The basic tenant of pay-for-performance (PFP) is that higher performance is rewarded with higher pay. 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 with all types of employees and at all levels of the organization, from CEOs to managers to entry-level workers. 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
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 is not related). Why is it that when managers receive performance bonuses employees quit more? The findings were explained by something called the “strain effect.”
HIGH STRESS, LOW MORALE
If you tell managers that their pay is based on their employees’ performance, 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? 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.
The bottom line is that if you are thinking about using a PFP system for managers, be aware that this can negatively impact the relationship between managers and their employees. 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 employee performance and satisfaction, so the company does not lose valuable employees to voluntary turnover.
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.