Financial Rewards: Performance Related Pay

Financial Rewards: Performance Related Pay

Motivation, job satisfaction and pay are closely related to each other. Individual or team achievement can not just be rewarded by giving due credit for a job well-done but must be adequately rewarded in order to provide motivation, keep the momentum going, or egging on employees to surpass themselves in their work. Traditionally, the objectives of rewarding employees were to "attract, retain and motivate" them. The usual salary was intended to attract potential employees to an organization, benefits were employed to retain them and incentive and bonus schemes were used to motivate them. Rewards are believed to consist of three separate components: remuneration or compensation, benefits, and perquisites or "perks." Remuneration is based on salary structure, incentive schemes and job evaluations. (Thomson, 1999, p. 84); (CIPD, 2009)

Benefits are not employee/team dependent and are usually provided to all employees and may include Christmas parties, paid leave, etc. Perks like private healthcare or car allowance are usually provided to a certain category of employees only. However, in recent years this divide has broken down and several studies have shown that it is the rewards system that attract, motivate or retain individuals in an organization. Rewards may be of various types some of which may be financial like profit-related, result-oriented or performance-dependent and some non-financial. It has been observed that financial rewards in the form of pay can be a big source of job satisfaction but is not regarded as a highly motivational factor until and unless it is directly linked to performance. (Thomson, 1999, p. 85); (CIPD, 2009)

Performance-related pay is mostly provided in non-profit-making organizations where increased or enhanced performance lead to a higher pay and decreased performance leads to low pay. (Thomson, 1999, p. 85); (CIPD, 2009) Performance-related pay is beyond the stricter confines of pay and extends to a wider interpretation of financial rewards varying from profit-sharing, pay incentives and bonuses to equity sharing and/or profit sharing schemes. Performance-related pay may be in the form of increased basic pay or cash bonus and is directly coupled with performance assessment, usually as per previously defined objectives. That means performance-related pay may be either added in a cumulative to the basic pay until the upper limit of the specified grade with regard to the performance level is reached or the maximum pay rate for that particular grade is achieved. Another method of paying performance is a variable one where increases are through cash bonuses for consistent high-level performance or some special achievements. (Armstrong, 2002, p. 261); (McKenna, 2002, p. 562)

The latter method may be a more reasonable approach to giving performance-related pay than the annuity approach which occurs in systems where performance-related pay increases are provided as a component of the basic pay. This is often regarded as a never-ending reward and gives rise to questions like "why should a person continue to receive such rewards for a feat which happened quite some time back?" Providing performance-related pay as a consolidated amount means that the organization has to bear the increase in pay expenses without any surety that the performance will be repeated or that it will be accompanied by an increase in profit or productivity. However, the principle of variable pay rests on the premise that cash bonuses have to be earned back and are payable only if accompanied by an improved performance or profits. (Armstrong, 2002, p. 261); (McKenna, 2002, p. 562)

Profit-related pay is another financial reward scheme which links employee's pay with the profits that the company makes, i.e. If the profits increase the pay also goes up and vice versa. This scheme was popularized in UK after the 1986 budget and approximately two million employees came under the purview of this scheme by 1995. (Thomson, 1999, p. 84) In skill-based pay, employees are paid according to the number/level/kind of skills developed/employed by them. Competence-based pay is an "effort-based" system and depends on a pay-curve scheme where pay-increase is directly linked to increase in competence. (Preker; World Bank, 2007, p. 170);

Performance-related pay in the form of bonuses may also be provided to employees who have reached the top of their pay grade but continue to perform exceedingly well. This serves to circumvent the problem of de-motivation for individuals who have reached the farthest extent in relation to financial rewards. Senior executives and directors may also be provided with incentive schemes or executive bonus in the form of substantial payments over and above their base salary. However, this remuneration package contains a certain amount of risk money with pre-defined conditions and specific rewards and penalties for them as the package is usually based on achievement of profitability and growth targets. Executive bonuses are usually larger than can be justified by the scale of individual performance but are generally employed as a strategy to attract high-quality management people as well as to highlight the role management plays in an organization. This system can be viewed as an "outcome-based payment" as the bonus is directly related to the overall organizational performance in which the management plays a key role. (Preker; World Bank, 2007, p. 165); (Armstrong; Murlis, 2007, p. 308)

Some organizations base their performance-related pay on the basis of formal performance ratings either on the basis of periodic performance reviews or through special pay reviews. Some of the major tenets on which such performance assessments are made include the following: the assessment must measure results and not efforts, assessment should be observable and objective, the results should be within the control of the employee, and the measures used should be adaptable or reusable in different settings. (Preker; World Bank, 2007, p. 168); (Armstrong; Murlis, 2007, p. 308)

Other organizations base such pay increases on a general evaluation of how much pay increase an employee should get by assessing their potential, performance, market worth and comparison of pay levels of peers. Some organizations may also use a formula in the form of a pay matrix in order to make a decision on the size of the pay increase. Pay progression through a graded structure in a decelerated manner is done in keeping with the learning curve theory according to which increase in pay must be higher in the early phases of a job when learning is typically at its peak. (Preker; World Bank, 2007, p. 168); (Armstrong; Murlis, 2007, p. 308)

The benefit of profit-related pay is that it provides definitive tax advantages however since it is an outcome-based scheme both the principal as well as the agents must share the risk. With regard to skill-based pay, the main advantage is that employees are motivated to develop more and more skills which directly and positively affect their performance and company productivity. However, skill-based pay has the disadvantage that improvement of skills may not directly improve employee performance as employees get paid in proportion to the level and number of skills acquired rather than on how proficiently that skill is employed at work. (Preker; World Bank, 2007, p. 178); (Armstrong; Murlis, 2007, p. 315) The disadvantage of profit-related schemes is that it may have a limited influence as employees very often do not have much control over the various factors governing the organization's profitability. (Hellreigel; Slocum, 2009, p. 178)

There has been considerable debate as to the degree of motivation that financial rewards like performance-related pay provide but there is no doubt that it's outcomes may differ from person to person and even for a single individual over a period of time. The issue of individual performance-related pay has been received considerable attention in the last few years and has highlighted several problem areas. Firstly, it is difficult to establish the basis on which the performance-based pay should be ascertained. Secondly, with regard to monetary advantage it is doubtful as to the extent to which such a financial reward is worthwhile. Thirdly, the efficacy of using performance appraisal systems for making such vital decisions about staff development and their pay still remains doubtful. Various studies have suggested that individual performance-related pay may be phased out and team pay may gain more prominence. (Bee; Bee, 1997, p. 118)

According to Armstrong, individual performance-related pay has conspicuously failed to deliver results in numerous instances making the focus shift away towards team pay or other types of incentives that reward the entire team. In fact, Peters has clearly stated that "Rewards should go to the team as a whole." Many experts contend that in reality individual performance-related pay impedes the performance of the team as a whole. This is because it promotes individual performance and not team performance and individual team members further their own objectives often at the expense of the team's goals. It does not encourage team spirit where individuals should ideally forget individual achievements and work collectively towards team goals. Moreover, it may also result in managers giving more emphasis on individual performance than on team performance. (Bee; Bee, 1997, p. 118)

However, there are several advantages associated with performance-related pay. At the macro level two benefits can be observed: first, in profit-related schemes, new recruitment results in reduction of quantum existing employees receive until and unless profits also increase leading to dissatisfaction amongst employees. Secondly, performance-related pay increases prevents inflationary tendencies since such increases are the outcomes of increased productivity. Managers and employees are benefited by performance-related pay increases in the following way: when profit or performance goes up higher earnings go to the employees. However, when the profits come down, the lowering of performance-related pay can protect employees from job losses. Moreover, there is enhanced motivation as employee can identify with the success of the business. Depending on the information-sharing habits of the management, pay variations may result in employees knowing more about fortunes and misfortunes that a business goes through. (de Silva, 1998)

Other advantages of performance-related pay include the following: it is an effective method of coping with poor performance; introducing such a reward system can help to develop a performance culture within the company; it can work as a direct incentive for employees to help reach defined job targets; an employee gets due recognition through a tangible reward for his/her work contribution; launching a system for rewarding employees demonstrating high performance can help to build up retain the most capable workforce in the company; it is highly likely that employees will place more emphasis on the areas in which they must improve if the improvement is directly related to pay. (Unison. 2006)

Different cultures have different perceptions about performance-related pay increases. However, one thing common amongst all countries is that all countries view pay incentives as extremely important. The Mexican, American, Latin American and Taiwanese employees regard job performance as more suitable for pay increases whereas Japanese, Taiwanese, as well as Indonesian staff consider seniority as more significant for any decisions about payment. Chinese employees feel that material and socio-emotional rewards should be differentially allocated whereas American employees feel that material awards should be performance-based and socio-emotional rewards should be equality-based. It has been observed that American employees give maximum importance to financial rewards as a motivating factor. (Vance; Paik, 2001, p. 279); (Gunkel, 2006, p. 105)

As per a Tower Perrin report of 2002 which studied executive compensation in different countries, it was observed that CEOs in France received one-third the compensation received by CEOs in the U.S. And even the highest paid CEOs in Europe such as the Swiss got only half of what was paid to American CEOs. Many experts are of the opinion that this difference is mainly cultural since most Europeans would be embarrassed by any kind of ostentatious or lavish pay whereas Americans are willing to go far in rewarding success. Performance-based pay in Japan and Korea seems to be appropriate in its historical and cultural context which places more emphasis on age, tenure, social class and education. China displays more complexity with the existence of three or more distinct subcultures within the same country. For instance, the subculture of the western and central regions is more collectivistic whereas the subculture of the southeast region is more individualistic. (Vance; Paik, 2001, p. 279); (Gunkel, 2006, p. 105)

Thus the importance of pay for performance also varies from region to region. Countries which display high individualism like United Kingdom, United States, Sweden, Canada, Italy, France and the Netherlands focus on individual performance-based rewards whereas countries which display low individualism like China, Taiwan, Hong Kong, Korea, Ecuador and Colombia use non-direct group-based contingent financial rewards which meets the minimum recognition needs of individual distinction. (Vance; Paik, 2001, p. 280); (Gunkel, 2006, p. 112)