Performance and Pay: Money Doesn't Buy Happiness (Or Results)
Recently I was having a conversation about the issues associated with putting in place a performance management process that is meaningful for both the company and employees. During the discussion, the issue of how to allocate bonuses based on the results of the performance review reared its ugly head. That led to a discussion on ‘forced’ distribution. The culture of the firm I was speaking with has always rewarded the top performers through the output of the performance reviews. I suggested that this sacred cow needed to be examined more closely.
Many organizations struggle with this concept: Do you link bonus and pay to the performance review or do you separate the two?
Once Work Begins, Pay Doesn’t Matter
Despite whatever beliefs we might have about how human beings function, the reality is that pay does not motivate performance. It only motivates which company will a person work for when they are looking for a job. According to the 2005 Annual Review of Psychology, "There is surprisingly little evidence about the performance implications of adopting, or not adopting merit pay programs." A November 2009 McKinsey & Co. report found that "...three noncash motivators, including visibility with top management, are more effective motivators than the three highest-rated financial incentives, including increased base pay and cash bonuses."
Indeed, research from both academics and global consulting firms find again and again that organizational, career and job-related factors for improving employee engagement and motivational levels outrank pay and bonus as motivators. Then why are we stuck on the idea that bonus, especially linked to the overall performance review, will in fact lead to improvements to performance or increases in commitment to the company and the job?
Dan Pink examined the common management notion that financial incentives drive employee performance. According to his summation of research for many jobs in the 21st century, employers will not elicit peak performance through monetary rewards, but by creating jobs with autonomy, mastery and purpose. Pink still associates pay for performance with jobs that are routine and clearly defined by objective production measures. But he notes that those in more complex cognitive roles will not be motivated to high levels of sustained performance through pay. Financial rewards can actually lead to impaired performance even for jobs that require a modicum of cognitive thinking.
Further a Towers Watson study found that conventional pay systems designed to engage employees do not effectively work. While designed to motivate employees to higher levels of quality, they only produce more quantity at best. In fact, the study in 2008 indicates that pay is not even among the top 10 drivers of employee engagement. Engagement being defined as ‘an employee’s ability and willingness to contribute to company success’.
Why is Pay for Performance Perpetuated?
Yet, when I do work with companies, I sense a widespread belief among HR professionals that there is a direct link between pay and performance. When I began working in Southeast Asia, for example, most HR professionals insisted that employees, at all levels, would change jobs for even miniscule differences in salary. Hence, it was vital to be intensely competitive on pay. In fact, survey by the Conference Board of America discovered that the tipping point for changing jobs seems to occur when the pay differential reaches 20% - a sizable amount of wiggle room.
Nevertheless, that belief underpins the common rationale for ensuring the results of the performance reviews are the foundation for pay decisions. This is even more problematic when you consider that the overall objectivity and honesty of many performance reviews are often questionable, at best!
It’s further complicated by the concept of ‘forced ranking’. (See a recent post The ABC’s of Forced Ranking.) Often forced rankings become political or "gamed" and t based on objective performance standards. It is not unusual for a manager to place a person in the highest performing category along the bell curve because they achieved desired business results even though their work and interpersonal behaviors make them undesirable employees. It is also common for managers to ‘punish’ long-term workers who are vested in the firm with lower rankings and lower payouts in order to advance a younger person in order to ‘save’ them and retain them, despite job performance that may not be as good. Indeed, the forced ranking system generally has a negative impact on performance, not positive. A system that leads to it being gamed needs to be rethought.
Performance reviews and performance management are best considered as part of a relationship based method rather than a transactional process. But that's for another time. For now, I am left pondering my original question: If pay and bonuses are not the drivers for improved quality of work, greater contribution, and longer commitment (i.e. retention) why are so many firms still linking money to performance reviews?
Finally, if pay and performance are not directly correlated one to the other why are they linked? Would it not be more advantageous to pay people what they should be paid and not hold over their head the looming merit or bonus? Currently we tell employees that their worth is, say $75,000 a year plus a bonus of $20,000. However, the bonus is dependent on the manager’s perception of you, thus creating anxiety. Wouldn’t it be better to say the job is really valuable and valued at $95,000 while identifying the criteria for success? Then, dependent of how the corporation performs at the end of the year, everyone from the CEO to the newest employee gets the same percentage change (+/-) dependent on the company performance. Would that not delink the performance from a rear facing to a forward facing process?
Why Make this Suggestion?
I have often asked of companies that we work with: When is the budget allocation for merit and/or bonus decided? I discover it is frequently decided prior to the start of the year-end review. This means that the money is already there and the only issue is how to distribute the funds. Would not the suggestion made above take the anxiety of making or (not making bonus) out of the equation? Even when people see the logic in the suggestion they respond that sales people would never accept not having a bonus. Perhaps a sales job falls into what Pink calls jobs that are clearly defined by objective production measures. As a result, merit and bonus can still apply for sales roles.
By the way have you stopped the discussion for a moment and simply asked your employees what they think? Just food for thought.
David is a globally recognized thought leader in the areas of talent management and corporate culture. He has been working with companies to align the people and the business for over 26 years. David works within a wide range of industries through training sessions, consulting, coaching and keynote speeches. His ideas have been featured in the media, professional workplace publications and at conference around the globe.
To read more on the importance of leadership acting with purpose (making the values real) and the impact of business success please read David's book on purpose, culture and leadership: Inside the Box: Leading With Corporate Values to Drive Sustained Business Success" His first book focused on the writing of behavioural competencies and their application to structured behavioural interviewing: The Talent Edge: A Behavioral Approach to Hiring, Developing, and Keeping Top Performers