14 Linking Pay to Performance
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14 Linking Pay to Performance
Merit pay, commonly called “pay for performance,” is perhaps the most widely used means by which U.S. organizations determine employee pay increases. The purpose of merit pay is to reward employees for individual contributions and to encourage the best performance possible. In theory, if all employees operate at peak efficiency relative to their capabilities, the organization will thrive.
The logic behind merit pay is straightforward: If pay is made contingent upon performance, then employee motivation to achieve high performance is increased. (See Figure 14.1.) The key to merit pay is founded in three motivational theories:
- Reinforcement theory states that merit pay should motivate improved performance because the monetary consequences of good performance are made known—the better one’s performance, the greater the pay increase will be.
- Expectancy theory states that merit pay should motivate improved performance because performance is instrumental to the attainment of a pay increase—improved effort to perform leads to increased pay.
- Equity theory states that merit pay should lead to improved performance because a pay raise is seen as a fair outcome for one’s performance input—the more one contributes to the organization, the greater the pay increase.
A successful merit pay program will:
- Reward employees for achieving performance results and exhibiting behaviors aligned with the objectives of the organization, which often are linked directly to the strategic business plan and mission of the organization.
- Provide rewards commensurate with contributions (i.e., bigger pay increases for stronger performers).
- Be communicated easily to employees.
- Be understood readily by employees.
- Recognize “bottom line” considerations and the organization’s ability to deliver pay increases.
- Be rational, structured, and administered in a logical manner.
- Conform to legal requirements.
- Use a well-founded, credible means of evaluating performance.
- Conform with and support management philosophy.
FIGURE 14.1 Linking pay to performance.
As with most business programs, a merit pay plan should be planned carefully to achieve these goals. If an organization takes the time to design its merit pay plan carefully, it will establish a strong link between pay and performance.
DETERMINING WHAT TO REWARD
Before a merit pay plan can be designed, the first steps are to determine:
- What the organization values.
- Which types of individual employee contributions should be rewarded.
- The organization’s ability to pay.
- The organization’s ability and willingness to communicate the plan.
- The organization’s ability to administer the plan.
Some organizations make these determinations through the planning efforts of senior management, who refer to the overall business strategy and mission. Other organizations use a structured human resources planning effort, which relies on formal performance-planning and goal-setting activities. Other organizations make informal determinations. Some additional steps to getting started on a merit pay plan are listed in Figure 14.2.
Without a clear understanding of the organization’s values and expectations, it is possible that employee contributions that are contrary to the organizational objectives will be rewarded. A successful plan requires that individual goals be aligned with the organization’s:
- Identity, which relates to whom the organization serves and what products and services are provided.
- Strategic plan, which relates to how the mission of the organization is accomplished.
- Objectives, which relate to what corporate goals have been established.
FIGURE 14.2 Getting started on a merit plan.
Once the link between individual and organizational objectives has been defined, merit pay can be used to align individual goals with those of the organization. When used properly, merit pay will reinforce the accomplishment of individual contributions that are in line with the identity, strategic plan, and objectives of the organization.
Merit pay also must be consistent with regard to the business environment of the organization. Business environment characteristics that support or detract from merit pay are shown in Figure 14.3.
DOCUMENTING PERFORMANCE STANDARDS
The second step in developing a merit pay plan is to devise a system that establishes and evaluates performance against individual objectives. Performance standards, also known as performance goals or objectives, are written statements that help determine the extent to which employees have contributed to the mission of the organization. These standards establish the basis on which employee contributions are evaluated, and they define the expected level of performance. Various ratings systems can be used to describe how successful an employee has been in attaining objectives. Some examples of common performance standards are shown in Figure 14.4.
FIGURE 14.3 How business environment characteristics relate to merit pay.
While establishing performance standards, determining which standards best meet an organization’s needs is critical. Objective standards—such as quality and quantity of work performed—should be assessed as well as more intangible, subjective aspects of the job such as teamwork, cooperation, and customer service.
Documentation of work standards is an essential part of the performance-evaluation process. Typically, this is an annual event in which supervisors and subordinates discuss goals and objectives for the coming year while evaluating the prior year’s performance. In some organizations, determining and documenting work standards is a cooperative effort between managers and employees. Other options include:
- Having managers determine objectives and then communicate them to the employee.
- Having employees present goals to their managers for discussion.
However work standards are established in an organization, obtaining employee “buy-in” is essential. If employees cannot comprehend the standards or accept their reasonableness, they are unlikely to perform in a manner that is consistent with the mission of the organization. To help ensure that employees accept and act upon performance standards, three actions should be taken:
14 Linking Pay to Performance
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