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Process Of Performance Related Pay Business Essay

Paper Type: Free Essay Subject: Business
Wordcount: 5341 words Published: 1st Jan 2015

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Globalization has led to increased competition in the developed countries. In order to face this fierce competition from the emerging countries and also to look an attractive organization to potential employees, organizations in western countries are continuously looking for ways to improve the productivity of their workforce. A widespread and famous instrument is performance related pay (PRP), which may stimulate productivity for two reasons. First, in states of irregular information about employees abilities or effort a PRP-scheme can be used to encourage employees to exercise ( Motivate ) the right amount of effort (Gielen, A. C et al 2010). Second, when hiring new employees, piece rates can be used as a screening method to encourage only the best employees to apply (Lazear E.P 1986). However, there are those who disagree with the above and argue that PRP in reality lowers productivity (Lawler, E. E. 1971; Gielen, A. C et al 2010).

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PRP as a method of compensation is commonly accepted as a sound management practice. We might argue about the relative importance of pay compared with other rewards, but few will deny that it is a powerful motivator for most people (Boselie, P. 2010). In fact, the principle of performance pay is so reasonable that it seems almost preposterous to criticize it. If two people are employed to perform the same job and one performs at a noticeably higher level than the other, surely he should be paid more for his higher contribution. Despite the obvious soundness of the simple principle on which PRP is based, a vast array of literature demonstrates that it does not always work with such sophisticated straightforwardness (Kohn, A. 1993; Marsden, D. and Richardson, R. 1994; McNabb, R., & Whitfield, K. 2007).

We will see form the essay that the fundamental aspects of PRP are – Does PRP motivate employees to perform more than their current level, how important are the PRP measuring methods to the employees and what kind of measurements are used, what role does trust play in PRP process , how does managers perceive PRP . Understanding these interrelated topics are principal to analyse PRP, which in turn would formulate the answer for the central question of can PRP – can PRP create healthy competition.

It is widely seen in the academia that while discussing performance management, it is common to include PRP as an intrinsic part of it (Clark, G. 1995; Dowling, B., & Richardson, R. 1997). Nonetheless, many authors believe that failure of effecting PRP implementation is down to futile methods of performance management procedures in organizations (Cannel, M. and Wood, S. 1992; Kohn, A. 1993; Moers, F. 2005). Lewis, P. (1998) argued that softer aspects of PRP implementation have been ignored by the authors. Hence, after conducting an empirical research, he concluded that aspects like “clear objectives, defining performance standards which emphasise how the job is done as well as the results of the job, monitoring progress towards objectives and feeding back to the employee the results of the monitoring in a developmental way are necessary pre-conditions for the acceptance of PRP by employees”. He concluded by saying that irrespective of the award that is associated with PRP , employees are more likely to accept the system if it is developed and conducted in efficient manner which aligns with the employees behaviours and needs . Most salary administrators will admit that a PRP plan is very difficult to administer properly. Unless the plan is diligently controlled, few managers actually administer the plan according to formalized policy.

The Process of Performance Related Pay

According to – Lewis, P. (1998), the PRP process can be seen in a logical order as opposed to series of discrete activities. By looking at the process, we can understand the PRP process in a much better sense and hence appreciate the problems that can arise. Understanding the process of PRP is fundamental for us to get to the answer to the question asked in this essay i.e. if it’s possible for PRP to create a positive competitive environment, and if it is than how can it be achieved.

Figure 1: The PRP process. Source- Lewis, P. (1998).

Stage 1: This stage is focused on setting objectives of performance management. According to Lawler, E. E. (1990), the objectives should be trustworthy and complete, they should not be narrow in scope but also not ambiguously wide. However, problems could arise due to lack on managerial skills which results in ineffective application of performance management. Hence, care has to be taken when developing objectives as weak fundamental objectives could harm the PRP process. Here an important decision needs to be made about the type of objectives that will be utilized i.e. subjective or objective.

Stage 2: A common issue that has come up in literature is that employees would agree in principal with the process but then become reluctant with the way in which process is implemented (Kessler, I. 1994; Deci, E. L et al 1999; Gielen, A. C et al 2010). This questions the validity of the entire PRP process. Two main questions dominate the empirical literature (Hamner, W. C. 1975; Procter, S et al 1993), first, the extent to which employees feel partiality is being practised, which in turn creates lack of trust between employee and manager. Second is the inclination for evaluations to cluster at the mid-point. Such clustering has the effect of not discriminating between individuals, which they feel is unfair. However, it is important to understand that according to Ehrenberg, R. G., & Milkovich, G. T. (1987), employees do not like to be differentiated based on the performance. Hence it is a catch 22 situation which can easily be created at this stage if PRP is not implemented with utmost care and caution. The arrow pointing back to stage 1 specifies that the measurement process may involve a redesigning and rethinking of the objectives.

Stage 3: Conveying feedback on performance is one where managers need to be tactical in their approach, because conveying bad news to employees can easily demotivate them and in no time the organizations will have many disgruntled workers. Communication is not the key here but effective communication is the key (McAdams, J. 1988; Clark, G. 1995). Communicating the feedback to employees about the performance comes under general scope of communication between managers and employees and is a complicated organizational and individual behavioural topic and beyond the scope of this paper. The arrow returning to stage 2 implies that a result of this process, modification of the measures may be needed in order to align the way feedback is handed out.

Stage 4: The final stage is where the performance after being evaluated is transformed into pay and rewards. It is the level at which a percentage of salary is paid to the employees, argued by Lawler, E. E. (1990), that anything below 10% of basic salary is meaningless. Or if the salary is entirely based on the PRP, then the future of the employee productivity depends in it. Here, the arrow points back to stage 1 because it is possible that employees may disagree with the result and would appeal formally and/or informally against the decision. This may result in modification of the entire system.

Communication as the central joining force: Communication is a key aspect of the business world; in fact it is the key to human interaction. In the model, communication is placed in the heart of PRP process. The management and HR department will need to communicate efficiently to the employees about the reasons of choosing the objectives, implementation methods, performance management systems, feedback mechanisms, pay and rewards schemes and everything that is linked with PRP.

Objective or Subjective Performance Measurement

Another topic of concern comes into play is deciding on how and what should the performance be measured in organizations. Authors have tried to distinguish measures based on subjectivity and objectivity. PRP systems can be based on objective measures of performance such as sales, divisional profits or subjective measures such as the assessed value of the employee to the organization (Baker, G et al. 1993; Moers, F. 2005). Although some jobs, such as in sales, lend themselves to objective measurement, performance in most jobs cannot be measured objectively because joint production mean that individual output is not readily quantifiable. The problem with the approach of measuring performance based on objective system is that incorrectly specifying the performance measure in an objective system could end up giving resourceful employees an edge over others by augmenting aspect of measures to suit themselves. Examples would be where employees would sacrifice quality for quantity and mangers would worry about short term benefits rather than long term since there pay depend on the profits and not the vision or the strategic direction the company is headed.

On the other hand there are many issues with subjective performance measures that are far more troublesome for the organizations, employees and managers in particular. Managers often prefer objective measurement schemes because they create fewer conflicts with disgruntled employees than subjective systems. Managers do not have to justify their personal assessment of performance in an objective performance measurement system (Baker, G et al. 1993; Dowling, B., & Richardson, R. 1997). Interestingly this is backed up by Psychologists as Lawler, E. E. (1971) stated that “pay plans based on subjective criteria have little chance of success” because employees don’t trust superiors to accurately evaluate their performance. He continues by saying that, “the more subjective the measure, the higher the degree of trust needed, because without high trust there is little chance that the employee being reviewed will believe that his pay is fairly based on performance.” Likewise, Hamner, W. C. (1975) believes that employees are frequently displeased with performance evaluations by their superior and recommends that performance pay should be based on objective rather than subjective measures. In addition to the criticism of the process, Meyer, H. H. (1976) adds another behavioural dimension. He argues that managers sometimes make relatively minor discriminations in salary treatment between individuals in the same job, regardless of perceived differences in performance. Everyone gets about the same size increase. Furthermore the discriminations are likely influenced by future potential and importance of the employee or the need to catch up when employee’s pay seems low in relation with others. It is very hard to disagree with this dimension since fundamentally decision making processes are not rational and will always have elements of other aspects in it apart from the main (Moers, F. 2005).

Humans are bounded rational beings; hence the decisions taken by the managers with regards to performance appraisals cannot always be seen and understood as rational decision taken under rational decision making process (Lukes, S. 1974). PRP systems can be seen in some dimensions as influential instigators of human action, consequently powerful that they can easily induce counterproductive behaviours in organizations. The not so uncommon in the organizations where there are trust issues between employees and managers and their aversion for conflict lead organizations to avoid PRP schemes based on subjective performance evaluation (Kohn, A. 1993). Similarly, difficulties related with objective performance measures, lead organizations to avoid PRP schemes based on objective performance methods. Hence in reality, the pay system that is a consequence from this will be the one with little or no performance related pay (Gielen, A. C et al. 2010; Baker, G. P 2012).

Reasons for Implementation of PRP across organization

Performance-related pay (PRP) has normally been introduced alongside other HR practices as part of a package of methods, the objective of which has been to increase the contribution of employees to the production process (Whitfield, K. and Poole, M. 1997). Some researchers have specified a link between individuals’ earnings and PRP due to the larger and better work effort by those who are on PRP (Booth, A.L. and Frank, J. 1999; Barkume, A. 2004). The inclination in such research has been to see PRP as both relatively standardised and restricted in its scheme. Predominantly, it is seen as synonymous with individual PRP, especially commission pay (Lazear, E.P. 2000; Seiler, E. 1984). However, PRP is much broader and can also involve group bases PRP, which are very different from individual based PRP. Some authors have ignored this aspect and used one size fit all approach when discussing PRP or combine group with individual (Booth, A.L. and Frank, J. 1999; Brown, C. 1990). Another impediment is that some organizations implement more than one type of PRP. The impact on earnings could, therefore, be different in those with just one type of system rather than a number of systems. Additionally, these variances could encompass connections that make the PRP earnings association differ from the condition when each is used in separation. Such connections could be either negative, whereby one type of system dampens the impact of another, or positive, whereby different types of systems are mutually strengthening.

According to McNabb, R., & Whitfield, K. (2007), the expansion and growth of PRP schemes has been due to a reaction by employers to the employer – employee problem. Employees have options in how they do their job. This can vary in effort, collaboration with colleagues, effectiveness of processes utilized to improve efficiency. In such places, mechanisms are needed to ensure that employees undertake their work in a manner that is consistent with the interests of the employers and the organization. One of the ways to achieve this is argued by Groves, T. (1973) is to implement process of close monitoring of employees performance and the disciplining of employees believed to be evading. However, this can be costly and demotivating and it shows a lack of trust in the employees. An alternative is to develop incentive schemes to reward individual. Such schemes have the advantage to the organization in that they not only encourage greater effort from employees, but they may also encourage the commitment of employees to the objectives and values of the organization. Hence PRP can be viewed as a control mechanism to monitor employees input to the production process, thereby carefully aligning workers’ pay and productivity. Some also view it as a mechanism for increasing worker effort (Brown, C. 1990). However according to the research done by Lazear, E.P. 2000 there are two ways in which PRP can increase productivity, first is that connecting pay to performance potentially introduces impartiality and consistency in the pay structured and secondly, it enables the organization to attract better work force .

The key criticism of the above is that such models take a very narrow view of PRP and its possible role in cultivating organizations performance. To be precise, they focus on individual forms of PRP and therefore ignore the aspect of group PRP and the potential for PRP to improve the performance of teams rather than individuals. They also ignore a possible intrinsic paradox with individual PRP schemes, that they may increase individual performance, but reduce that of the group as a whole, by creating a hindrance for employees to work supportively with others. Additionally, such models also ignore that PRP is only one form of payment system designed at increasing the input of employees to the production process (Boselie, P. 2010). Also important are structures for sharing profits and employee share-ownership. These could be seen as wide-ranging practice of group PRP, though their link to performance is much less direct. Such structures, being potential alternatives for the non-individualistic types of PRP, are likely to reduce the impact of PRP on earnings.

Issues with introduction of PRP in organizations

PRP can be either an individual incentive process, such as a piece rate wage, or a collective profit sharing. Despite the potentially positive productivity effects, PRP may not always increase productivity (Gielen, A. C et al 2010). In case of group PRP, individual performance is difficult to measure, hence there is a motivation for free-ride. In such a case, group-based incentive schemes may have little effect on individual productivity. Moreover, wilful incentives may arise in situation of multitasking. When employees are required to do numerous tasks, they will focus only on those undertakings for which they are being rewarded and ignore others. Therefore it is not always clear that the introduction of a PRP will indeed increase productivity. To emphasize the point that pay is not always linked with performance increase, a comprehensive study conducted by Lawler, E. E. (1971) found out that the relationship between pay and performance is not very closely linked to each other in the organizations that claim to have better productivity increase pay system.

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PRP is almost regularly introduced on the initiative of management, and the reasons or justifications given for individual schemes vary considerably. According to Dowling, B., & Richardson, R. (1997) , PRP may be introduced in an organization to overcome issues with current incremental pay schemes, to increase or in some cases develop employee motivation, to promote organizational change, to reduce difficulties of recruitment . In addition to above reasons for deploying PRP , Kessler, I., & Purcell, J. (2007) suggests that PRP might also be utilized to improve the equality of a payment system, to decrease union power and give added responsibility and influence to line managers to generate employee commitment. These various drivers suggest a plethora of probable methods by which PRP might be evaluated, some of them very hard to measure directly. It is also true that many schemes are likely to have more than one justification, so that a full evaluation should look at more than a single outcome measure.

One such example is effect on productivity by PRP. There have been some studies on the effect of productivity due to PRP implementation in organizations. However, in these, exhaustive evidence about productivity is vague. Therefore, wage is used, a rudimentary indicator of individual productivity. For the US, Ewing BT (1996) conducted a survey and found out that PRP is associated with about 5 % higher wages. In the case of UK data, Booth AL & Frank J (1999) found out that PRP effects of 9 % for men and 6 % for women. As a consequence of lack of appropriate productivity indicator in surveys has given rise to literature, where information based on single organization is utilized to estimate the influence of PRP on productivity in general. Such studies found out that implementation of PRP increased productivity (Paarsch HJ & Shearer B. 2000; Lazear, E.P. 2000). The criticism of these studies is that what works for one organization not necessarily will work for another.

In both the public and private sectors, pay-for-performance schemes have the announced intention of motivating workers to higher levels of performance and productivity by linking performance to financial incentives. They can also assist in attracting and retaining employees and, to some extent, in regulating Labor costs (Milkovich and Wigdor, 1991, p. 80). Given the emphasis on differentiating between employees, pay-for-performance should also be expected to not reward, and even to punish, those employees whose performance is not satisfactory. In most cases, a formal performance appraisal process provides the link between individual or group performance and reward. This performance appraisal provides the basis for supervisory decisions that differentiate among the employees in determining performance awards. The research of Lawler (1982) and others demonstrates that it is critical for the employee to perceive the appraisal process to be fair and objective, and to clearly link reward to effort, if pay-for-performance systems are to achieve their stated objectives. Some form of regularized performance appraisal underpins virtually all private sector efforts; the extent to which private firms have been successful in establishing the performance/reward linkage, and in documenting their success, would appear fundamental to efforts to determine overall success or failure of the policy in that setting. In fact, however, a great deal of private sector research documents the difficulties inherent in creating the necessary linkages, except under the most controlled circumstances.

Another problem with PRP is that it is based primarily on the decisions of his supervisor. The plan assumes that a supervisor can make objective and valid differences between the performances of various employees who report to him. In many organizations employees do not trust their managers to make judgements about their performance. Hence, the validity of this assumption is so often questioned, the idea of a manager being in control of decision of PRP is often a hindrance in accepting PRP. The managers’ role in determining pay creates another problem. It reminds the employee that he is dependent upon the manager for his pay and not the Job which he is doing. In this respect PRP can be seen as demeaning. The employees would put their effort in pleasing their manger more than putting hard work in the job.

PRP for Employee Motivation

There is clear empirical evidence which advocates that employee motivation is high on the list of organisations’ motives for the introduction of PRP (Dowling, B., & Richardson, R. 1997; Cannell, M. and Wood, S. 1992) .Consequently, it is only to be expected that the central concern of both researchers and practitioners is with the degree to which PRP has motivated employees to work in ways in order to achieve a PRP. This leads to the question about the extent to which PRP has influenced employee motivation towards job.

However, there are those in the literature arena who believe despite the benefits that PRP can bring , organizations resist introducing PRP to have a major motivational effect (Hamner, W. C. 1975 ; Kohn, A. 1993 ; Moers, F. 2005 ;). One explanation that comes up against PRP is that financial rewards are counterproductive. Deci, E. L et al. (1999) argues that money essentially lowers employee motivation by decreasing the intrinsic rewards that an employee receives from superordinate. Similarly, Slater, P. E. (1980) concludes that getting employees to chase money. Only creates workers pursuing money and nothing else. The critics of PRP believe that using money as a motivator will lead to a progressive deprivation of production. As per Kohn, A. (1993) there exist three reasons why PRP systems are counterproductive. Firstly, getting pay based on completing an individual task encourages workers to focus narrowly on a job and to do it as rapidly as possible without considering different angles and aspects to it. Secondly, extrinsic rewards can wear down intrinsic aspects of the Job. Thirdly, the employees will eventually come to see themselves as being controlled by the PRP and not be the motivation of doing their job well up to the standards (Boselie, P. 2010).

Among the side effects often mentioned is the fairness with which the PRP system is deployed in organizations and problems associated with imperfect performance measurement. Hamner, W. C. (1975) argues PRP decrease motivation because managers systematically mismanage performance related pay programs. Organizations often embrace the virtues of horizontal fairness systems, which treat employees at the same level in an organization fairly and equally. However, Ehrenberg, R. G., & Milkovich, G. T. (1987) pointed out that ultimately PRP involve differentiating employees on the basis of their performance, and there is a large literature arguing that treating employees differentiated from each other is damaging to employee motivation. An appropriate example from my work experience: Employees often overestimate their input and underestimate others. Employee X gets PRP when the performance of X in eyes of employee Y was not as much as Y performance. This will create Y to dislike the system, even though in reality X may have performed better than Y. We are humans and most of the time we think from the heart and then head. This will demotivate Y and hence create unhealthy working environment

Mangers Perception of PRP

PRP models are oversimplified in the way they see manager’s behaviour and motivation influenced by PRP assessments (Morris, J., & Fenton-O’Creevy, M. 1996). Further , many organizations do not give enough importance to the needs of the individual, the valence of the reward offered and the perceived strength of the link between effort, performance outcomes and reward. An important observation from Lawler, E. (1983) criticise PRP as sometimes being too less compared to the high basic salary that a managers would get , hence the motivations impact from monetary gain is negligible . Others have argued that PRP has adverse consequences for task execution, PRP is said to misrepresent the overall importance of the job by getting managers to focus on those tasks which are most critical to reward achievement (Hamner, W. C. (1987)). However, there remains a lack of empirical analysis on senior managers’ attitudes to PRP, although that is the collection which has allegedly benefited most from the spread of PRP. The work done by (Gregg, P et al. 1992; Conyon, M. 1995) found out that the link between rewards and corporate performance is poor. This would suggest that the motivational impact is likely to be small.

Also it can be assumed that there is a differentiation between senior and junior staff related to PRP. The rationale being that junior staff perception will be different from those of senior management because of the degree of control over performance they have and the customary way pay is structured (Marsden, D. and Richardson, R. (1994)). The structure of managers or high ranking employees PRP is also usually different from those of other groups because the flexible component is more complex and more closely tied to organization performance (Seiler, E. 1984; Paarsch, H.J. & Shearer, B. 2000). Morris, J., & Fenton-O’Creevy, M. (1996) in their research on the attitudes of managers suggested that the design of effective PRP is not just a technical issue, but views of fairness with respect to the compensation package and the clear communication of goals are important in getting senior managers to focus on organizational interests.

Furthermore, as we have seen that in the PRP process cycle, effective communication is the key, it is even more important that the PRP system should be understood and appreciated by the managers on personal level before they communicate it to their staff. Only when a manger is clear about the objectives of the PRP and believe in the fairness of the system, they can convey the same to other employees. Therefore it is important for any PRP to be successful, that managers are on board with it.


The purpose of analysis of PRP systems was to achieve an answer to the central question of “can PRP create healthy competition”. The answer based on the essay is no. A PRP system cannot create healthy competitive working environment. The fundamental reason is that we are not rational beings and our decision making process of PRP will not be a rational one. As a result of our bounded rationality, there will always be employees who will not be satisfied with the process of PRP and hence it will not create a harmonious working environment.

Also PRP forces employees to compete for rewards. Salary pounds are always a restricted resource. To allocate these on the basis of relative performance forces employees into a win-lose competition. These will create a hostile environment as competitors are seen as enemies, and thus hostility develops toward them. Perceptions of productivity becomes inaccurate, an employee always think that he/she works more than others. Interaction and communication with employees are decreased and team working goes out of the window in individual PRP systems. Even in Sales, where one would see PRP encouraging individuals to get more and more sales. However as shown earlier, this comes at a cost of inharmonious behaviour towards co-workers. Unfortunately, these kinds of reactions are usually detrimental to the achievement of the organization’s goals. The effective working of all organization involves the integration of individuals. Competition among employees is usually dysfunctional.

After careful investigation of the PRP literature, one could argue that , it’s not that PRP systems are ineffective but rather that they are too effective, strong performance related pay motivates employees to do exactly what they are told to do not what they are meant to do. Large monetary enticements create unpremeditated and sometimes counterproductive results because it is problematic to effectively stipulate exactly what employee should do and therefore how their performance should be measured. Moreover, PRP encourage employees to spend energy lobbying about both the specification and application of the system to measure and evaluate performance. This could question the ethical aspect of PRP, but that’s beyond the scope of this essay.

It is a known fact and also from my personal experience that some people do not work just for money, they work for the intrinsic awards that come with a job. Some employees are motivated by how successful they can be in their profession and not monetary gains. Hence the excuse that many organizations use in order to implement PRP systems as a motivational measure can at times back fire. It cannot be said with 100 % accuracy that highly paid persons would put out any more effort than those who are less well paid. The entire PRP process can be jeopardised if some fundamental elements are not clear to employees. Also the very nature of PRP system makes it vulnerable to power and politics of the organizations. No two human beings are same, some will be motivated by PRP and some will not. That’s relevant when individual’s behaviour and productivity is measured. However, an organization is made up of individuals and it is relevant from the essay that when PRP is seen from organizations perspective, differentiating employees on the basis of perceived performance based on a system which is susceptible to power play is demotivating and detrimental to the employees and negatively affects the productivity of the organization in many ways. In recent times much criticism has been directly towards unjust PRP systems where senior management received heavy pay despite the organization on the edge of bankruptcy. Hence it could be argued that the strategic relevancy for PRP in organizations needs to reflect the changing times (Boselie, P. 2010). It can be said that PRP does have the ability to create a competitive environment, but where organizational objectives are replaced by individuals selfish monetary goals and where employees work not for the organization but for the Performance relates pay systems.


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