When it comes to performance appraisals and the linking of performance ratings to pay, there are two schools of thought:

1. It’s BAD, because managers can be put under pressure to downgrade appraisal ratings in order to suppress pay raises. This can create an unhealthy dynamic between the manager and their direct reports and can lead to:

• Lack of trust – direct reports suspect that their manager has a hidden agenda and is being neither objective nor fair in the way in which they are handling appraisal sessions.
• De-motivation – direct reports feel that resulting appraisal ratings fail to reflect their efforts adequately and that there is a corporate culture that suppresses upward-mobility within the organization.
• Breakdown in basic rules of accountability-reward structures – those direct reports who put in greater effort feel that there is no differentiation made between them and others who perform poorly.

2. It’s GOOD, because linking pay to performance encourages employees to try harder and can help the pursuit of excellence by:
   • Improved target achievement – by using the appraisal process to clear up misunderstandings and reinforce objectives, direct reports are given improved opportunities to perform well and contribute towards the success of the organization.
   • Better communication – appraisal sessions give both the manager and the direct reports the opportunity to understand each other’s objectives and challenges.
   • Achievement of a more flexible organization that is more capable of retaining its talented staff during downturns in the business cycle. Because such organizations have a larger proportion of their salary bill paid in performance-related payments, their core wage bill is lower. During business cycle downturns, this allows them to maintain financial viability by reducing the levels of performance-related bonuses as opposed to reducing employee numbers.

Consider Employees’ Motivational Styles

During the development of Talent Chaser’s Performance Appraisal and Task Action Planning Module, we worked with a wide range of managers operating in a diverse range of industries. Our objective was to identify a methodology that would help create an organizational culture that would enable employees to be rewarded for improved performance while avoiding the pitfalls associated with linking pay to performance.

One of the facts we discovered was that individual employee motivational priorities influence whether or not performance-related pay will improve their productivity.

Some employees are intrinsically motivated while others are extrinsically motivated and when it comes to linking pay to performance, the following motivational factors are important:

Intrinsic Motivational Factors

• Need to do things the right way
• Need to Contribute
• Need to make decisions

Extrinsic Motivational Factors

• Money
• Status

Our research data revealed these general facts, provided the appraisal process includes clear advice and support to help the appraisee overcome any performance problems:

• Intrinsically motivated employees thrive in situations where their performance is appraised regularlyregardless of whether or not their pay is linked to their performance.
• Extrinsically motivated employees achieve higher performance ratings where their performance is appraised regularly and their pay is linked to their performance.

What this reveals is that the argument, for and against linking pay to performance, is not clear-cut, but based on intrinsic motivation or extrinsic motivation of the employee. Doing so may or may not be necessary in order to improve performance, and under some circumstances, it may be a waste of money.

Creating an Effective Bonus Plan

While linking pay to performance can improve performance, in practice, it depends on carefully:

• Matching employees to the demands of roles
• Identifying and specifying clearly the basis on which performance bonuses will be paid
• Ensuring that bonus payments are distributed throughout the organization in a manner which is not only fair but which will also be perceived to be fair by all employees

When it comes to creating an effective bonus plan, each organization will have its own unique needs. What will work for one organization may well not work for another. This is an area where organizations that use a process of trial and error succeed.

By adopting an evidence-based recruitment screening and management development approach, the efficacy of a bonus plan can be constantly monitored and ongoing changes can be made in the light of experience. With this approach, it is possible to use the linking of pay to performance as a way not only to improve productivity but also to make a significant contribution to the effectiveness of any employee retention program.

Watch our animated demo to learn how evidence-based recruitment helps with recruitment of the right people for the right jobs based on thinking styles and improve your employee retention and performance drastically over time.