Performance-based compensation is common in many jobs, such as sales, where team members earn a commission for each sale they land. Although it may not be appropriate for some roles, performance-based pay is often lauded as a way to incentivize employees and boost productivity. But does it always work as well as advertised?
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Performance-based pay refers to compensation that is earned when employees drive sales or meet other targets. This pay, such as a commission or a bonus, is usually offered in addition to some level of base compensation and is intended as an incentive for employees.
Performance-based pay can be difficult for employers to track, as employee performance may ebb and flow. Companies that want to keep better tabs on their payroll should consider using one of the best online payroll software solutions, especially when transitioning to a structure such as performance-based pay.
Research shows that performance-based pay seems to encourage employees to work harder and drive better results for the company. However, the trade-off is that employees are more likely to overwork themselves, leading to low job satisfaction and, potentially, high employee turnover (which can become expensive for the company.)
A study published in IZA World of Labor found that “performance-related pay is a relevant policy to improve firm performance and competitiveness, although the adverse effects on work intensification and employees’ physical strain and psychological stress should not be overlooked.”
Therefore, when an employer implements a policy of performance-based pay, it is essential to hold regular meetings to gauge team members’ overall morale and assess whether they are at risk of occupational burnout, which can seriously hamper their productivity.
A study published in the Human Resource Management Journal similarly revealed that workers who receive performance-based pay work harder but end up with higher stress levels and lower levels of job satisfaction. The research found that employees who receive performance-based pay or know how well their employer performs financially are more likely to feel overworked. That pressure offsets the gains in productivity that the pay structure is designed to produce, the study’s authors said.
The study revealed the flaws with performance-based pay models, said Chidiebere Ogbonnaya, the study’s lead author and a research fellow at the University of East Anglia at the time of the study. He added that many employees who receive performance-based pay feel immense pressure or do not have enough hours to complete work tasks.
“By tying employees’ performance to financial incentives, employers send signals to employees about their intention to reward extra work effort with more pay,” Ogbonnaya said in a statement. “Employees, in turn, receive these signals and feel obliged to work harder in exchange for more pay.”
Although employees may value these earnings and see the pay structure as positive, the ultimate beneficiary of their extra effort is the company.
“As a consequence, performance-related pay may be considered exploitative, or a management strategy that increases both earnings and work intensification,” Ogbonnaya said.
When the researchers looked specifically at pay tied to company profits, they found that performance-based pay increased job satisfaction, employee commitment and trust in management if the profit-related pay was distributed equitably across the organization. When profit-related pay was given only to a small portion of the workforce, by contrast, there were lower levels of job satisfaction, employee commitment and trust in management, the study found.
Employees respond better to performance-based pay when it’s tied to company profits rather than to individual performance and when it’s distributed equitably across all levels of the business.
Many studies have shown that the amount of pay someone receives does not directly contribute to their level of performance. No matter how much you pay employees, they’ll eventually cycle through their normal routines. If those routines include slacking off and underperforming, then that’s what will happen.
Moreover, a study in Harvard Business Review found that not all employees respond well to incentive-based pay. For example, accounting or human resources professionals may want a steady salary instead of a commission for each report they complete. Still, pay increases and bonuses for bulk work, even in operational environments, can be beneficial.
There’s also a chance of corruption: If employees get in desperate financial situations outside of work, they may cheat the system to get more pay. This issue caused Wells Fargo retail bank employees to fraudulently open customer accounts to meet aggressive sales quotas, resulting in a $575 million lawsuit at the end of 2018.
Not all employees respond well to incentive-based pay, but there are ways to implement this policy without damaging the relationship between the employer and its employees.
There are advantages and disadvantages to adopting a performance-based pay model.
Performance-based pay is expected in the investment industry, such as for hedge fund and portfolio managers, but comprehensive pay structures are more common in most other industries. Generally, employees experience performance-based pay only in the context of bonuses and extra rewards, not as their full compensation.
You should consider several other compensation structures before deciding if performance-based pay is right for your workforce. Hourly wages and salaries are the most common forms of compensation for employees and often include “indirect compensation” in employee benefits, such as insurance and yearly raises.
Commission is a type of compensation that’s more closely related to performance-based pay. It can be offered in conjunction with a salary and usually reflects a percentage of an individual’s or team’s contributions to the company.
Performance-based pay isn’t for everybody. While some employees thrive on it, others need a steady, predictable paycheck. With a properly executed incentive plan, performance-based pay can work for companies of any size, but be sure to consider your employees’ needs and the alternatives first.
Jacob Bierer-Nielsen contributed to this article.