Should performance reviews be linked to compensation?
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
- 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
- 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.
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
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
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
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
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
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
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
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
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
- 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
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.
Making Pay-for-Performance a Reality, Edwards E. Lawler III and George T.
Milkovich, Workstream Compensation,
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