Pay-For-Performance: Literature Review Only Journal

Pay-For-Performance: Literature Review Only

journal articles from January 2004

Because studies have shown time and again that pay represents one of the most important factors involved in retaining qualified employees, it is little wonder that there has been a great deal of attention focused on how best to compensate employees for their performance in recent years. Moreover, because employee performance and productivity is inextricably related to organizational profitability, these issues have assumed new relevance and importance in the current economic environment. There have been some mixed reviews concerning pay-for-performance approaches to enhancing employee performance, though, that suggest there is more involved than simply throwing money at top performers. Despite these constraints, many authorities suggest that pay-for-performance programs have a lot to offer organizations seeking to identify better ways to improve employee performance. In this regard, Miller, Hildreth and Rabin (2001) note that, "Individual incentives have a central role to play in the success of most conceptual schemes related to performance. Such plans, while very difficult, have large possibilities; seemingly insurmountable obstacles can be overcome if the emphasis moves to the employee's relative needs for power, affiliation, and achievement" (p. 230).

These are tall orders for any human resource manager and an organization's leadership, though, and the fact remains that measuring individual performance is a complicated affair in many types of organizational settings, particularly the nation's schools where the controversy over pay-for-performance has been especially pronounced. When the need to take into account individual employee's relative needs for "power, affiliation, and achievement" and thrown into the mix, it is not surprising that pay-for-performance programs are considered difficult to implement and even harder to effectively execute and administer. The following journal articles provide some valuable insights into the challenges and obstacles that have been identified in this regard, and these sources, together with the tips and guidance offered by the authors, can help provide a set of best practices that organizations of all types can follow when considered implementing such an incentive pay approach to rewarding top performers. A summary of the research and salient findings are provided in the chapter conclusion.

Discussion

From Bayley's (2006) perspective, pay-for-performance programs, also known as incentive pay or merit pay, are a solid approach to rewarding top-quality performance by employees in many types of organizations including healthcare settings. This author also qualifies this characterization, though, by emphasizing, "Pay for performance programs are not one thing, they are many [but] pay for performance is only the next best thing. The very best thing would be to stop playing the current game and design a system -- a cost-worthy, predictably priced and quality-rewarded system -- that works for everybody" (p. 1). Given the challenges associated with developing such an approach, though, "the next best thing" provided by pay-for-performance programs may represent the optimum tactic for many types of organizations today. This has been especially true in the field of education where incentive pay initiatives have become a topic of hot debate among educators and policymakers alike.

The same constraints and challenges that typify pay-for-performance in other types of organizations, though, are also present in the nation's school systems and are particularly pronounced when it comes to measuring teacher performance because of the enormous number of confounding factors involved. For example, Lavy (2007) reports that, "Tying teachers' pay to their classroom performance should improve the current educational system both by clarifying teaching goals and by attracting and retaining the most productive teachers. But implementing pay for performance poses many practical challenges, because measuring individual teachers' performance is difficult" (p. 87). The experiences of the Denver school system suggest that this approach is doomed to failure unless all of the stakeholders involved are actively involved in its formulation, implementation and execution. According to an analysis by Gratz (2005), the Denver school board elected to implement a merit pay regimen without soliciting feedback from the affected teachers and they ultimately regretted their decision to implement such a program as well as their lack of soliciting educator feedback. Moreover, the merit pay program used by the Denver school system was marked by many of the same obstacles that other schools have experienced when attempting to implement such an initiative in terms of accurately measuring teacher performance when there are so many confounding variables involved (Gratz).

Indeed, different class sizes and student body characteristics will undoubtedly affect the ability of even the most qualified teacher in producing substantive academic outcomes, and if incentive pay is available for those who demonstrate the most improved results on standardized testing, for instance, there is a real danger of educators simply "teaching to the test" rather than promoting the critical thinking skills needed by students in the 21st century. In this regard, Lavy suggests that many of these constraints can be overcome through a careful and thoughtful program design. According to Lavy, "Many of the practical challenges faced by performance-related pay can be addressed through careful design of the system" (p. 87). It must be noted, though, that Lavy also emphasizes that implementing a pay-for-performance regimen in educational settings is not a static, one-time affair, but rather requires ongoing fine-tuning to ensure that the initiative is producing the types of academic outcomes that are desired while avoiding the pitfalls that have created more problems than they solved in the past. As Lavy emphasizes, "Setting up a performance-related pay system that works is not a one-time task. Even with the best preparation, initial implementation is likely to be problematic. But if the effort is seen as ongoing, it should be possible to make progress gradually in developing incentives that motivate the desired teaching behaviors and that will be perceived by teachers as fair and accurate" (p. 87).

Unfortunately, the perception of such incentive pay approaches is rarely viewed as "fair and accurate" by all of an organization's employees and this perception, even if it is misplaced, can adversely affect even the most thoughtfully and carefully designed and implemented pay-for-performance program if employees consider its use to be anything less than fair across the board, particularly in the public sector where people may be motivated by a wide range of intrinsic factors that may not be related directly to the pay involved. For instance, Risher (2005) advises, "While it is effectively a universal practice for white-collar employees in non-government sectors, [pay-for-peformance programs] represent a radical and difficult change for public agencies" (p. 121). Likewise, Hyde (2005) advises that, "Pay for performance has been proposed, debated, and dismissed for over fifty years in public personnel management. Although legal challenges have been filed, pay for performance emerges as the new model for federal human resources pay practice and the cornerstone of federal public management strategy" (p. 3). Nevertheless, beyond the legal challenges involved, there are a number of constraints to the implementation and execution of such initiatives that can make or break their success. This point is made by Kellough and Nigro (2006) who report that a pay-for-performance initiative in the State of Georgia known as "GeorgiaGain" has been viewed by many state employees as inherently unfair and wracked by favoritism despite the enormous amount of resources devoted to the program's design and implementation. In this regard, Kellough and Nigro note that, "After four years of experience with the new system, only 28% of the workforce agreed that GeorgiaGain was a good way to motivate employees, and only 21% agreed that their pay was based on how well they did their jobs. These findings are remarkable given that the state had invested heavily in designing and implementing its pay-for-performance system" (p. 447). In fact, more than two-thirds (68%) of George state employees believed that the GeorgiaGain initiative was flawed by favoritism in terms of the distribution of pay raises in their agencies and that too much emphasis had been placed on using money as an incentive and not enough on other sources of employee motivation (Kellough & Nigro).

Likewise, in his analysis of pay-for-performance initiatives in the federal government, Trahant (2008) found that the current attempts to promote a pay-for-performance culture in federal agencies today require that policymakers take into account the fundamental differences that may exist between public and private sector employees where the former are perhaps motivated - at least in part - by the value of the work involved. According to Trahant, "It is important to design compensation systems to emphasize long-term job attractiveness to employees and to avoid performance-related pay that crowds out intrinsic motivations associated with public service and valuing the work itself" (p. 55). In addition, Trahant makes the point that some of the studies to date concerning pay-for-performance in the private sector fails to provide the desired outcomes (i.e., improved employee performance) and that in the area of public service arena, such initiatives "can actually be detrimental to employee job commitment and motivation" (p. 56).

Indeed, simply implementing such an initiative is one of the fundamental stumbling blocks that quickly emerges from the relevant literature. According to Lavy, "Implementing performance-based pay requires meeting the daunting challenge of devising a system for measuring performance. The system must measure true performance in a way that minimizes random variation, as well as undesired and unintended consequences. It must align performance with ultimate outcomes and monitor performance to discourage cheating" (p. 88). In fact, Lavy suggests that any initial incentive pay program implementation will likely be flawed in some ways, but gradual progress in achieving a viable program is possible if the foregoing considerations are taken into account.

Assuming that organizations can successfully implement and administer such a pay-for-performance program, though, the returns on investment can be worth the effort required - but only if everyone involved "gets on board" with the approach. According to Fiorito, Bozeman, Young and Meurs (2007), "Employees should view incentive pay as a form of support and show increased commitment in return. Despite well-known problems with incentive systems, this basic idea suggests that workers will be more committed in firms where performance is an important earnings influence. Prior research by provides some support for the positive effects of an incentive pay system on commitment" (p. 186). The growing body of research into this area indicates that organizational commitment is a good predictor of a number of important factors that may affect employee performance, including organizational citizenship, absenteeism, and turnover. Research has also shown that organizational commitment is a factor in employees' intentions to seek alternative jobs as well as their intent to leave their existing jobs (Fiorito et al.). In addition, higher levels of organizational commitment have been shown to reduce absence frequency and have been positively to improved organizational outcomes, including job satisfaction and attendance motivation (Fiorito et al.). Moreover, organizational commitment has been shown to be higher in those cases where compensation levels are discretionary, such as in the case of pay-for-performance programs (Fiorito et al.). According to these researchers, "One argument for incentive pay systems is that they harmonize employee and employer interests by aligning incentives. Further, incentive pay systems should promote equity feelings because workers are paid for performance contributions. Accordingly, employees should view incentive pay as a form of support and show increased commitment in return" (Fiorito et al., p. 187).

Such reciprocation is not always forthcoming, though, and in order to have half a chance at succeeding in improving employee performance, though, pay-for-performance programs must receive support from the top-down as well as the bottom-up in ways that are reflective of the organizational culture that is in place. In this regard, Risher (2007) notes that, "The culture is always an important consideration, often the most important, in gaining acceptance for new policies and work management practices like pay for performance" (p. 51).

Therefore, absent an organizational culture that creates a performance-oriented workforce, simply throwing money at top-performers will likely fail to achieve the desired results. As Risher points out, "In an organization with a strong performance culture, employees know what they are expected to accomplish and are emotionally committed to organizational success. They believe in the mission and goals and are quick to put their energy into a task without being asked or monitored" (p. 51). A performance-oriented organizational culture is not difficult to discern because the focus on achieving organizational goals is evident throughout the firm. According to Risher, organizations with a strong performance oriented culture are apparent: "Informal conversations with coworkers frequently focus on performance problems and recent organization results. They tend to celebrate successes as a team or group. The commitment to performance is a way of life in the organization" (p. 51). To help develop and maintain an organizational culture that is performance oriented, Risher provides some solid guidance as shown in Table 1 below.

Table 1.

Management practices that contribute to a performance-oriented organizational culture.

Management practice

Description

Performance monitoring

1. Performance is tracked and communicated, both formally and informally, to staff.

2. Performance is continually reviewed, with follow-up actions to ensure continuous improvement. Results are communicated to staff.

3. Regular performance conversations focus on problem solving and addressing root causes.

4. Meetings are used for constructive feedback and coaching.

5. Targets balance financial and nonfinancial performance targets.

6. Corporate goals focus on shareholder value and cascade with increased specificity to lower levels of management.

7. Long-term targets are translated into specific short-term "staircase" targets.

8. Targets are genuinely demanding and grounded in solid economic facts.

9. Performance measures are well-defined, strongly communicated, and reinforced in all performance reviews.

10. Failure to achieve targets drives retraining in areas of weakness or a job change to where skills are more applicable.

Human capital management

1. Managers are evaluated and held accountable on the strength of the talent pool they develop.

2. Training and development opportunities are available for top performers.

3. Ambitious stretch performance goals with clear performance accountability and rewards are established.

4. Company does whatever it takes to retain top talent. 5. Managers are responsible for trying to keep desirable staff.

6. Company tries to provide a unique "value proposition" to attract talented people.

7. Company HR practices are planned to achieve this goal.

9. Company actively works to identify, develop, and promote top performers.

10. Managers are assessed on the basis of succession plans for individuals.

11. Company moves poor performers out of the company or to less critical roles as soon as weakness is identified.

Source: Risher, p. 52.

Some of the more successful approaches to implementing and administering pay-for-performance programs to date provide some useful guidance for organizations considering this approach to employee motivation and in "getting everyone on board" with the initiative. In his case study of one such company, Mcdonald (2006) reports that in 2002, Meyners + Co. initiated an aggressive business development program to better align employee performance and compensation with its core organizational values and competencies in an effort to prepare its staff to perform an additional workload; not surprisingly, the company experienced some problems as it pursuing these goals. To its credit, though, the company operationalized its expectations in ways that made what was expected in terms of improved performance clear to its staff members. In this regard, Mcdonald notes that, "The core of Meyners's training is developing demonstrable competency in seven key areas: client development, client management, business management, technical expertise and work quality, personal participation and professional development, leading and developing others, and administration" (p. 51). To achieve this improved alignment of core organizational values and competencies, Meyners + Co. implemented a pay-for-performance compensation that was intended to reward employees who (a) exemplified the firm's core values, (b) mastered the core competencies required at their level and - contributed to the firm's overall strategic goals (Mcdonald).

The pay-for-performance initiative implemented at Meyners + Co. used a three-tiered structure: (a) salary, (b) general bonus and - firm-profitability bonus; however, Mcdonald emphasizes that administering this incentive pay initiative "involved a lengthy, data-intensive review and elaborate numerical calculations based on multiple evaluation forms filled out annually by supervisors, staff and peers" (p. 51). This unwieldy approach is indicative of the foregoing assertions that any initial implementation effort will be flawed, but the company's management did learn from its mistakes, but this required some time and some setbacks before the lessons became apparent. In this regard, Mcdonald adds that, "When the firm did not meet its goals and the third salary component wasn't given, some staff members felt unfairly punished" (p. 51).