Problems with Performance Based Pay ~ Strategic Human Capital Management (HCM) Blog

Thursday 12 May 2016

Problems with Performance Based Pay

It was interesting hearing the speaker from AXA yesterday suggesting we need to do away with bonuses. I tend to agree. Here are my comments on the problems with bonuses, taken from the ATD's Handbook of Talent Management, and my chapter on innovation within reward:

Despite the general shift from fixed to variable reward, there is little evidence that offering enhanced pay for higher performance has led to increased motivation or real gains in performance. This should not have been a surprise to us. After all, our understanding about the limited impact of reward dates back to the 1940s and 50s with research by Abraham Maslow and Frederick Herzberg but has also been reinforced and extended by more recent insights emerging from behavioural science, neuroscience and behavioural economics. These insights increasingly suggest that there are major difficulties involved in attempting to link pay to performance.

Firstly, we know that reward is a hygiene factor rather than being a true motivator, i.e. it has little ability to motivate but if it is inappropriate or even just perceived as inappropriate it can be a powerful demotivator. People may also end up feeling punished if they do not receive the full potential or expected payout.

In addition, although performance based pay may work for employees working on a production line it has a particularly low impact on Peter Drucker’s knowledge workers. The over justification effect, identified by Edward Deci, suggests that the only thing extrinsic reward does do for these people is to reduce the intrinsic motivation that they started out with. For example many investment bankers are less interested in high pay than the symbolic value of this payment and the way pay helps them compare their performance to their colleagues. (You can see this very clearly if you happen to be in an investment bank when the annual bonuses are announced.) By encouraging bankers to see reward as a proxy for their value we have encouraged them to become extrinsically motivated and have also got locked into a very expensive system for communicating their comparative worth.

Incentives will also not work, even for production line workers, if they are seen as too small and unimportant. They will also have limited impact on those who are not materialistic and have their own value system or are just more focused on fairness and equity than they are on maximizing their own wealth.

Any impact of variable reward is also likely to be short-term so an organization may find someone will be more engaged for a short period after receiving a reward but they will very quickly return to the former level of rather lower engagement. And the reward the person has received very quickly becomes an entitlement and therefore an even higher reward is required next time to produce the same increase in engagement.

Rewards can also encourage short-termism and reduce risk taking which can lead to a culture of compliance rather than improvement. I have even heard it suggested that it is because reward practitioners tend to get better paid than their other talent management colleagues that we see less innovation within the reward space!

But inappropriate reward can also encourage excessive risk taking as we saw with the activities of investment bankers which triggered the recent global recession.

I also had an interesting experience working with one of the big global banks shortly after 2008 financial crash. This firm’s CHRO put the world’s troubles down in no small part to the HR Business Partners who supported the firm’s investment bank. She explained that when it came to the annual salary review she got no trouble at all from most HR practitioners but the HRBPs in the investment banking group would be up in arms. Basically they had gone native and taken on the characteristics and behaviours of their client group. This, together with their own comparatively high rewards within the HR function and profession, had stopped them seeing the dangerous consequences of the ways that the investment bankers were being paid.

Various studies have also shown that high pay, or the potential for high pay, reduces productivity and performance and that at a certain level of reward organizations no longer have to pay more to get higher performance.

Individually focused reward can also sabotage work relationships, hindering team working and collaboration. This is important as a high proportion of work undertaken by knowledge workers (generally over half), as well as other employees, tends to be collaborative rather than individual in nature, that is performance results from the collective action of teams, networks and communities not just of the individual employees themselves.

A final issue is that trust in organizational management is declining. For example, one of the leading global surveys on trust, the Edelman Trust Barometer, has found significant falls in trust in the last decade or so, and notes some of the greatest falls are for hierarchically based relationships and with positions of authority such as a CEO.

Linked to this, there are also concerns about the way reward programmes are implemented and whether they are applied fairly. For example, equal pay audits have often highlighted unintended but unequal pay practices that lie behind ongoing gender pay gaps.

Lack of trust in management, and in the reward programmes executed by this management, also reduce the positive impact these sorts of schemes will have as employees apply a psychological discount in the way that they value them, focusing on what they believe they are likely to realize, rather than the full realisable pay.

Given all of this, how much value do we really derive from our performance based pay schemes?