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 it’s 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 disjoin the two?
Despite whatever beliefs we might have about how human beings function, the reality is that pay does not motivate performance. 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 out rank 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 increases in commitment to the company, the job or improvements to performance?
Dan Pink examined the common management notion that financial incentives drive employee performance. According to his summation of four decades 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’.
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, surveys and academic research show 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 in question!
And it’s further complicated by the concept of ‘forced ranking’. In a forced ranking system, employees are categorized based on performance reviews. However, a forced ranking system is based on the expected numbers, not on reality. People are not categorized on their actual performance, but relative to one another. This fails to take into account the fluctuation of both individual, departmental and organizational performance. From the perspective of an employee, being assessed based on things out of your control is a de-motivator, which is the opposite of the goals of performance management. The net result is that by applying the pressure of forced ranking on employees the organization runs the risk of losing good people.
Often forced rankings become political or "gamed" and not 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 gaming 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 a blog 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 why are so many firms still linking money to performance reviews?