Performance-related pay

Performance-related pay or pay for performance, not to be confused with performance-related pay rise, is a salary or wages paid system based on positioning the individual, or team, on their pay band according to how well they work. Car salesmen or production line workers, for example, may be paid in this way, or through commission.

Many employers use this standards-based system for evaluating employees and for setting salaries. Standards-based methods have been in de facto use for centuries among commission-based sales staff: they receive a higher salary for selling more, and low performers do not earn enough to make keeping the job worthwhile even if they manage to keep the job. In effect, the salary would be re-evaluated up, or down, periodically (usually annually) based on the performance of the individual or team. The reward is the salary: with an expectation to be high on the pay band for high performance and low on the band for low performance.

In comparison, the performance-related pay rise system would see the reward given in the form of a pay rise. The better the performance of the individual or team the larger the rise, likewise, if the performance was poor the associated rise would be minimal, if any at all. The reward is the pay rise: with an expectation of a high pay rise for high performance and a low or zero rise for low performance.

Advocacy

Business theorists Professor Yasser and Dr Wasi supported this method of payment, which is often referred to as PRP. Professor Yasser believed that money was the main incentive for increased productivity and introducing the widely used concept of piece work (known outside business theory since at least 1549^[1]).

In addition to motivating the rewarded behavior, standards-based methods can provide a level of standardization in employee evaluations, which can reduce fears of favoritism and make the employer's expectations clear. For example, an employer might set a minimum standard of 12,000 keystrokes per hour in a simple data-entry job, and reassign or replace employees who cannot perform at that level.

Employees would be secure in knowing that their performance was evaluated objectively according to the standard of their work instead of the whims of a supervisor, or against some ever-climbing average of their group.

Opposition

A fundamental criticism of performance-related pay is that the performance of a complex job as a whole is reduced to a simple, often single measure of performance. For instance a telephone call center helpline may judge the quality of an employee based upon the average length of a call with a customer.

As a simple measure, this gives no regard to the quality of help given, for instance whether the issue was resolved, or whether the customer emerged satisfied. Performance-related pay may also cause a hostile work attitude, as in times of low customer volume when multiple employees may compete for the attentions of a single customer. Where a customer has been helped by more than one employee, further resentment may be caused if the commission is taken by whoever happens to make the final sale. Macroscopic factors such as an economic downturn may also make employees appear to be performing to a lower standard independent of actual performance.

Performance-based systems have met some opposition as they are being adopted by corporations and governments. In some cases, opposition is motivated by specific ill-conceived standards, such as one which makes employees work at unsafe speeds, or a system which does not take all factors properly into account.

In other cases, opposition is motivated by a dislike of the consequences. For example, a company may have had a compensation system which paid employees strictly according to their seniority. They may change to a system that pays sales staff according to how much they sell. Low-performing senior employees would object to having their income cut to match their performance level, while a high-performing new employee might prefer the new arrangement.

Another argument is that the judgment of one's performance can be subjective (the judgement of the same quality of work can vary from department to department in a company and from supervisor to supervisor).

Research

Academic evidence has increasingly mounted indicating that performance related pay leads to the opposite of the desired outcomes when it is applied to any work involving cognitive rather than physical skill. Research^[2] funded by the Federal Reserve Bank undertaken at the Massachusetts Institute of Technology with input from professors from the University of Chicago and Carnegie Mellon University repeatedly demonstrated that as long as the tasks being undertaken are purely mechanical performance related pay works as expected. However once rudimentary cognitive skills are required it actually leads to poorer performance.

These experiments have since been repeated by a range of economists,^[3]^[4] sociologists and psychologists with the same results.^[5] Experiments were also undertaken in Madurai, India where the financial amounts involved represented far more significant sums to participants and the results were again repeated. These findings have been specifically highlighted by Daniel H. Pink in his work examining how motivation works.^[6]

Cultural aspects

An international study by Schuler and Rogovsky in 1998 pointed out that cultural differences affect the kind of reward systems that are in use. According to the study, there is a connection among

status-based reward systems (as opposed to achievement-based) and high uncertainty avoidance,
individual performance based systems and individualism,
systems incorporating extensive social benefits and femininity and
employee ownership plans with individualism, low uncertainty avoidance and low power distance.^[7]

(See Geert Hofstede for the dimensions of cultures used.)

Sources

↑ Oxford English Dictionary s.v. "piecework": "1549 Coventry Leet Bk. 792 No persone of the Craft of Cappers shall put owt eny pece-woork, but to suche of the same Craft as the maisters..shall agree & consent vnto."
↑ "Large Stakes and Big Mistakes, Working Paper 05-11 by Dan Ariely, Uri Gneezy, George Loewenstein, Nina Mazar" (PDF).
↑ "Relative Rewards within Team-Based Compensation, Labour Economics. 15 (2008), Bernd Irlenbusch and Gabriele K. Ruchala" (PDF).
↑ "Pay-for-Performance Doesn't Always Pay Off, Harvard Business School Working Knowledge".
↑ "Value for Money, David Marsden looks at the record of performance related pay in the public sector" (PDF).
↑ "Dan Pink at the Royal Society for the encouragement of Arts, Manufactures & Commerce".
↑ Schuler, R. S. and Rogovsky N. (1998) 'Understanding compensation practice variation across firms: the impact of national culture', Journal of International Business Studies, 29(1):159-77.

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