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Performance Related Pay

Organizations pay salaries to their employees based on the type of services rendered. Salary levels rise system is one of the most critical elements in strategic human resource management. This is primarily due to the role played by rewards and compensation system in determining employee productivity. Rewarding the employee on the basis of his productivity or performance generates enthusiasm and interest within the employee to perform better.

Moreover, this approach tends to increase the level of motivation encouraging him to perform better.

An intrinsic part of rewards and compensation strategy is performance management that seeks excellence and high quality work from the work force. The study highlights various theories in relation to performance related pay and associated human resource strategy. The discussion provides an insight into essential features of performance related pay such as motivation, performance management, appraisals, feedback, and learning that play a vital role in creating effective performance related pay strategies. It also identifies some practical problems faced by managers and strategic alternatives that can effectively meet these challenges.

What is performance related pay? Performance related pay is the financial compensation paid to an employee based on his work performance. It translates to rewarding employees for effective performance. Bruno Frey (2002) observes in his book Successful Management by Motivation “Variable performance related pay has become an increasingly popular form of compensation. The key to performance related pay is that compensation is adjusted to reflect an employee’s individual performance. ” This form of compensation is similar to rewards system adopted by organizations to motivate their work force and extract higher quality work.

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The strategic issue involved in rewards system of compensation is based on job, skills, or competence. The performance based pay covers “the particular aspect of performance and whether it is based on individual or group performance” (Beaumont, 1993; pg 104). Performance related pay has been practiced by a large number of organizations since the inception of trade and commerce.

Managers have implemented various forms of rewards and compensation schemes to motivate their employees to deliver better quality and higher volumes of work. In Britain some 400,000 (out of total 585,000) civil servants in 1989 had some part of their pay determined by performance appraisal” (Beaumont, 1993; pg 107). Since the 1980s the performance based payment system has undergone gradual changes in the nature of implementation and scope of application within an organization. In the last ten years the performance based pay practices have spread from management level to cover different levels of the organization and there has also been an increase in the use of collective or group performance schemes at the team level (OECD Report).

The system has now evolved to include identification of measurable parameters while assessing performance, use of positive reinforcement and feedback mechanism to instill confidence within employees, and ongoing training development sessions to equip the workforce to meet operational challenges. Theoretical bases of performance related pay Rewarding an employee with financial compensation is a form of motivation that is intended to increase productivity and encourage others within the organization to strive harder to reach the specified performance targets.

Motivation has been defined as the “driving force that determines the direction and strength of goal-oriented behaviors” (Preker, 2007; pg 240). Performance based pay schemes have failed in many instances to motivate the employees to the desired level of performance. Many explanations have been given for this failure and it is to some extent attributed to the amount of compensation in lieu of the hard work and the management fairness during performance appraisals. Vroom’s expectancy theory and the Adam’s equity theory provide explanation to the fundamental problems faced during the process of deciding the level of compensation.

The amount of financial compensation being provided as incentive should meet the extent of hard work required to reach the desired level of performance. This is illustrated clearly in context of Vroom’s (1964) expectancy theory of motivation that claims “motivation is likely only when a clearly perceived relationship exists between performance and outcome and satisfies the need” (Preker, 2007; pg 239). According to this theory the financial motivation works only if the link between effort and reward is clear and the reward is worth the effort. In many organizations the cash rewards or compensation is too small to motivate the staff.

Another theory that explains the failure of financial reward compensation schemes in motivating employees relates to the Equity theory put forward by Adam’s in 1965. According to this theory, “people will be better motivated if they think they are being treated fairly and de-motivated if they think they are being treated unfairly” (Preker, 2007; pg 239). The performance related pay systems are based on performance appraisal of the employees by their line managers and most often these appraisals are biased and some degree of favoritism influences the line manager’s opinions.

This leads to unfair appraisal and feedback that in turn influences the bonus and pay hikes. In this context it is essential that the management provides tangible yardsticks for measuring performance within the organization. In certain cases like sales department the number of units sold and amount of sales achieved during a specific period of time forms the base for evaluation. However, workers within an operational environment involving technical processing or administrative functions, make the process of evaluating performance slightly complex.

In such cases, the management outlines certain parameters based on which the performance of an employee is assessed. Some of these parameters include quantum of processing done, error rates, and level of innovation applied to get a specific job done. “Under this broad heading one can include individual piecework, payment by results, merit pay, group bonuses, payments linked to overall organizational performance and numerous variants of each of these” (Beaumont, 1993; pg 107).

The performance based pay system requires three essential components that the human resource department needs to implement. First and foremost, the management needs to set the objectives to the staff in context of their work process defining exact parameters on which work will be assessed and evaluated. Secondly, the organization needs a performance appraisal system to discuss the performance with the staff on an individual basis. Thirdly, the performance should be linked to adequate financial compensation. Problems faced by managers in implementing performance based pay

A case study cited in Successful Management by Motivation by Bruno Frey (2002) states that H. J. Heinz paid their managers bonus only if they managed to increase their profits over the previous year. This resulted in managers manipulating profit figures to show an increase on the previous year figures. This was done by means of delaying or accelerating customer deliveries and adjusting payments in the specific time periods. The managers thus secured pay hikes but the organizational growth and value in the long term were compromised.

The above instance reflects how the performance related pay system can restrict company growth in the long run and act as a deterrent to its goodwill and reputation. This form of reward and compensation scheme is dependant on a large number of factors for its successful implementation within an organization. Managers practicing this strategic move are faced with negative results owing to lack of careful planning and understanding of human behavior. “Reward can act as the catalyst for improved performance and better productivity” (Accel, 2008).

This form of compensation is introduced by the management to motivate the existing staff and create a competitive environment within the organization that triggers enhanced productivity and increased efficiency. The OECD report on performance related pay in the government sector states “performance pay is an appealing idea, but the experiences reviewed in this study indicate that its implementation is complex and difficult. ” The study highlights the primary reason for the failure of this compensation scheme is the way these schemes are designed and implemented at the organizational level.

Moreover, employee survey results show that job content and career development prospects play a significant role in motivating employees to perform better rather than financial rewards. However, monetary rewards provide the means to satisfy different needs of the individual and hence its role in driving work performance cannot be undermined. “Increasing the remuneration related to people’s performance helps them feel they are valued and provides a tangible sign of recognition” (Preker, 2007; pg 242).

Managers implementing this scheme in their organizations often face practical difficulties that tend to limit its potential benefits and advantages. In many cases the managers are unable to identify the performance constraints faced by the employees. This limits their scope of performance and unfairness in determining the productivity level of the staff.


An essential ingredient in implementing a successful performance related pay system is the trust in management. Employees need to have complete faith in their managers and the policies adopted by them. This obviously requires “strong management commitment, a top down introduction process, the maintenance of a competitive base salary structure, a valid job evaluation system, a well designed, accurate and trusted appraisal system, a comprehensive and effective communication strategy, regular and systematic training for managers in performance review and feedback and an ongoing monitoring and evaluation process” (Beaumont, 1993; pg 110).

The performance related pay system needs to be supported by a thorough understanding of the organizational culture, adequate monitoring and supervision of managers, transparency in communications and suitable growth opportunities to reinforce employee motivation.

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Performance Related Pay. (2016, Dec 04). Retrieved from

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