What is Performance- related pay (PRP)?
Performance related pay offers individuals financial rewards in the form of increases in basic way or cash bonuses which are linked with an assessment of performance, usually in relation to agreed objectives. PRP emerged in the 1980s as the answer to motivating the people and developing performance -oriented cultures. It was seen as a major lever of change and the government of the day adopted it with much enthusiasm, but little understanding, as a means of transforming public sector into business.
The institute of Personnel Management in (1991) and the institute of Manpower Studies found that PRP was used in 54 percent of the organisations they surveyed. Research conducted by the IPM and NEDO established that 47 percent of the 390 organisations they used PRP (Cannel and wood, 1992). Most schemes are for managers and salaried staff. Relatively few organisations have introduced PRP for manual workers, although Kinnie and Lowe (1990) give some examples. PRP schemes may be restricted to certain categories of employees such as senior managers.
Agreed outcomes (targets) Performance measures Performance Rating Formula Performance Pay
Source: Self-Copiedfrom handbook employee reward management (2005)
Method of operating PRP
Methods of operating PRP vary considerably but its typical main features are as follows:
Pay Structure – This is designed to provide scope for pay progression within pay brackets attached to job grades.
Pay progression and performance-The rate and limits of progression through the pay brackets are determined by performance ratings.
Decelerated progression -Pay progression relating to performance is typically planned to decelerate through the grade because it is argued, in line with earning with curve theory, that pay increases should be higher during the earlier period in a job when learning is at its highest rate.
Performance related pay increases may be added cumulatively to basic pay (ie consolidated) until either the maximum rate of pay for the grade or a limit within the grade defined in terms of a level of performance is reached.
Refinements and variations of the basic Model
There are many refinements and variations of this basic model, as described below:
Pay spine and incremental systems
Ina pay spine or other type of fixed increment payment system performance-related pay may grant one or two additional increments or may withhold an increment, depending on performance ratings.
Cash bonuses
Performance-related payments may take the form of cash bonuses for particular achievements or sustained levels of high performance. Individuals could be eligible for such bonuses when they have reached the top of the pay bracket for their grade, or when they are assessed as being fully competent, having completed their learning curve. The pay rate of someone who reaches the required level of competence can be aligned with market rates according to the organisation pay policy. The principle of paying cash bonuses avoids the pension approach which takes root in any system where merit increases are perpetuated as part of the basic pay.
Competence and skill-related progression
Some pay structures are designed to support a continuous development policy by rewarding people for acquiring and using necessary skills and competences and through career development pay.
Rationale of Performance-Related Pay
Three propositions are most frequently advanced to justify PRP:
- It is an effective motivator because it provides a financial incentive and rewards people according to the level of performance they achieve. If PRP is based on measured performance in relation to agreed objectives, is fully transparent, as it should be, and provides worthwhile as well as attainable rewards it will function in accordance with the principle of expectancy theory
- It conveys a clear message to employees that the organisation believes in -indeed requires a high level of performance from everyone and is prepared to pay for it. PRP therefore can be used as a lever of cultural change helping to create performance oriented organisations and individuals.
- It is right and proper for pay to be related to the contribution individuals make to achieving organisational objectives. High performers should be paid more than low performers.
Reasons for introducing PRP
Kessler and Purcell (1993) found that there were two main reasons why the organisations contacted introduced PRP:
- To attract the right type of applicant and to send a strong message to those employees the organisation wanted to lose as well as to those it wanted to retain.
- To transform the organisation by suggesting that the company was performance driven, cost conscious and flexible, and by encouraging employee commitment-‘locking’ individuals in through objectives cascading from the company’s business plan.
Thompson (1992) found that the two most important factors influencing the decision to introduce PRP were the desire to link pay and productivity more closely and the need to motivate employees.
The purpose was not to provide more money for senior executives but to get them to focus on things which mattered to the business. It was a way of crystallising manager’s minds on what are seen by the managing director to be the key targets.
Example: At NatWest a Performance Related Reward plan was introduced to improve the business performance of the Bank. The scheme will provide a greater concentration on corporate and personal objectives. It will do this by clarifying at each level what the key objectives are, relating them to specific circumstances and rewarding managers according to how well they achieve them.
This is good example of an approach which links PRP clearly with performance management processes where the emphasis is on assessing performance against agreed objectives and integrating individual objectives with those of the organisation.
Kessler and Purcell (1993) distinguished the following problems when assessment is linked with pay:
Tunnel Vision -Employees concentrate on those aspects of the job linked to pay to the neglect of other aspects of their job.
Cost of living – The strong tradition of cost of living increases can still lead employees to refer to inflation in their evaluation of any pay increase, so diluting the performance linkage.
Mismatch between appraisal and pay – The small amount of money sometimes devoted to PRP may mean positive appraisal ratings leading to only small pay out-turns.
Diversion of merit money – In cases of grading anomalies or labour market pressures, line managers may use the pay pot to address these problems rather than directly reward performance.
Principal-Agent Moral Hazard Analysis of Performance Pay
The theoretical rationale for performance related pay has been most clearly stated