Insights

Recognizing individual contribution through direct compensation: Yes? No? How?

Analysis
Published on: April 27, 2022
Subjects:  Total compensation, Performance and bonus

In our October 26 article, we saw that adopting a participative, continuous performance management approach can have a major positive impact on an organization, as it helps to:

  • Increase employee engagement
  • Enhance the manager’s role
  • Improve overall organizational performance 

We also saw that today’s employees place much more importance on development, that they need to understand how they contribute directly to the success of their organization to feel engaged and that they want to be recognized for their contribution. And while this has become increasingly common, it is not a new phenomenon by any means. In 2013, a study published in the Harvard Business Review1 reported that employees who are intrinsically motivated are three times more engaged than employees who are extrinsically motivated.

All of this has led to a “culture of recognition,” as a growing number of businesses are taking non financial approaches to rewarding employee contributions. Now, does that mean that an employee’s performance should no longer be reflected in their compensation? Well, that’s taking it a bit far!

In a PCI survey on performance management, 96% of organizations polled said that they directly or indirectly compensate employee performance. Whether or not this is always a good idea is a perfectly legitimate thing to wonder, and it’s a question that comes up regularly in our discussions with industry stakeholders. As with so many aspects of talent management, there is no right or wrong answer or one-size-fits-all solution. So, how can you make an informed decision?

Should you directly compensate individual performance?

To answer this question, you first need to consider the type of organization, its industry sector, the characteristics of its workforce, its culture and its compensation philosophy. And you need to remember that each approach has its advantages and disadvantages.

Directly compensating individual performance

Advantages Desadvantages
  • Helps align employees’ and company’s interests (insofar as objectives and expectations are clearly communicated through a formal performance management process).
  • Recognizes the contribution of high-performing employees.
  • Incentivizes employees to exceed objectives.
  • Acts as a catalyst for the sales force.
  • Risk of subjectivity in performance assessment that can undermine the perception of fairness.
  • Risk of moving away from the performance focus (“how could I have gotten more” vs “how could I have contributed more to achieving organizational objectives”).
  • There is usually a limit based on the pay scale maximum (salary cap).
  • Time consuming for managers (the process must be well established and familiar to everyone).
  • Less effective to motivate some employees (some are more motivated by non monetary rewards, skill development, etc.).

Not directly compensating individual performance

Advantages Desadvantages
  • Keeps the focus on performance management and skills development rather than on an X performance rating resulting in a Y bonus or salary increase.
  • Risk of disengaging top performers who may not feel that they are fully appreciated.
  • As a growing proportion of companies offer variable compensation, not doing so can make the overall compensation package less competitive (companies that do not offer bonuses are rarely willing to pay in salary what others pay in variable compensation and which is not guaranteed).
  • Equality does not necessarily mean fairness.

After analysis, if you are leaning towards the option of directly compensating individual performance, the next question arising is: how to do it.

Rewarding employees’ contribution cannot be done using a simple linear equation. People are subjective by nature and often bring their own unconscious biases to the table. There is no foolproof formula or algorithm that can fairly and equitably give every employee a percentage raise based on performance with a single mouse click. 
The key to success for an organization that wants to use compensation as a performance lever is to have a rigorous process that is consistent with its DNA. And such process needs to be well thought-through. 

How to effectively link performance and compensation?

1.    Examine your organization

  • What are the characteristics of your workforce and the culture and compensation philosophy of your organization? 

2.    Define your terms, objectives and benchmarks

  • How do you define performance in your organization? 
  • How do you measure individual performance? With performance ratings? If so, is your methodology consistent with best practices?
  • Do you want to tie performance to salary, bonus or both? 
  • What are you trying to incentivize/recognize through compensation? Individual contribution or team contribution? Proficiency in key competencies, soft skills or alignment with organizational values? A balanced mix of multiple criteria? You might be tempted to try to measure everything, but remember that keeping it simple will greatly help you when it’s time to communicate your plan.
  • Are you considering a single program for all employees or a hybrid formula where some employees are compensated for performance and others are not?

3.    Encourage stakeholder buy¬ in

Use a cascade communications approach. First ensure that your executives and managers not only understand but also strongly adhere to the terms, objectives and benchmarks that you have defined. Then make sure they are well-equipped to effectively disseminate the information across the organization.

4.    Ensure fairness

There is a certain amount of subjectivity involved in assessing contribution. In the interest of internal fairness, you must put in place certain mechanisms to ensure that your managers interpret the ratings in the same way, and that the results are properly calibrated. This step is even more crucial when the score affects the employee’s compensation.

5.    Be transparent

Procedural fairness is important to ensure employees’ perception of fairness in the performance management process. More than ever, employees are looking for feedback and meaningful work. They want to understand how their pay is determined and what they need to do to improve their performance. More transparent communication is always welcome. Transparency nurtures trust and engagement. And engagement, as we know, is a key driver of organizational performance today.

Key takeaways

When it comes to compensation, the real question is not how much, but how. First consider all your options and weigh the pros and cons. Then, if you decide to link your employees’ compensation to their performance, make sure that your process is well defined, that it aligns with your values and culture, that it is applied with consistency and fairness, that you communicate it with transparency and, most of all, that it fosters employee engagement. 

Let’s continue the discussion…

If you'd like to receive the results of our pulse survey on performance management practices, please contact us. You can also watch the “Continuous Performance Management: Driver of Engagement?” webinar presented at the toolkit training day organized in May by the Ordre des CRHA2

Authors

  • Mélissa Allard, CHRP, CMS, Compensation Consultant
  • Michelle Gervais, Senior Analyst

Sources

1“Does Money Really Affect Motivation? A Review of the Research,” Harvard Business Review, April 2013
2“Continuous performance management: Driver of engagement?" workshop presented by PCI Compensation Consulting as part of the Ordre des CRHA's “Journée Boîte à outils,” May 26, 2021

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