Worker performance has a direct influence on the overall performance and ultimately the success of a business. Reward schemes and pay are two factors which influence worker behaviour and performance. This article will specifically discuss the effects of performance related pay (PRP) in relation to employee's attitudes and organisational performance.
PRP is a reward system in which an increase in workers' pay is partly or wholly based on the amount of effort they put in or the quantity of output they produce. PRP schemes aim to establish a performance based culture within organisations by encouraging individuals to achieve agreed working objectives, i.e. sales targets or customer satisfaction) which is linked in return for a reward (Armstrong, 2002). The objectives of PRP systems are to recruit, retain and motivate.
Since the 1980's there have been five fundamental changes in the nature of PRP schemes. Firstly there has been a shift away from assessments based on personal qualities to setting individual objectives in line with those of the organisation as a whole (Marsden 2007). Secondly the schemes have been introduced in the public sector more and more. This is perhaps the reason for the majority of journals concerning the effectiveness of PRP systems have conducted their surveys in public sector organisations. Thirdly there has been an expansion of PRP schemes from the traditional area of managerial positions downwards to all job categories. The fourth change is that there has been a shift away from a general two-part increase, which included a cost of living increase and a performance related element, towards a single increase based only on performance. Lastly PRP schemes are becoming linked more to the overall objectives of the business.
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In a study conducted by Marsden et al (2000) which considered the public sector, there is evidence to suggest that PRP has a positive incentive for a large number of employees gaining above average financial reward. The key argument in favour of PRP schemes is that they motivate people to improve performance. Improved individual performance translates into improved corporate performance. Also PRP facilitates the recruitment and retention of good performing workers. Furthermore it acts as a communication mechanism between managers and workers as it makes both aware of workplace performance. It also reinforces management control. In addition PRP reinforces individualisation of pay as harder workers are rewarded with higher pay.
However, the nature of PRP is subject to the quality of the goal setting and the appraisal process. Performance measurement within PRP is highly controversial since it can be difficult to measure. In the case study carried out by Marsden et al (2000) some employees reported their present appraisal system wasn't a fair representation of their performance. In extreme cases, workers can become de-motivated as they felt that they were unable to improve personal performance. Thus, the success of PRP is dependent the way in which employees are separated into different performance grades and the ability of line management to appraise fairly.
Other disadvantages of PRP include the difficulty associated with objective setting, high cost of administration, as well as the difficulty associated with organising and delivering necessary managerial commitment to implement the PRP system. There is also a risk or perceived risk of bias in PRP, which in extreme cases may lead to accusations of favouritism. There is also a concern that PRP places too much emphasis on the short term goals and fails to address long term fundamental problems. For instance, if sales targets are supposed to be the most significant objective, this could be potentially damaging to long term customer relations, as well as between staff and management, hence appropriate care must be taken when setting performance objectives. There is also a tendency for workers to cut back on productive activities which are considered non rewardable (i.e. maintain safe working practice, helping work colleges or striving for quality) which they may otherwise engage in. Thus PRP can result in counterproductive behaviour and reduce performance under certain conditions. (Heywood, 2007) illustrates this when military recruiters paid in accordance with the number of recruits enrolled ended with lower quality. A PRP system may also lead to corruption and dishonesty within the organisation. For instance according to (Fry B. and Osterloh M., 2002), there was a case where managers manipulated profit figures year on year in order to secure a pay rise, when in fact the company was making a loss, thus severely compromising the future growth and success of the company.
Case Study 1 Description : Performance Related Pay for Executive Directors
Always on Time
Marked to Standard
The issue of remuneration of executive directors of listed companies has drawn public concern and interest from academics. (Ruth Bender, 2004) looks at why companies use PRP for their executive directors.
The research conducted was interview-based. 35 individuals from 12 companies took part. 9 were in the FTSE 100 and 3 were in the FTSE 250. The original research design was to carry out semi-structured interviews with 5 individuals at each company: the human resources (HR) professional, the chief executive officer (CEO), the chairman of the remuneration committee, another non-executive director (NED) and the consultant they used. However some companies offered more individuals for interview than others.
The level of fixed pay in the companies varied between 35% and 50% of the total pay for on target performance.
Findings and Evaluation
There were differing views among the interviewees in relation to whether pay is a motivator. Some agreed that pay was a motivator and PRP schemes were put in place to incentivise people. According to agency theory, paying people to achieve results will motivate them to work harder and so the organisation improves as a result. A NED stated that people take risks because there is a reward, meaning that directors may not apply themselves fully if they were not being rewarded for their efforts. An opposing view was that senior managers were motivated by factors other than pure salary. People in that position must be naturally highly motivated for them to be in that position in the first instance. One of the CEOs was of the view that PRP does have an impact but it depends on the type of market that you're in.
Another reason for the implementation of PRP schemes is 'focus'. Agency theory explains that using PRP makes the agent work harder, preventing "shirking" (Bender 2004). It ensures that executives focus on the responsibilities and actions that are viewed by the board to be important. Other points put forward related to the notion that variable pay can be used to communicate a message throughout the organisation. It sends a message to the CEO about what the board thinks is important and it sends a message to the rest of the company about what the CEO thinks is important. One of the HR managers pointed out there was little point in setting targets if the reward system did not recognise them and so therefore variable pay is a way of communicating strategy.
Many of the interviewees stated fairness as a reason for implementing PRP systems. One aspect of fairness was that between workers in the same company; better performers should receive higher rewards. One HR manager stated incentives that are fair and recognise the extraordinary performer for going the extra mile is totally appropriate in business.
Another important aspect of the fairness discussion was fairness to shareholders; that is not paying large amounts to executives when shareholders had suffered a loss in the year.
Case Study 2 Description : Police and Performance Related Pay
(Tonge et al, 2009) did a study on the effects of PRP on a local authority police force. The aim of their study was to assess the perceptions of a group of serving police officers of relating pay and performance within a county police service.
The research focuses on one local authority police force even though it recognised that it is difficult to assume that results in other forces would be the same. Fourteen police officers were interviewed but it was only possible to use data on thirteen of those officers (5 constables, 6 sergeants, 1 inspector and a chief inspector). The officers' experience ranged from under one year to over 20 years.
The sampling methodology used a snowball approach to obtain the sample of officers for interview. The effect of this is that results may be biased. Snowball sampling is a process where the researcher makes contact with a single or small number of individuals suitable for research participation, who will then put the researcher in contact with other suitable participants. In this particular project a detective sergeant was contacted and through him the other officers were recruited. The interviews were semi-structured to allow officers to discuss some areas in depth.
Findings and Evaluation
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Five of the participants felt that they were not currently paid in accordance with their performance, experience, qualifications, responsibility or the skill required for their positions. The rest of the interviews consisted of a set of statements to which the interviewees had to apply a ranking followed by an explanation. They were asked to what extent they agreed that officers with work related qualifications should receive extra pay. Of the officers with at least ten years experience, two strongly agreed, two agreed and one was neutral. For the officers with less than ten years experience, three strongly agreed, two agreed and 3 disagreed. Those who disagreed stated that officers who had qualifications were still undertaking the same roles as those equal to them. They also stated that studying theories and hypothetical situations couldn't prepare an officer for real world situations. With regard to the statement 'individuals should be paid solely on individual performance', nine officers disagreed with this. Four disagreed strongly. The basis of their disagreement was the complexity of police work, the teamwork involved and the issues with accurately and fairly quantifying individual performance. The majority of police officers interviewed felt that if performance was measured solely on individual performance the quality of police would reduce as officers would only focus on the measurable aspects of the job and the immeasurable aspects would 'suffer'.
Seven officers agreed with the actual principle of PRP based on the notion that above average performance should be recognised. Four disagreed on the basis that it is divisive especially in their occupation where a lot of team work is required. Two were neutral. Even though officers believed PRP impacted on competition, the majority were of the view that it would not have a good influence on standards. They believed competition arising from PRP would be detrimental to the service as a whole. One officer mentioned the possibility of corruption and conflict of interest.
The following case studies by (Bender, 2004) and (Tonge et al, 2009) each illustrate different scenarios where performance related pay (PRP) systems are studied and the effectiveness the scheme has on employee performance. Employee performance is fundamental to the overall success of the business. (Bender et al, 2004) explores the importance of PRP schemes in large organisations. Conversely, (Tonge et al, 2009) researches how PRP affects the mind frame of police officers', in particular focusing on behaviour and motivation.
Despite widespread beliefs that PRP doesn't affect motivation, PRP schemes are being introduced throughout the UK on an increasingly scale. (Bender, 2004) suggests the reason for this can be attributed to the following:
Agency theory: this involves how contracts of directors are designed to relate pay with performance. Many firms believe that the use of these schemes help motivates employees. This however got mixed responses in (Bender, 2004) study. Some disagreed with the statement; they believed the scheme had little effect especially at the senior level. Those in favor believed if they did not exists, executives would play the safe game and not take risk. One positive aspect of performance related schemes that most people agreed on was that it highlights what the heads of the organizations think is important. In doing so, it provides employees an idea of what aspect of the business needs to be focused on.
Motivational theory: comprises of two namely equity and expectancy. There was little evidence of the latter in the case. Equity theory (involves the fair nature of pay and has implications when workers perceive the association between effort and reward.) on the other hand was linked with fairness as a reason for using performance related pay. Some interviewees believed this could be used to identify those that are putting in poor performances and they could be eliminated. Another aspect of fairness was that between a director and his peers in other companies. The interviewees were of the view that directors should have the same opportunity to earn large sums as their peers did. This was essential so as to attract good people to the company, and to retain their services.
Institutional and legitimacy theory: these are the external factors such as corporate governance and market practices that cause companies to adopt PRP schemes. Many interviewees believed one of the reasons why most companies adopt this scheme was because everyone else is doing it and not following the masses would cause isolation which could be a negative thing.
Based on the research conducted by (Tonge et al, 2009), the method of pay varied from officer to officer. When each officer was asked; 'how is the pay you receive decided', 23% of the officers replied thinking they were paid based on their experience, qualifications and performance. 38% disagreed, and the remaining believed they were paid according to experience and responsibility.
The use of PRP schemes within organisations is debatable when it comes to dealing with the emotions of the employees which is acknowledged by the employees involved in the process. This was observed in the study by (Tonge et al, 2009). When officers were asked whether they should be paid exclusively based on performance, the majority of the officers disagreed, the remainder believing allocating rewards would help. Those that disagreed argued the case that it is detrimental to effective police work, as it could lead to cutting corners and poor teamwork.
In the same study (Tonge et al, 2009), 62% of the employees agreed to the statement 'Performance related pay does not contribute to the motivation of staff'. They believed PRP had an adverse effect on staff motivation. The majority of the officers in the study claimed personal achievement and job satisfaction was a motivation factor. Thus, despite a varied response, a significant proportion of the officers share the view that PRP does not lead to motivation, but however occurs as a result of other factors, such as job satisfaction and providing much needed services for the public.
(Tonge et al, 2009) suggests PRP leads to different outcomes owing to varying reasons. The type of job is one influence. Jobs involving team work and safety of the customers such as police force do not encourage this as it causes motivation problems, and could leads to dishonest due to competition amongst team mates. Other jobs as mentioned in section 1 such as car sales and manufacturing, encourage this method as competition is helpful in those situations and could lead to an increase in productivity.
(Tonge et al, 2009) exposed some limitations to the PRP theory. Performance measurement in the context of PRP can be difficult to measure since there are too many factors that influence good performance. For instance, if a court was paid depending on the number of cases they closed, certain variables would influence the cases such the difference and difficulty in cases; a theft is different from an assault case. Certain variables such as witnesses and evidence will influence when, how and if the case is solved. Another limitation with PRP is it encourages competition, which can lead to a lack of co-operation or teamwork amongst employees. Consequently, this may have an adverse effect on officers' behaviours.
In conclusion, it is suffice to say the theories involved in human resources management are complex ones and will vary depending on the scenario. It is vital to establish a strategic fit between an applied performance related pay scheme and a business' overall strategy in scenarios, where the scheme leads to focus and alignment with stakeholders objectives. In relation to motivation, PRP has little or no effect. Motivation is mostly influenced through factors such as job satisfaction and individual personality. This is illustrated by both (Tonge et al, 2009) and (Bender, 2004). The limitation of individual PRP is that it can lead to competition between work colleagues in team working cultures which can be potentially damaging to operation of the business. An alternative scheme to PRP is a concept known as 'Team reward'. Team reward aims to reward employees collectively based on their performance as a group with the intention of increasing employee contribution and productivity. In theory, team reward provides many advantages over PRP by providing an incentive to improve performance through team working and co-operation, clarify team goals and align individual team objectives with the wider organisational strategy. Team reward can also encourage low performers within the organisation to improve to meet the team standards.
Based on these cases, human resources theories should be used as a form of guideline. Therefore it can be practiced but it should do up to some extent. Other pay schemes areâ€¦â€¦â€¦â€¦..