COURSE: MBA BUSINESS INTELLIGENCE WITH

KNOWLEDGE MANAGEMENT

MODULE: HUMAN RESOURCE MANAGEMENT

Question:

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“Performance related pay is one of the most effective solutions
to lagging performance culture”

How far would organisations agree with such a statement?

Introduction:

Recent years have witnessed a variety of attempts to link pay to a measure of performance. Among the
various extensive innovations brought to compensation systems, a substantial growth in the use of

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performance related pay (PRP) has been noted. Such innovations have often been related to broader
initiatives to improve the performance of organisations and especially efforts to increase employee
involvement in decision-making (Appelbaum and Batt 1994; Walsh 1993). While the original
performance related pay systems were concentrated in the private sector, an increasing number of public
sector employers have introduced this scheme recently, or are considering of doing so. For instance in
2007 government of Mauritius introduced PRP in the public sector.

The most common and oldest PRP scheme is the “piece-rates”, where a price is paid for each unit of
output. “Payment by results” is another form of PRP. Here, bonus earnings depend on measured
quantities or values of output for individuals or groups, usually based on work studied time units; this
covers a wide range of bonus schemes.
There is also “Plant or organisation wide incentives” which ensures that bonus earnings or pay levels are
based on measured quantities or values for the whole establishment. “Merit pay” is another widely used
PRP scheme where bonus earnings or pay levels are usually based on a general assessment of an
employee’s contributions to performance.
“Performance related pay” which is currently being applied within different organisations across the
world is another form of PRP scheme. This PRP system ensures that bonus earnings or pay levels are
based on an assessment or appraisal of an employee’s (or team’s) performance against previously set
objectives, usually part of a performance management system. This is a fairly recent development,
particularly in the public sector, which has grown sharply in use since the 1980s.
“Competence based pay” is another form of PRP where reward and training are linked to competency
frameworks, based on the worker demonstrating certain skills (eg. Problem solving, decision making,
leadership, customer service, dealing with differing views) or achieving certain qualifications.
There is also “Profit related pay” which is a PRP scheme where bonus or share options are based on the
organisation’s profit performance; this is widespread in the private sector, where share options are often
important for senior managers.

PRP can be individual or group based. The key to all performance pay systems is the measurement
required to determine the output on which to base payments. The main steps are setting objectives,
appraisal results and linking achievements to pay. The ultimate reason behind the adoption of PRP by
organisations is to enhance performance. People like processes and systems, are a source of competitive
advantage. In order to make the most of this advantage, an organisation need to make sure that its
employees are motivated and are working on achieving the company’s set objectives.

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All organisations are concerned with what should be done to achieve high levels of performance through
people. This means giving close attention to how individuals can best be motivated. Motivated employees
are associated with higher productivity, Better quality of work with less wastage, a greater sense of
urgency that is things happen quicker and more employee feedback and suggestions made for
improvements.

PRP helps organisations to:

• clarify objectives and engage employees with the organisation’s goals

• motivate employees by linking pay to achievement of targets and not length of service
• reward achievement and identify under performance; foster teamwork and fairness
• contribute to overall improvements in productivity
• introduce more flexible pay systems or deal with recruitment and retention problems
• (in some cases) give greater power to managers and weaken trade union influence in bargaining
and representation of staff
With PRP organisations ensure that they are working towards achieving sustained high levels of
performance that will give them a competitive edge within the industry so that they can achieve their
objectives and goals.

There has, however, been little systematic research on the effects of performance-related pay (PRP)
schemes. Moreover, existing evidence seems somewhat contradictory, with some studies suggesting that
PRP schemes have a positive influence on organisational performance (for example, Booth and Franks
1998, Asch 1990 and Lazear 2000) and others finding no such positive relationship, or even a negative
association (for example, Marsden 1999).

Performance related pay across organisations:

PRP is the norm in the private sector for quite some time now. Traditionally it was largely concentrated
on high level managers and was a means of giving them some kind of incentives for good performance.
Now it has been extended to the entire organisation including lower level employees. Managers normally

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receive cash incentives or stock options as incentive for performance and lower level employees receive
individual or group bonuses for high performance.

PRP is helpful in retaining employees who are at the top end of the pay scale for their job ranking, but
whose performance is still outstanding. Such employees are more numerous in today’s flatter
organisations, where the opportunities for promotion to a higher rank are fewer than they were in the
multi-layered organisations some two decades ago. But in such a situation PRP can lead to frustrations
among employees if there is not a well implemented performance appraisal system that is trusted by all
parties concerned.

PRP also helps in resolving the principal-agent problem inherent in the employment relationship. Many
workers have a wide range of discretion in how they undertake their work. They can vary their effort,
their cooperation with colleagues and management, and their contribution to improving the effectiveness
of both their and related inputs. In such a situation, mechanisms are needed to ensure that workers (the
agents) undertake their work in a manner that is congruent with the interests of their employers (the
principals). The principal-agent problem can be most directly addressed by the close monitoring of
workers' performance. However, this can prove costly, not only because of the need to pay supervisors,
but also because the demonstration by employers of a lack of trust in their workers can encourage
behaviour based on narrow opportunistic motives (Drago and Perlman 1989).

An alternative is to design incentive schemes to reward individual or group output. Such schemes have
the advantage to the firm in that they not only induce greater effort from workers, but they may also
encourage the commitment of workers and reinforce existing cultures and values where these foster high
levels of performance, innovation and team-work.
Linking pay to performance also potentially introduces equity and consistency in the pay structure and
enables the firm to attract more able workers (Lazear 2000). Incentive systems based on individual
performance are, however, problematic for a number of reasons. First, it may be difficult to disentangle
each individual's contribution to production. This is seen to be particularly important for jobs involving
specific human capital (Fitzroy and Kraft 1987). Secondly, the output of a work team might exceed the
sum of individual contributions. Thirdly, such schemes are seen to discourage what Lazear (1989) terms
'political interaction' among workers, which often positively influences the level of output. Moreover,
compensation systems that tie pay to individual performance can be divisive and conflict with other
employment strategies based on team-working and inclusive forms of employee involvement (Kleiner et
al. 2001).

Individual performance related schemes are costly to monitor, may be applied in an arbitrary and
inconsistent manner and can promote unhealthy competition between workers, which reduces output

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levels. Also, PRP schemes based on individual measures of performance could be particularly
problematic where the attaining/sustaining of competitive advantage requires that the work process
undergoes continual change. This can be expected where either consumer demands are subject to constant
and significant change and where innovation is the key to product market success.

PRP schemes based on individual performance (especially piece-rates) can increase the resistance of
workers to changes in work or product lines, because their productivity is likely to be lower in new rather
than familiar settings (Kleiner et al. 2001). Recent changes in technology making customisation possible
and permitting a wider range of firms to attain cost-competitiveness without recourse to expensive
technology have increased the range of firms to which this potentially applies, thereby reducing the scope
for successful individual-based PRP.

Performance-related incentive systems based on group output are potential responses to the problems
associated with individual performance systems. These are more likely to promote and value employees
working collaboratively to achieve goals and objectives that involve teamwork and co-operation.
However, they suffer from a fundamental free- rider problem. The failure of the individual to contribute
fully to group effort has little impact on that individual's earnings if other members do not shirk (Ben-Ner
and Jones 1995). The rational instrumental worker will therefore minimise his own effort, while
encouraging the other workers to maximise theirs.

With PRP organisations encourages the building of a more 'high trust' relationship between the employer
and employee. Offering workers increased involvement in decision-making, a financial involvement in
the performance of the organisation and linking pay to performance goals and achievements are all seen
as ways of encouraging loyalty, motivation and commitment. Central to this argument is the role of peer
pressure. Kandel and Lazear (1992) distinguish between internal and external pressures. Internal pressure
is basically the guilt that someone feels if they do not perform well even though their own contribution is
not observed. It does not therefore involve direct pressure from peers. Internal pressures arise from
feelings of loyalty to colleagues and from the development of team-spirit at the workplace. External
pressures arise from the shame associated with not performing well and exist in situations where there is
mutual monitoring and each individual’s contribution is observed by colleagues.

Group incentive schemes provide both the motivation and means to exert peer sanctioning, whilst team-
based production creates mutual dependence amongst workers and thus the possibility of peer
sanctioning. It can therefore be expected that individual PRP schemes are likely to be successful in
improving organisational performance in only a narrow range of work settings, namely those in which

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team-working is not important, where high-trust relationships are not correlated with performance, where
it is easy to disentangle individual contributions to output and where the key to competitive success does
not lie in constant change to the work process (either because of continually changing consumer demands
or the need to be highly innovative). That is not to say that such schemes can never be successful; there
are likely to be some jobs for which these conditions are met, at least to some degree. Moreover, it is not
certain that group-based PRP schemes will be successful in situations where they are not met.

Unless organisations are able both to prevent free riding and to tie their schemes to other aspects of the
production process, they are unlikely to yield performance benefits. However, it is to be expected that the
types of workplaces in which individual-based schemes are likely to be successful will be more limited
than those in which group-based schemes will be effective. Individual and group PRP schemes might also
conflict when located in the same setting. Workplaces operating both types of scheme might be offering
mixed messages to their workers and thereby have worse performance, all other things equal, than those
that opt for one or other (or neither) of the routes.

Although there is a general support to PRP a significant minority feels hostile to it (Marsden and
Richardson, 1992). PRP in the public sector will certainly bring an increase to the level of performance
and ensure quicker deliverables. However it can be very difficult to implement a PRP scheme in an
organisation where the main objective is not profit making. As Dr.A. Mishra and Dr S. Mishra (2007)
rightly points out that "Performance is a deceptively simple idea, Simple because it is easy to express key
concepts and objectives; deceptive because it is hard to apply these ideas in government". With PRP it is
expected that government officials will exert themselves a higher level of on-the-job performance and
achievements. This will result in productivity gain and service delivery enhancement in the public sector
and will improve individual motivation and accountability.
Processes and systems required for PRP implementation act as a catalyst for introducing organisational
changes and helps organisation in recasting their culture. Introduction of PRP will bring in a new culture
where goal setting and clarification of objectives will be done to all employees. An implementation of an
effective appraisal system, clarification of tasks, acquisition of skills, enhanced team work and increased
flexibility in service delivery. This will certainly promote a high performance culture and increase
motivation among the employees.

However there are evidences that positive motivational effects have been modest and in some cases this
has resulted in de-motivation among staffs (Marsden and Richardson 1992). The main reason for failure
to motivate is that PRP is seen as unfair. For PRP to succeed there need to be the implementation of a
performance appraisal system that is transparent and trusted by all employees. Both supervisors and

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subordinates need to be well trained and there is also a need for a feedback mechanism so that
improvement in the performance appraisal is a continual process.

Also for PRP to lead to higher performance it is primordial that the pay rewards is large enough to justify
a change in behaviour. In Mauritius an important chunk of public sector employees have part time
businesses. In such a situation if the reward given to the employee is not significant enough it will not
result in increase in performance.

Also sometimes a lack of training and benchmarking may make these employees to feel that that they are
already working in the right standard and that they cannot improve further. It is noted that there is also the
tendency for PRP to be widely accepted among younger and lower grade staffs than civil servants with
longer service and more senior staffs. This is so because senior staffs or staffs will longer service may
have reached the salary scale limit and the percentage increase in the PRP reward will not be as
significant as among younger staffs.

Another factor that is very important for the success of PRP is the culture within the environment the
organisation is operating. For instance, in a country where social activities and time spent with family is
considered more important than an increase in pay, objectives set for PRP will not be achieved. In fact
human behaviour and motivational factors differs.
Maslow (1954) suggested that there are five major needs categories which apply to people, starting from
the fundamental physiological needs and leading through a hierarchy of safety, social and esteem needs to
the need for self-fulfilment, the highest need of all.

Some critics argue that pay is not a major motivator in the workplace. They quote Frederick Herzberg’s
view that the job itself is the source of true motivation, backing up their claim with studies such as one
where staff cited pay as fifth on their list of top ten motivators. Others object to PRP on the grounds that it
accentuates the difference between the highest-paid and lowest-paid employees in an organisation. CEO
pay as a multiple of average pay has been rising steeply in recent years.

Also, financial situation of people can have an impact on the success of PRP. Developed countries and in
situation where the economy is booming employees will be in a better financial position compared to a
country which is facing an economic crisis. Here, introduction of PRP may not result in a rise in
performance because people are already better off and will not want to sacrifice the time spent with
families and other social activities to the reward scheme.

Gender can be an important determinant for the success of PRP. In countries where Males are considered
to be the bread winner and the salary of the woman is only a monthly plus PRP will lead to higher

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performance among the male rather than female workers. PRP will not be beneficial to organisations
where there is a high concentration of female workers.

Another factor that may influence a rise in performance with regards to PRP is the type of workers within
the organisation. Immigrants will tend to react better to PRP than local workers. This is because normally
immigrants do not take part in much social activities in the country where they work. Their main
objective will be to make maximum money so that at the end of their contracts end they can return to their
countries and lead a more comfortable life back home. Local workers have many personal commitments
which will prevent them to react in the same manner as immigrants with the introduction of PRP.

Though PRP can be a good motivator, this motivation does not automatically translate into performance.
People can be highly motivated but still perform badly because of a range of impediments, e.g. poor
management, inadequate training or obsolete equipment. Equally, people can be poorly motivated but
perform well, for example if there is very tight management. Motivation, then, is something that can lead
to better performance, but only when other conditions are met.

Despite the different difficulties and certain drawbacks of PRP many organisations are adopting this
scheme. PRP if implemented correctly certainly leads to high performance in organisations. Organisations
are now operating in a more global environment, one where competition is fierce. Higher performance of
employees is a must and many companies cannot evade implementation of PRP schemes.

Performance Culture
Although PRP can contribute to a rise in performance among employees, PRP does not necessarily ensure
the creation of a performance culture across the organisation. Performance culture is a whole change in
mindset across the organisation which demands much more than just implementing PRP. Reid and
Hubbell (2005) say that a performance culture is based on discipline. This discipline promotes
decisiveness and standards of excellence and ensures direct accountability. Such discipline is a main
reason why commitments and expectations are always clear. On the other hand, a lack of resolve and
sanctions in a culture usually characterises a culture in which there is little or no accountability. In a
performance culture, proactive performance management blocks obstructive behaviours and supports,
reinforces and rewards constructive ones. In such a culture, people are truly engaged in the business of the
organisation.

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For successfully implementing a performance culture, it is important that it starts from at the top. It is
important to have a leader who wants to make this change. Normally it should be the CEO to drive this.
Jack Welch, former CEO of General Electric (GE) is considered to have turned GE into a high
performance organisation. GE is considered as a reference in terms of performance culture in the business
world. Jack Welch says that “focus on speed, simplicity and self-confidence stayed with him throughout
his tenure as CEO of General Electric”. This message was reinforced throughout the organisation in
leadership expectations, performance management, the Work-Out program, and leadership development
programs at Crotonville, Connecticut. Welch was convinced that to realize his vision and be number one
or number two globally, you must "combine financial strength, market position and technology leadership
with an organisational focus on speed, agility and simplicity." (Jack Welch, Harvard Business Review,
September/October, 1989).
Leaders in performance cultures are clear about what they lead: strategy and change, self, their people and
teams, their organisation and their results. They are also clear on how they lead: with authenticity and
vulnerability, with discipline and tough empathy, with intuitive thinking and decision making, and by
playing to people's strengths and respective differences. (Goffee & Jones, Harvard Business Review,
Sept.-Oct., 2000)

Other important factors for a performance culture includes “Openness and trust” across the organisation.
Sincerity should be encouraged and there has to be a willingness to speak the unspeakable. An
environment of trust reduces defensiveness when issues are raised. People react more honestly, ask
questions more frequently, and are more spontaneous with their comments and ideas. The organisation
derives greater value from its talent, and employees get to develop their competence and contribute to
success.

“Managing differences” is another important aspect for the implementation of performance culture across
the organisation. Conflicts has to be addressed and unfulfilled commitments should be exposed, the better
to learn from and correct. Alternatives and options will have to be looked at without a predetermined
outcome. People will be encouraged to express real opinions and move beyond the perceived "safe talk."
In that sense issues will be resolved more effectively.

“Simplicity and focus” as mentioned by Jack Welsh is a very important aspect. This will ensure that the
organisation is sharply focused on implementation, with clarity and precision defining what needs to be
accomplished and how. There is a commitment at all levels to remove (not add) complexity from the way
of doing business. Being results driven and having fun are not seen as mutually exclusive, but dependent
on one another. Changes occur, as do positive results.

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Organisations will have to “Play to people's strengths”, that is, leaders know their people and effectively
match talent and task. They understand their people's strengths and how best to elicit them. They and their
people will have to focus less on closing gaps and more on learning and building on strengths.

Conclusion:

PRP is one type of payment system aimed at increasing the contribution of employees to the production
process. PRP if implemented correctly helps in mainly to address the ever existing principal-agent
problem and leads to higher performance across the organisation. In the public sector PRP has helped in
retaining employees with outstanding performances. PRP is a reward scheme that helps in motivating
employees and all successful organisations are driven by a motivated workforce. It is the employees who
drive the organisation forward, slow it down or even put it into reverse. Poor productivity is most of the
time likely to be associated to employee performance.

Many studies have shown that if not implemented correctly PRP may not achieve its purpose and in some
cases may be responsible for de-motivation among employees. PRP can be costly to monitor and in some
cases may lead to resistance from employees. Internal and external pressures may hinder performance and
organisations need to manage properly individual and group PRP in order to eliminate the issues related
to free riders. For PRP to be successful it is primordial that a well defined appraisal system is in place.
The appraisal system should be transparent and accepted by the employees. Both employees and their

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mangers need to be well trained on the appraisal system so that this does not lead to frustrations across the
organisation.

There are other schemes like sharing profits and employee share-ownership that can be used to increase
performance. These could be seen as forms of group PRP, though their link to performance is much less
direct than those group schemes.

The increased development of work systems offering workers a greater role in decision making and in
increasing functional flexibility in recent years has focused enhanced attention on the need to develop
innovative pay systems. Innovations such as quality circles, briefing groups, total quality management
and team-working have resulted in a marked change in the way in which work is done. They involve
workers taking more responsibility for key aspects of the production process and, in particular, being
more responsive to product market pressures. Such changes not only empower workers in key areas, but
also intensify the potential for principal-agent divergences. There is evidence that workplace changes
aimed at increasing employee participation in decision-making are typically only successful in raising
organisational performance.
PRP does not automatically ensure a performance culture across organisations. Although it is right to say
that PRP may lead to higher performance in the organisation but implementing a performance culture will
require much more. For instance there will be the need for a strong leader who will drive this project.
Implementation of a performance culture would require the involvement of all employees from managers
to lower level staffs. The organisation will have to engage in ensuring “openness and trust, managing
differences, simplicity and focus and play to people's strength” are norm within the organisation.

Although PRP does not automatically lead to performance culture across organisations it certainly
increases performance levels and helps organisations in achieving their objectives. PRP can be therefore
classified as the first step in the ladder that will lead to performance culture across organisations.

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References
Appelbaum, E. and Batt R. (1994). The New American Workplace, Cornell: ILR Press.

Walsh, J. (1993) Internalzation v. Decentralization: An analysis of recent developments in pay

bargaining , British Journal of Industrial Relations, 31, 409-432.

Booth, A. and Frank, J. (1999) Earnings, productivity, and performance-related pay, Journal of
Labor Economics, 17: 447-63.

Asch, B. (1990). Do incentives matter?: The case of navy recruiters, Industrial and Labor
Relations Review, 43: 89-107.

Lazear, E. (2000). Performance pay and productivity , American Economic Review, 90: 1346-
1361.

Marsden, D. (1999). Why are some employees motivated by performance pay, and others not?
Performance pay in the British public services, Paper presented at the conference
Human Resource Management: Confronting Theory and Reality, Erasmus University,
Rotterdam, November.

Drago, R. and Richard Perlman, R. (1989). Supervision and high wages as competing

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incentives: A basis for labour segmentation theory , in Robert Drago and Richard
Perlman (eds), Macroeconomic Issues in Labor Economics: New Approaches, New York,
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Lazear, E. (2000). Performance pay and productivity , American Economic Review, 90: 1346-
1361.

Fitzroy, F. and Kraft, K. (1987). Co-operation, productivity and profit sharing , Quarterly
Journal of Economics, 102: 23-35.

Lazear, E. (1989). Pay equality and industrial politics , Journal of Political Economy, 97: 561-580.

Kleiner, M., Helper, S and Ren, Y. (2001). From piece rates to group incentives: Who gains
the company or employees. Paper presented to the Industrial Relations Research
Association, New Orleans, January.

Kandel, E. and Lazear, E. (1992). Peer pressure and partnerships , Journal of Political Economy,
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D. Marsden and R. Richardson (1992). Motivation and Performance related pay in the public sector: A
case study of the inland revenue, London School of Economics, Paper no 75.

Dr.A. Mishra and Dr S. Mishra (2007). Formulating the Concept, Principles, and Parameters for
Performance-Related Incentives in government. Six central pay commission.

Joanne Reid and Victoria Hubbell. (2005). Creating a performance culture, Ivey Journal
Jack Welch. (September/October, 1989) Harvard Business Review

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