demotivate does not necessarily imply that more money will result in high levels of motivation and satisfaction. Moreover, employees might be resentful towards the employer for failing to provide them with a more meaningful program that might have significant effect on their living standards such as opportunities for career development (Weibel et al., 2010). Therefore, such workers may only be motivated to perform to the average standard required to maintain their employment while considering exerting extra effort as wasting their time.
The fifth disadvantage of using pay-for-performance scheme is that it is time consuming (Baumann & Stieglitz, 2014). Ederer & Manso (2013) suggested that the amount of energy and time that an organization can dedicate to making productivity measurable to facilitate merit pay such as developing performance baselines, measurements and competencies can be better spent on enhancing the quality of services that customers receive (Ederer & Manso, 2013). The time-consuming aspect of pay-for-performance plan also emanates from the need to involve employees, top managers, and line managers in establishing the criteria for assessing the outcomes of workers. Apart from being time-consuming, the implementation of the pay-for-performance can also be inconvenient to employers since it is laborious (Fang & Gerhart, 2012). This process needs vast knowledge regarding the organization, significant preparation, as well as an in-depth understanding of both the external and internal organizational environment.
The sixth disadvantage of using pay-for-performance schemes is that employers should create favorable circumstances that can enable employees to achieve their goals while, at the same time, ensuring that organizational objectives are attained (Weibel et al., 2010). Finding this equilibrium is hard yet it is key to ensuring the effectiveness of the discussed systems (Weibel et al., 2010). It causes the need to have a wide plan that hinges upon the vision and strategic direction of the entity.
Another disadvantage of using pay-for-performance to employers is that it discourages risk-taking among employees (Fang & Gerhart, 2012). Fang & Gerhart (2012) point out that an individual will set out to perform what he/she is asked to do when presented with a significant reward. This is where the problem lies. Whenever people think about what they will receive for accomplishing a task, their minds are fixated on that particular task and become less interested in exploring other possibilities (Weibel et al., 2010). Simply stated, providing employees with performance-based pay stifles creativity among staff members. For instance, when a worker is informed that his/her income will be determined by his/her performance ratings, he/she will place a significant emphasis on the numbers. Sometimes, personnel might complete the tasks illegally or unethically (Ederer & Manso, 2013). Moreover, employees have a tendency of choosing easier tasks when pay-for-performance plans are implemented by the organization.
Organizations can measure the effectiveness of pay-for-performance plans using various ways including assessing the extent of its reward alignment with the organizational goals and strategies; analyzing its impacts on retention and productivity; evaluating how objective the performance measures are; and analyzing their influence on employee and organizational productivity. This paper also explored the disadvantages associated with the pay-for-performance schemes from the perspective of both workers and employers. For employees, the drawbacks of the discussed system include working well only for the top-performing staff members and not the majority of the personnel thereby disregarding the developmental needs of employees; disregarding crucial factors likely to affect productivity; and depending significantly on the judgment of the supervisor or the line manager. For employers, the shortcomings of the pay-for-performance plan consist of placing emphasis on quantity at the cost of quality by workers; hindering teamwork; measuring performance objectively is challenging; impossibility to sufficiently motivate employees; consuming significant amounts of time that could otherwise be devoted to enhance the quality of services; and stifling creativity and innovation.
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