The Dark Side of Pay-for-Performance Programs

Perform better, get paid more, is the basic tenant of pay-for-performance (PFP). One type of PFP strategy is bonuses, which are easy to hand out and motivate employees to accomplish short-term goals. PFP can be used at all levels of the organization, from CEOs to managers to entry-level workers. Want that project done by the end of the month? An extra monetary incentive won’t hurt! Or will it?

Although the concept is simple, the positive and negative outcomes of this compensation system are much more complex. One team of researchers (Pohler & Schmidt, 2016) investigated how giving managers bonuses for better performance leads to employee turnover.

Pros and Cons of Pay-for-Performance for Nonexecutives

                             The Good

                     The Not-So-Good

  • Considered best practice in the strategic HR literature
  • Applicants may be more attracted to firms with fixed compensation practices
  • Can attract and retain high performers to the organization while encouraging low performers to voluntarily leave
  • The presence of PFP leads to more voluntary and involuntary turnover
  • Increases productivity and motivation for individuals
  • Lower paid employees may experience feelings of inequity, relative deprivation, and injustice
  • Bonuses are easily administered and linked to short term performance goals
  • Unequal distribution of rewards can lead to turnover in lower level managers
  • Without PFP, employees may be inclined to shirk responsibility or free ride
  • May weed out high performers who avoid risk
  • PFP in managers may reduce underperforming employees through involuntary turnover
  • Employees don’t really consider short term incentives when deciding to join or leave a company

By surveying representatives who could answer questions about PFP and employee turnover, the researchers collected data across many different types of organizations. They measured PFP as bonus eligibility, or the proportion of managers and employees who can receive a performance-based bonus. Turnover was either measured as voluntary, meaning employees who quit, or involuntary, meaning employees who were fired.

So, does manager bonus eligibility hurt employee relations? The larger the proportion of managers who can receive a bonus, the more employees quit (the number of employees who got fired isn’t related). Why is it that when managers receive performance bonuses employees quit more? The findings were explained by something called the “strain effect.”

THE STRAIN EFFECT

If you tell managers that their pay is based on subordinates’ performance, guess what will happen? They will watch their employees like a hawk! By monitoring and directing employees, they have more control over receiving better performance evaluations for themselves and receiving bonuses. But this behavior can be bad for employee morale because it increases competition, stress, conflict, and mistrust. This puts strain on the manager-employee relationship, an integral part of a healthy and productive working environment.

How do we pay managers who perform better, but reduce the strain on the manager-employee relationship? Easy. Train and incentivize managers to treat employees well. Researchers found that organizations who employ certain practices had the same amount of voluntary turnover regardless of how many managers could receive bonuses. These practices include placing more emphasis on evaluating managers based on how they treat employees, training managers to treat employees fairly, and showing appreciation to employees who perform well.

ORGANIZATIONAL IMPLICATIONS

The bottom line is that if you’re thinking about using a PFP system for managers, be aware that this can negatively impact the relationship between managers and their subordinates. To remedy this, train managers to reduce over-monitoring and encourage them to consider employee wellbeing—not just performance. Another suggestion the researchers offer is to include financial and nonfinancial measures of performance (like satisfaction with manager) in the manager’s evaluation. This way, the PFP system will motivate managers to increase subordinate performance and satisfaction, so the company doesn’t lose valuable employees to voluntary turnover.

Want to find out more about the relationship between satisfaction and turnover? Read more here: https://www.ioatwork.com/job-satisfaction-and-turnovernow-thats-change-we-can-believe-in/

Pohler, D., & Schmidt, J. A. (2016). Does pay-for-performance strain the employment relationship? The effect of manager bonus eligibility on nonmanagement employee turnover. Personnel Psychology, 69 (2), 395-429.

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