Briefly discuss the Problems and Benefits of performance related pay.

Whether extrinsic rewards such as performance-related pay actually motivate employees to better performance is a matter of controversy. It has been claimed that monetary rewards usually have a limited time-span in regard to their motivating effect. Therefore extrinsic rewards such as performance pay, even if they can exert a continuing impact on performance, should

• be consistent with overall management objectives, so that performance pay may not be consistent with, for example, a purely cost reduction strategy;

• only be used to reinforce a motivational system in which intrinsic (non monetary) rewards exist, such as reorganization of work processes, training, employee involvement/consultation in decision-making, two-way communication, opportunities to contribute ideas, career development plans and goal setting.   

Some of the reasons for the failure of performance-related pay and some of the problems and issues facing employers flow from a variety of circumstances such as the following:

i. Inadequate criteria to measure performance, or criteria which are not easily understood, communicated and accepted. Performance pay should therefore be negotiated.

ii. Inappropriate performance appraisal systems in that the objectives of the appraisal system (e.g. where it is intended to identify training needs or suitability for promotion) do not match the objectives of the reward system.

iii. The absence of regular feedback on performance.

iv. The reward system is not designed to meet the objectives sought to be achieved. There could be a variety of objectives e.g. to satisfy distributive justice, attract and retain capable staff, match particular levels of pay in the labour market, change organizational culture (e.g. towards greater customer satisfaction) or to reinforce it.

v. The absence of a right mix of extrinsic and intrinsic rewards.

vi. The lack of an appropriate quantum of pay which should be subject to performance criteria.

This occurs when the amount which depends on performance is too small, or it is too large and therefore the amount placed at risk (when performance is poor) is not acceptable to employees.

vii. The absence of periodic evaluation of the scheme.

viii. Non-recognition of the fact that performance, especially profit, is sometimes (even often) dependent on factors outside the control of employees e.g. management decisions, exchange rates, recessions.

There are many arguments in favor of performance-related pay which are theoretically attractive. However, it is not easy to find evidence which unequivocally supports or disproves these views, because of the scarcity of empirical evidence or because the introduction of the scheme has been faulty. Governments can sometimes facilitate the introduction of performance-based pay. In Britain for instance, the Finance Act of 1987 introduced tax relief for approved schemes to encourage their adoption and proliferation.

Two benefits at the macro level have been claimed for performance pay. The first relates to employment. If increases in basic pay are transferred to a profit-related scheme (e.g. 10% of basic pay), the employer may be more inclined to hire new employees as his wage cost is less than otherwise. If the percentage of profit to be shared remains fixed, additions to the workforce do not cost the employer more in terms of the profit-related pay. On the other hand, new recruitment would reduce the quantum existing employees will receive unless profits increase, and consequently dissatisfaction among employees could set in.

The second argument is that if basic pay is reduced as a percentage of total earnings, increased earnings will not result in inflationary tendencies as such increases are the result of increased profits/productivity.

The benefits to management and employees are:

• where performance/profits increase, higher pay is an incentive to employees

• where profits reduce, the reduction in the performance-related pay can cushion employees against redundancies

• employee identification with the success of the business is enhanced

• variations in pay lead to employees becoming more familiar with the fortunes (or misfortunes) of the business. This would depend on the information-sharing practices of the management.   

Several criticisms of a general nature (apart from those directed at particular types of schemes) have been made against performance-related pay. Among them are the following:

i. where the performance earnings fall employees are less inclined to accept reductions in their guaranteed pay

ii. positive employment effects could be negated due to opposition from employees to recruitment as it would dilute their earnings

iii. since performance/profits depend on a variety of factors beyond the control of employees, it is not possible to link pay to the performance of employees. If it is linked to the overall performance of the enterprise, then management decisions should logically be subject to scrutiny by employees.

iv. it is difficult to determine whether the amounts paid out under schemes are more than matched by performance gains.

Even though the evidence is not always clear whether profit-sharing, for instance, raises productivity levels, the positive link between profit-sharing and productivity is clearer in enterprises with employee participation arrangements. Where the extra payments replace a fixed wage component and is not an additional component of pay, there is a greater likelihood that the extra pay is matched by performance increases. In the case of group incentives payments are never proportionate to individual performance, as poor performers ("free riders") benefit from the efforts of others.