Should performance reviews be linked to compensation?

Yosie Saint-Cyr, LL.B., Managing Editor, HRinfodesk.com---Canadian Payroll and Employment Law News, February/March 2009

It’s the time of year again when companies commonly prepare and conduct annual performance reviews, to ensure each staff member receives feedback on job performance—to determine whether employees are meeting the requirements of their jobs, but also to improve the working environment so that employees can do their jobs better.

Because employee performance affects company performance, many employers link performance reviews to pay raises. However, linking pay to job performance is quite controversial. Some HR experts don’t believe it is a good idea because of the negative impact it may have on actual employee productivity and morale, and it does not necessarily drive better performance. Others feel they need an objective method of measure to decide if they should award pay raises. However, proponents of pay for performance assert that people respond constructively to financial rewards.

The concept of aligning the contributions of individual employees with corporate goals is one of today’s hottest business topics. Pay-for-performance plays an essential role.

Our latest HRinfodesk poll asked participants, Is it your workplace policy to combine the annual performance review with an offer of an annual increase? According to 86 out of 227 poll respondents (37.89%), they combine an employees’ annual performance review with the annual pay raise. However, 79 respondents (34.80%) indicate that they use a separate process to provide employees with appraisals on their job performance and annual salary increase. Also of interest, 53 respondents (23.35%) indicated that they link performance reviews to pay increases for some, but not all employees.

Here are some of the comments respondents provided:

• No, as we are a unionized environment, and merit increases are automatic until the employee reaches the maximum of the pay scale. Merit increases may be withheld for poor or unsatisfactory job performance, but if a person is at max there is no recourse. We do have an annual performance review process, but it is not tied to performance except for senior management who are not unionized.
   
• All our performance reviews are linked to salary increases with the exception of our unionized technicians. Their increases are competency-based, and they also receive an annual CPI increase.
   
• We’ve stopped linking pay to performance since employees started comparing their pay to others and making judgments about fairness of pay. Different practices and/or circumstances in the organization cause perceptions of inequity and reduce the perceived link management intends. So we went towards a CPI-based annual increase and do performance reviews separately.
   
• Don’t like pay for performance reviews because corporate budgets for bonuses and pay raises often limit payout. Therefore, payout amounts may not be seen as consistent with performance outcomes obtained.

The following tables summarize the information received from the 227 organizations who responded to the HRinfodesk poll. The following commentary also provides an overview on the topic of linking the performance review process to salary increases.

What does it mean to link pay raises to performance?

In general, pay-for-performance systems are systems in which pay decisions are based on defined performance levels rather than entitlement, tenure or other non-performance related factors. Pay for performance is offered for specific performance results rather than simply for time worked.

Should pay be linked to job performance?

According to global compensation specialist George Milkovich, Making Pay-for-Performance a Reality, employers want employees to perform in ways that advance organizational performance. He says, “The way people are paid affects the quality of their work; their attitude toward customers; their willingness to be flexible or learn new skills or suggest innovation. … This potential to influence employees’ behaviour, and subsequently the productivity and effectiveness of the organization, is another reason it is important to be clear about the meaning of compensation.”

However, he further states “Without a connection to compensation, performance management lacks the element of execution—how can companies ensure that employees will actually be financially rewarded for meeting performance objectives? Adding compensation to the equation brings the required element of execution to performance management, ensuring that it is a true pay-for-performance strategy that can deliver tangible business results”.

According to other HR experts, pay-for-performance plays an essential role in aligning the contributions of individual employees with corporate goals. This compensation management discipline is practised with varying degrees of success—by many leading companies, which typically rate their employees annually on a bell curve, assigning an overall performance rating from “Exceeds objectives” to “Does not meet objectives”. At many companies, the employee that “Does not meet objectives” has to go, while others are awarded bonuses, raises and stock option grants commensurate with their rating.

Those who argue against linking pay to performance state that most wage increase and bonus programs only reward or punish what was or wasn’t done, as opposed to driving performance. According to some experts, it robs the employee of the intrinsic satisfaction of doing their work. They argue that pay-for-performance directly interferes with the true intention of performance management: if an employee knows that their raise or bonus is directly affected by their performance rating, they are much more likely to argue over criticisms and squabble over ratings. When trying to give constructive feedback to an employee, it is almost impossible to get a person to accept that they need to improve when admitting to such also means admitting they should be paid less or not receive a raise.

Implementing a pay-for-performance management system

Whatever system you decide to implement, if you communicate it properly, and provide clear guidelines, it has a better chance of succeeding. Moreover, it is important to have an understanding of all aspects of the system’s implementation: how it is done, when it is done, and the basis on which it is done, can make all the difference in whether your efforts will succeed.

A pay-for-performance management system has three key objectives: (1) to provide candid and constructive feedback to help individual employees maximize their potential, through understanding and realizing the goals and objectives of the organization; (2) to provide management with the objective and fact-based information it needs to reward top performers; and (3) to provide the necessary information and documentation to deal with poor performers.

If your organization is seeking to create a pay, incentive and reward system based on valid, reliable and transparent performance data, with adequate safeguards, and to link employee knowledge, skills and contributions to organizational results, you may want to consider implementing a pay-for-performance system.

Here are some elements to consider:

• Using competencies can provide an objective basis to evaluate employee performance. Organizations use validated core competencies in two ways: (1) as a key part of comparing individual contributions to organizational results; or (2) based on the individual employee’s position.
  

  Example 1– core competencies applied organization-wide can reinforce employee behaviours and actions that support the organization’s mission, goals and values, and can provide a consistent message to employees about how they are expected to achieve results. Competencies include: problem solving, teamwork/cooperation, customer relations, leadership/supervision, communication, and resource management. Supervisors can supplement the competencies to further describe what is expected of employees.
  

  Example 2– core competencies based on the individual employee’s position. Each employee’s performance plan will have between two and six critical elements, along with the major activities required to accomplish the element. Supervisors assign a weight to each element on the basis of its importance, the time required to accomplish it, or both.
  

  You might also develop an employee performance plan that includes criteria tailored to individual responsibilities. The criteria must be consistent with the employee’s work unit’s goals and objectives, and can be set in two ways, depending on the nature of the position: the “task approach” defines an individual’s output; the “function approach” defines the required skills and how well they are to be performed. Employees and supervisors choose from a menu of skills, such as planning, analysis, coordination and reporting/documentation.
   

• Translating employee performance ratings into pay increases and awards—established predetermined pay increases or awards, depending on a given performance rating.
  

  Example – a numerical rating determines how many “increments” the employee will receive. An increment is a permanent pay increase of about 1.5 percent of an employee’s base salary.
  

  Or you can delegate the flexibility to individual pay pools to determine how ratings translate into pay increases and awards. For example, supervisors evaluate employees on a range of performance elements on a scale of 0 to 100. Employees with scores below 40 are rated as “unsatisfactory”, and are not eligible to receive performance pay increases, awards, the CPI or local pay adjustment. Employees with scores over 40 are rated as “eligible”, receive the full CPI and local pay adjustment, and may receive a performance pay increase, award, or both.
   

• Will employees’ current salaries play into performance-based pay decisions to make a better match between an employee’s compensation and contribution to the organization? This allows an organization to make meaningful distinctions between acceptable and outstanding performance of individuals, and appropriately reward those who perform at the highest level. In this way, two employees with comparable contributions could receive different pay increases and awards depending on their current salaries.
   
• Managing costs of the pay-for-performance system. The increased costs of implementing alternative personnel systems should be acknowledged and budgeted for up front. Experts have indicated that salaries, training, evaluations, administrative expenses and automation/data systems were the major direct costs of implementing their pay-for-performance systems. It is a good idea, for example, to consider fiscal conditions and the labour market, manage advancement through the pay group, and provide a mix of awards and performance pay increases.
   
• Providing information to employees about the results of performance appraisal and pay decisions. To ensure fairness and to safeguard against abuse, performance-based pay programs should have adequate safeguards, including reasonable transparency in connection with the results of the performance management process. To this end, it is a good idea to publish information such as the average performance rating, performance pay increase and award.
   
• Implementing mandatory ongoing training for all employees is a key factor in ensuring that employees receive consistent performance messages and thoroughly understand the process. At the beginning of the year, each employee should know what he or she needs to achieve in order to receive a good performance review and the pay increase or bonus.
   
• Holding all evaluators accountable for completing timely and effective performance evaluations so that the link between pay and performance is not compromised.
   
• Communicating the plan to explain the benefits of the system to employees and the organization as a whole.

According to HR experts who believe in the pay-for-performance management system, individual performance objectives are measurable and based on prioritized goals that support the accomplishment of the overall goals of the total organization. With this type of system. the performance of your organization is ensured because you focus on developmental plans and opportunities for each employee.

Sources:

Making Pay-for-Performance a Reality, Edwards E. Lawler III and George T. Milkovich, Workstream Compensation,
www.workstreaminc.com

Promise and Peril in Implementing Pay-for-Performance, by Michael Beer and
Mark D. Canon, John Wiley & Sons, Inc, 2004, ISSN: 0090-4848

Performance Management, by Robert Bacal, Briefcase Books,
McGraw-Hill, ISBN 0-07-071866-0

By Yosie Saint-Cyr, LL.B., Managing Editor, HRinfodesk.com

Published on HRinfodesk---Canadian Payroll and Employment Law News and Developments

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