What is pay based on performance called?
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Share26 Jan 2022Performance-related pay Introduces performance-related pay and issues linking employee pay and performance On this pageOn this page
IntroductionPerformance-related pay (PRP) is a way of managing pay by linking salary progression to an assessment of individual performance, usually measured against pre-agreed objectives. This factsheet explores the justification for linking pay and performance as well as the potential issues around implementing PRP schemes. It provides an overview of key issues including the role of line managers, measuring performance, distribution of awards and the impact on employee behaviours. It also highlights the latest research. See the full A-Z list of all CIPD factsheets. What is performance-related pay?Performance-related pay (PRP) is a way of managing pay by linking salary progression to an assessment of individual performance, usually measured against pre-agreed objectives. It's also known as individual PRP or merit pay. Wage increases awarded through PRP are normally consolidated into basic pay, although sometimes they may involve the payment of non-consolidated cash lump sums - see more in our pay progression factsheet. PRP has grown since the 1980s as employers sought ways of improving performance by linking employee earnings to achieving business objectives. However, in some circumstances, PRP has proved a rather crude instrument and the 1990s and beyond witnessed several challenges to theory and practice. As some of the earlier schemes failed to deliver the promised results, some employers brought in new or revised PRP schemes, for example linking pay to a wider definition of employees’ ‘contribution’ rather than simple ‘performance’. This emphasises not only performance in the sense of the output (often objective measures, such as sales) but also the input (often subjective measures assessing employee behaviours, such as being collaborative, professional, etc). Others introduced or moved to new approaches altogether (for example, skills-based pay). Recently, linking reward to employee performance has attracted media coverage with some well-known firms breaking this practice. However, one of the findings from our Reward management survey is that performance-based reward is still widespread in the private sector. Not only that, but the measures used in performance reviews are still quite traditional. Nearly all organisations surveyed assess performance against individual goals, with most using it to inform a salary and/or a non-salary reward decision. The next most common approaches are assessing achievement against team goals, an absolute view of one individual’s performance, and an employee’s own self-assessment. By contrast, recent innovations in assessing employee achievement such as peer assessment, 360 degree feedback or external assessment are used rarely by our survey respondents. Even when such approaches are part of the review process, there's reluctance to use them for making reward decisions. Read more on the findings on PRP from our Reward management survey. The rationale for performance-related payPRP objectives may be grouped under three main headings. 1. Encouraging high performance levels by linking performance to payHere the idea is to motivate staff by linking their salary to their work performance. If pay incentivises them to hit their targets then the overall performance of the organisation improves. While the CIPD report Incentives and Recognition: An evidence review finds financial incentives have a positive effect on employee motivation and consequently performance, the research often does not compare PRP with non-consolidated financial rewards, such as incentives. So, we can’t say if that one approach is better than the other. The appropriateness of using PRP or paying bonuses or possibly both, will depend on the organisational context. 2. Embedding an entrepreneurial or high-performance culture across an organisationPRP can send a message to workers about what achievements the organisation wants and is prepared to reward, although there are other (non-monetary) ways of doing this. 3. The notion of equity or fairnessHaving their efforts rewarded and recognised appeals to staff, and that high performing employees should receive a larger pay rise than low performing colleagues. Our survey on employee attitudes to pay found private sector workers are more likely than their public sector counterparts to want their rewards to reflect performance. When it comes to financial recognition, our report Incentives and Recognition: An evidence review finds strong evidence that fairness is an important factor to the success of using financial incentives. This is the case for distributive justice: if employees feel this allocation is fair, then the incentive does more to motivate them. It is also the case for procedural justice: incentives are more effective if the procedures and how managers apply them are seen to be fair. Of course, this then raises the question of what’s meant by fair, something that’s touched on in our report Incentives and recognition: an evidence review. Practice summary and recommendations. Measuring performancePRP typically uses a system based on consolidated pay progression within pay brackets attached to each grade, level or zone. However, for performance to be rewarded, an effective means of measuring that performance is needed. Historically, this has been via performance appraisal, though some employers are now using less formal approaches to appraise success. Linking pay with performance In traditional performance reviews, each employee’s performance is typically ranked on a scale ranging, for example, from ‘unsatisfactory’ to ‘superior’ (sometimes using ‘forced’ distributions, as detailed below). Some systems allow for managers' discretion in translating these scores into levels of pay rise, while others determine increases through a formula or a matrix system linking each grade, level or zone to each of the performance categories. This method may involve the use of a comparison ratio, or ‘compa ratio’, the term given to the relationship between each employee’s current salary and the mid-point of their grade. Thus, for a worker at the mid-point of their pay range, the compa ratio is 100%. It’s often felt appropriate for pay rises associated with each performance category to be higher for employees at lower points within the pay brackets, given the presumed existence of a learning curve for new entrants to a grade. However, more senior employees who’re performing very highly may resent the award of comparatively low percentage pay rises. Incentives and recognition: an evidence review shows that where ratings are used to gauge performance and allocate incentives, the rating method used makes a difference. If a greater number of categories is used in the rating segmentation (for example, five), employees are more likely to feel that it’s fair. When it comes to the use of objective and subjective measures of employee performance the picture is more nuanced. Although subjective measures are generally seen as potentially prone to bias because they involve an element of judgement, research suggests that not including them may be detrimental and cause employees to perceive the rating process as unfair. However, performance evaluation that puts a lot of weight on subjective measures is also considered by staff to be unfair. Overall, this suggests a balance between objective and subjective assessments will be more effective than an overreliance on one or the other. Coverage and trends in performance-related payWho gets performance-related pay?While various estimates of the coverage of PRP exist, partly because of differing definitions of PRP, we’ve identified the following broad themes and trends:
PRP in the UK public sectorDespite considerable interest in PRP in the public sector over many years, it’s proved harder to translate into practice. Where performance pay does occur, it often takes the form of non-consolidated bonuses and/or team-based incentives, an approach recommended by the Makinson report on performance pay in central government, rather than individual merit pay. Nevertheless, in recent years there have been several high-profile initiatives such as the introduction of a PRP scheme for teachers, which some researchers argue has resulted in some discernible performance improvements. When introducing PRP in a public sector setting, several distinct issues arise, including the potential difficulty of measuring individual effort in certain roles. Moreover, certain public sector workers are arguably just as motivated by non-financial rewards and this could be undermined by some forms of PRP. One theory is that PRP in this type of public service setting can help employees to work more effectively, by encouraging them to focus on key objectives, rather than the money alone. The impact of government PRP policy in the public sector is unclear, given the over-riding policy of restraining pay rises for most workers in the sector in recent years, although it seems likely that there’ll be further attempts to increase links between pay and performance. The Hutton review examining senior public pay includes a section on the perceived need to ensure that pay reflects performance, focusing on the use of 'earn back', where senior staff have an element of their basic pay ‘at risk’, which must be earned back through meeting agreed objectives. However, this recommendation hasn’t been widely adopted. Since September 2013, all decisions on pay progression for teachers in England and Wales are based on the outcome of a performance review linked to their individual performance, rather than their length of service. Measuring trends in merit awardsUnder PRP arrangements, the pay review process may provide for either:
Trends in performance pay are commonly measured via the pay review budget (or pay bill budget) allocated for the merit element of awards. However, the scope for any merit element of pay tends to be reduced during times of low pay award levels, for example during the first year of the pandemic, with some employers finding it simpler to award a modest across-the-board increase rather than attempting distribution based on merit. Implementing PRP schemesFor PRP to succeed, effective arrangements must be in place to define, measure, appraise and manage performance. The focus should be on encouraging high performance first, underpinned by effective performance management systems, and only then on pay as a reward to help achieve that goal. To create a sustainable high-performing workplace, the whole range of financial and non-financial rewards must be carefully designed to ensure that they support and are supported by PRP. The key issues for employers implementing PRP include: Line managers' objectivity and consistencyLine managers are key to effective implementation of PRP. They should be involved at an early stage in designing systems to ensure consistency and transparency when assessing achievement. Some schemes try to eliminate marking differences between ‘hard’ and ‘soft’ managers using ‘forced distribution’ arrangements, that is insisting that all managers band a certain proportion of staff in each performance pay grouping (for example, 10% ‘poor’ and 10% ‘superior’). Research evidence reported in Incentives and recognition: an evidence review suggests there is no difference between competitive schemes, in which only the highest performers are rewarded, and non-competitive schemes, where all employees whose performance increased receive an incentive. However, given the importance of perceived fairness, highly competitive schemes that are seen as ‘winner takes all’ may well demotivate people. In a similar way, our evidence review on performance management found that the use of competitive ‘forced ranking’ in staff appraisal tends to backfire, due to perceived unfairness. On balance, it seems forced distribution can be used to an extent, but there may be little point in condensing rewards in highly competitive systems, as this approach is no more effective than more equitable rewards and risks backlash. Ensuring objectivity is also important to avoid rewarding favourites. The potential for unlawful discrimination is particularly serious. It’s important that managers are made aware the impact that unconscious bias can have through training and for monitoring of merit pay awards by gender, ethnicity, age and so on). See more in our line managers' role factsheet. Distributing pay awardsAs some HR commentators note, pay isn’t the only motivating factor, and sometimes might not even be the most important one. And the performance element of pay is often relatively small, particularly for those relatively middling performers who will form the bulk of the workforce. The problem is accentuated in times of low inflation when the pay bill increase is usually limited to relatively small percentage figures. Even where PRP may have a motivational impact for high achievers, the corollary can be the demotivation of the lower or middle level performers. So it’s important to consider the issue of pay award distribution carefully. Identifying development needsA major concern is that linking pay awards to the performance review process may inhibit an open and honest discussion of an individual’s training and development needs in case this influences the size of their pay rise. One solution is to separate the pay review aspect of performance assessment from the broader performance/development review, for instance by holding separate meetings some weeks or months apart. Communication can also suffer as employees may feel constrained about having open conversations with their line managers in case this influences the size of their pay rise. Time-consuming natureThe processes associated with PRP, such as performance reviews, can be administratively very time-consuming. In general, it's important to allow enough time away from day-to-day duties for managers and employees to be able to engage in the PRP process effectively. Undesired impacts on employee behaviourBehavioural science shows that while financial incentives can increase worker performance, if they are leveraged too strongly, they may create excessive risk. As a result, they may either distort people’s motivations by incentivising unintended or excessive behaviour, or weaken the motivating effect if people feel averse to the added risk. Rather, the size of incentives should be commensurate with what employees can reasonably do to increase their performance. Research (Incentives and recognition: an evidence review) indicates that linking pay to both individual and team achievements may be better than just focusing on one or the other. For more on what behavioural science says about how employees might respond to financial rewards and incentives, see our report Show me the money! Further readingBooks and reportsCOTTON, C., GIFFORD, J. and YOUNG, J. (2022) Incentives and recognition: an evidence review. Practice summary and recommendations. London: Chartered Institute of Personnel and Development. ARMSTRONG, M. (2017) Armstrong's handbook of performance management: an evidence-based guide to delivering high performance. 6th ed. London: Kogan Page. HIGH PAY CENTRE. (2015) No routine riches: reforms to performance-related pay. London: HPC. MARSDEN, D. (2009) The paradox of performance related pay systems: why do we keep adopting them in the face of evidence that they fail to motivate? CEP Discussion Paper, 946. London: London School of Economics, Centre for Economic Performance. PERKINS, S.J. and WHITE, G. (2020) Reward management: alternatives, consequences and contexts. 4th ed. London: Chartered Institute of Personnel and Development. Visit the CIPD and Kogan Page Bookshop to see all our priced publications currently in print. Journal articlesBRYSON, A., FORTH, J. and STOKES, L. (2017) How much performance pay is there in the public sector and what are its effects? Human Resource Management Journal. Vol 27, No 4, November. pp581-597. COTTON, C. (2018) Is time up for performance-related pay?CIPD Voice. Issue 13, 26 February. HUNT, B.G. (2018) Pay for performance: six takeaways to shape a better outcome. Workspan. Vol 61, No 6, June/July. pp52-55. SHAW, J.D. and GUPTA, N. (2015) Let the evidence speak again! Financial incentives are more effective than we thought. Human Resource Management Journal. Vol 25, No 3, July. pp281-293 CIPD members can use our online journals to find articles from over 300 journal titles relevant to HR. Members and People Management subscribers can see articles on the People Management website. Download factsheet This factsheet was last updated by Charles Cotton: Senior Performance and Reward Adviser, CIPD Charles directs CIPD’s research agenda and public policy on performance and reward. He speaks for CIPD at government consultations on topics such as, pensions, retirement, CEO remuneration, low pay and employee tax. Explore our related contentReports This report examines the extent to which employee matters impact performance-related pay in the FTSE 100 Factsheets Outlines the purpose of pay structures and progression, including the common ways of structuring pay and of determining, reviewing and controlling pay progression Topic pages Learn how to implement a reward strategy that supports organisational objectives Factsheets Understand the basics of bonuses and incentives, the trends in their application, and how to design and operate schemes effectively and ethically
People Management PM jobs Copyright © The Chartered Institute of Personnel and Development 2022. Incorporated by Royal Charter, Registered Charity no. 1079797 What is it called when you get paid based on performance?Performance-based compensation (PBC) is a system for rewarding employees financially, outside of their regular salaries.
What is the meaning of pay for performance?Pay for performance (P4P), in healthcare, is a payment model where hospitals, physicians and other healthcare workers are given financial incentives for meeting performance objectives. P4P is also known as value-based purchasing. P4P programs are supported by insurance providers, Medicaid or Medicare.
What is a pay for performance structure?The term “pay for performance” refers to a pay strategy where evaluations of individual and/or organizational performance have significant influence on the amount of pay increases or bonuses given to each employee.
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