Pay-For-Performance Compensation Plan: Pros & Cons

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Table of Contents

Abstract
Introduction
Advantages of Paying for Performance
Disadvantages of Paying for Performance
Strategies for Improvement
Conclusion
References

Abstract

In this paper, the overall effectiveness of pay for performance plans is described. The main strategies implemented by contemporary organizations to increase employee performance are analyzed. The advantages and disadvantages of paying for performance are presented. According to the results, in terms of work where cognitive skills are needed, the disadvantages of this strategy prevail. However, as for work where physical abilities are required, advantages are more. Regarding cognitive skills, certain techniques are presented to make the strategy of paying for performance effective and efficient.

Introduction

Offering rewards for achieving certain goals and demonstrating good performance can be considered an effective way to engage employees in work. Organizations often implement pay for performance plans to motivate their employees to work better. In some cases, these plans turn out to be successful, which brings benefits to both employees and organizations. However, in other cases, these plans simply do not work but even inhibit employees’ performance (Holmström, 2017). Therefore, it is crucial to understand in what situations and how these plans should be implemented to be successful.

Advantages of Paying for Performance

Paying for performance can bring many benefits to an organization in the form of its success and its employees in the form of salary. Thus, employees feel secure knowing that their performance is highly appreciated by the work they do instead of personal whims of their employers or some rules implying that the average salary for all employees is the same (Miller, 2016).

The first and most important benefit of implementing pay for performance plans is the overall increase in employees’ productivity. In general, the thought of receiving additional payment for achieving certain results drives employees and makes them perform better. In this respect, the program allows employees to build their financial future (Urech et al., 2015). Thus, employees can decide for themselves what to do and how much to work, thereby choosing the work rate at which they feel most comfortable.

The second advantage of paying for performance is that it attracts the best talents. This strategy helps distinguish between talented employees and low performers. Moreover, it creates a fairer environment for the best employees.

The third advantage of this strategy is that it makes administration easier. When reviews on performance are directly connected with compensation, it improves the efficiency of including the information on pay increase into the payroll systems and consequently generating reports (Ederer & Manso, 2013). If compensation is not tied to the process of reviews, HR managers often spend much time entering pay increase into the payroll system (Holmström, 2017). Thus, if used properly, the system of paying for performance is very effective in getting the best from employees.

Disadvantages of Paying for Performance

Even though it seems logical that paying for performance is beneficial and extremely effective in increasing employees’ performance, it has several major disadvantages. For example, first, in companies that are focused more on teamwork and not on the work of an individual, this strategy is detrimental. The reason for this is that it causes high competition among the employees who need to cooperate, thereby decreasing their overall productivity (Holmström, 2017).

The second disadvantage is that there is sometimes a misunderstanding between an employer and an employee. For example, an employee works hard for several months and then receives a lower than expected payment, as he or she did not know exactly what factors would influence the salary (Ederer & Manso, 2013). Therefore, it is important to clearly explain what aspects of work will be additionally paid for.

One more disadvantage of this program is that rewards reduce innovation, creativity, and risk-taking. Thus, employees will tend to stick to old well-proven methods of solving certain problems and will be reluctant to introduce any innovations. This strategy destroys creativity, as employees begin to focus more on their reward but not on generating original ideas. Additionally, employees are reluctant to take any risks, as if they fail, they will not receive a reward (Miller, 2016).

Finally, the most common and the most dangerous disadvantage of paying for performance is seduction. In this respect, when employees know that the more they do, the more they receive, most of them certainly will try to do as much as possible to earn more money (Holmström, 2017). As a result, they usually overestimate their abilities, and their performance significantly decreases, or they completely fail in performing their duties.

Apart from the disadvantages mentioned above, there is one more crucial drawback of this strategy. According to the results of the overwhelming majority of academic studies, the strategy of pay for performance plans in most cases leads to the opposite of the expected outcomes. Particularly, in terms of work where cognitive skills are required, in most cases, this strategy leads to poorer performance from the side of employees. Conversely, regarding work where physical skills are needed, in the majority of cases, this program leads to better performance. This tendency can be explained by the fact that such characteristics as creativity and originality cannot be improved by hard work, while physical skills directly depend on the amount of work done by an employee (Ederer & Manso, 2013).

Strategies for Improvement

Although the overall results of the research show that paying for performance has more disadvantages than advantages, in general, the idea is not bad and can be improved by implementing certain techniques. The first method is to differentiate between different tasks, for example, for the tasks where the creativity of the highest quality is needed, employers should provide more payment and set limits in the total amount of these tasks performed by one employee (Urech et al., 2015).

Second, it is crucial to make certain that employees understand how they can get a reward. Employers should express their vision and goals very clearly. Third, it is also effective to divide employees into groups to perform tasks. Besides, all members of one group should have approximately equal capabilities.

Additionally, the most important method for employers is to oversee every action of their subordinates, and for employees, to know their abilities and not yield to the temptation to earn more profits (Ederer & Manso, 2013). Thus, if these techniques are taken into account, the strategy of paying for performance will turn out to be successful.

Conclusion

The method of paying for performance is not new, as it came into use centuries ago. However, nowadays, it has become very common. Many companies implement this strategy and try to make it more efficient. Nevertheless, it still needs much improvement, as the current research shows that it has more disadvantages than advantages. However, regarding work where physical skills are required, the advantages prevail, as the more the employees work, the higher their performance is, to a certain extent. In work where cognitive skills are needed, certain techniques might help to get rid of some disadvantages. The most crucial technique, but difficult to use in practice, is that the employees who cannot adequately measure their abilities and desperately desire to earn more profits must be thoroughly supervised by their employers who should explain to them their problems.

References

Ederer, F., & Manso, G. (2013). Is pay for performance detrimental to innovation?. Management Science, 59(7), 1496-1513.

Holmström, B. (2017). Pay for performance and beyond. American Economic Review, 107(7), 1753-1777.

Miller, S. (2016). Employers seek better approaches to pay for performance. Web.

Urech, T. H., Woodard, L. D., Virani, S. S., Dudley, R. A., Lutschg, M. Z., & Petersen, L. A. (2015). Calculations of financial incentives for providers in a pay-for performance program: Manual review versus data from structured fields in electronic health records. Medical Care, 53(10), 901-907.

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