8 Reasons Why Pay For Performance Only Works In Theory

8 reasons why pay for performance only works in theory

In this short paper I will explain why the statement “The introduction of individual pay for performance contributes to an improvement in a company's (financial) performance” is to my opinion not valid. Before we can jump into a reflection on the statement, two questions arise that will be discussed as an introduction “What is pay for performance?” and “Why is pay for performance considered as a system that might contribute to a company’s performance?”

What is pay for performance?

Pay for performance is a motivation concept in human resources, in which employees receive compensation for their work based on the level of reaching certain targets (individually or with their team, department or company). The term is often referred to when one is addressing the topic of variable pay based on performances. Although not generally recognised, the term pay for performance should, to my opinion, include as well, aside of variable pay, fixed pay and intrinsic rewards.

According to Dreher and Dougherty most current pay systems are not related to performance but only to circumstances and skills and competencies: �Most pay structures can be labelled job based pay (…). Some firms introduced a new pay system toward a skill- or competency based pay. In these systems employees are given pay increases as they acquire additional skills or competencies, not as they move to a job in a higher pay range’ .

Ideally we should include intrinsic rewards in the discussion as well. 'Employees receive both intrinsic and extrinsic rewards for performance. Intrinsic rewards are self-granted and consist of intangibles such as a sense of accomplishment and achievement. Extrinsic rewards are tangible outcomes such as pay and public recognition’ . The value of intrinsic rewards is often neglected, without reason as according to some research: “extrinsic rewards can lose their motivating properties over time and may undermine intrinsic motivation” . And “some research shows that workers value interesting work and recognition more than money” .

Why is pay for performance considered as a system that might contribute to a company’s performance?

One of the objectives of Human Resource management in general is to align the human resources of the company with its strategy and with specific circumstances. “What better way to drive people to work harder and more efficiently, you may ask, than to offer them a special carrot: more money for hitting specific company targets? ” Pay for performance is a performance appraisal system that motivates employees to perform activities in line with the company targets, and rewards employees that meet the specific targets. On the one hand the system stimulates performance in line with company strategy, but on the other hand when targets are not met, the company saves money. The system вЂ?puts some of the risk of doing business from the firms to the employees ’.

Several underlying unspoken assumptions are behind the pay for performance concept, which derive from the very nature of the society that we live in and are not necessarily accurate.

- Money motivates people to work harder.

- Increased motivation will increase performance.

- Fair measurement of work performance is possible.

Let’s take a closer look at these assumptions.

Money as a motivator: There is no doubt that money can be a powerful motivator. Dreher and Dougherty state that вЂ?effective merit pay creates a strong connection (instrumentality) between the employees’ level of performance and the subsequent size of their salary increase’ . From the Vroom expectancy Theory we learn: “The strength of a tendency to act in a certain way depends on the strength of expectancy that the act will be followed by a given consequence (or outcome) and on the value or attractiveness of that consequence (or outcome) to the actor ”. Within a pay for performance system the described relation can be considered among the highest. However, money isn’t always the motivator. For example, if you love gardening, you will put your heart into it. If you get paid to garden but don’t really like doing it, you’ll do it for the money but probably won’t do as good a job as someone who loves gardening.

Motivation leads to increased performance: Motivation is clearly linked to performance. However, in many cases motivation is not the problem. The performance problem may be due to lack of skills, poor organization, bad strategy, or a host of other factors.

Performance measurement: Measuring performance is difficult and the most significant practical problem in a variable-pay system. But paradoxically, precise measurements may lead people to do precisely the wrong thing. For example, two offices will compete rather than cooperate on a job because each is measured on its own profitability. Even harder to manage is the problem of perception. Even where there are real, perhaps obvious, performance differences, the employee who doesn’t perform well is more likely to attribute his or her low output to favoritism rather than performance.

Why individual pay for performance won’t contribute to the company performance

Although embraced by a high number of companies in the beginning a large number of them have already abandoned the pay for performance system. Based on the theory, other available resources (e.g. interviews, newspapers, internet, etc.) and personal experiences I identified 8 key reasons why individual pay for performance will not contribute to the company performance (see picture 1).

1. Changing market conditions

In a pay for performance system targets are set based on assumptions on market conditions. In a situation like we see today with ABN-AMRO in the Netherlands where the position of the bank, due to the situation of a possible merger or acquisition has changed dramatically the perspectives on performance criteria like “customer retention” or “customer acquisition”. The example is perhaps a bit dramatic, but the fact is that market conditions change and the pay for performance