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Engaging climate & collaborative culture

Few HR issues have as much symbolic value as pay for performance (PFP). How much? How? What for? An effective PFP policy answers these questions. Yet Xavier Baeten (Manager of the Centre for Excellence in Strategic Rewards, the Executive Remuneration Research Centre and the Compensation & Benefits Management Programme at Vlerick) feels many companies don’t have clear answers. On the contrary, in many cases, PFP raises even more questions. “The practice of giving strategic rewards is not just a matter of bringing your policy in line with industry trends or the market average. If wielded properly, PFP can be a powerful tool for communicating where a company wants to go. It’s about choices and communicating the underlying logic.” However, one prerequisite for implementing PFP is to have a good performance management system.

“Hard workers and slackers get the same bonus. So why bother?” [Disgruntled worker]

Baeten: “If you want teamwork, you need to reward it. Studies have shown that bonuses based on individual performance tend to discourage teamwork. However, other studies have found that team-based incentive schemes are vulnerable to the free-rider problem. How can you deal with this? By making individual contributions visible. Free-riding happens less in smaller teams.”

“My employees see no connection between what they achieve and how much they’re paid in bonuses” [Line manager]

“This is a typical drawback of profit-sharing schemes where companies distribute part of their profits as bonuses to their employees. Certainly, in larger organisations, not all employees can see their impact on profit (i.e. ‘line of sight’). You might question the motivational power of such incentive schemes. Higher up in the organisation, this is less of an issue because there’s a stronger link between the executive’s actions and the firm’s performance.” 

“40% of my bonus depends on customer satisfaction” [CFO in telecoms]

“You could argue that a CFO has little impact on customer satisfaction. Yes, but it sends a powerful message as to what the company thinks is important. Criteria like these force people to think about what they can do to contribute, which is often more than they initially realise.”

“In a good year my bonus is double my base pay!” [Successful sales rep]

“Studies differ as to what percentage a bonus should be. There seems to be a consensus that the variable portion should be at least 5-10% to be effective and that 18% yields the best results. I’m not keen on bonuses exceeding 50% of base salary as people then focus too much on the activities that determine their bonus, ignoring other equally important aspects of their jobs. It’s virtually impossible to include all desired behaviour in a PFP system. It would become unmanageable.”

“Any base pay increase should be at least 6% to have an effect on performance or motivation” [Prof. Jason Shaw, during the 3rd European Reward Management Conference last December]

“I’m afraid that’s not realistic. Incidentally, this study implies that our practice of an annual 2-3% base pay increase does nothing in the way of motivating people or enhancing performance. In the current economic climate, there’s even more reason to question this practice. What’s more, I believe base pay increases should be linked to acquired skills and expertise, not performance. That’s what bonuses are for.”

“We’re in an economic crisis. Why do executives still get their bonuses?” [Reader’s comment]

“Actually, the crisis has had more impact on executive than on employee bonuses. As a result of the crisis, there’s a trend for companies to include long-term performance as well as non-financial criteria. Indeed, financial indicators have little predictive value. In addition, firms start considering relative performance, for example their own growth compared with that of their competitors. True, some have changed their criteria just to be able to continue paying bonuses. But it’s not all bad. These changes are definitely a step in the right direction, although there are some exceptions.”

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What makes a good PFP policy? Find out all the do’s and don’ts in “Managing for Performance Excellence”.

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