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The Link Between Pay and Performance 1

The Link Between Pay and Performance

Peter Reilly, Associate Director, IES

Introduction

This is a short note examining the relationship betweenperformance and remuneration. We have concentrated on thelink at individual (rather than group or corporate) level andwe have focused on pay, not any other forms of reward.Finally, we have not looked specifically at the differenttechniques for relating performance to pay. We have producedseparate papers on team-based pay, skills-based pay andcompetency-based pay, all of which are on the IES website.

We look first at the theoretical underpinnings to motivationand reward before turning to the relationship between payand motivation. We conclude with a look at its practicalapplication and the implications of these findings.

The theory on motivation

The theoretical starting point with respect to humanmotivation and work is sometimes taken to be that ofreinforcement. This theory suggested that behaviour could beencouraged through the use of rewards and praise and, to alesser extent, discouraged through punishments. People willexperience these outcomes and modify their behaviouraccordingly. In the eyes of a behaviourist like Skinner,learning only takes place through external positive andnegative reinforcement. These ideas were applied by Taylorand the Scientific Management school. Taylor thought moneywas the sole motivator for workers to perform. He, forexample, advocated piece rate payments as a means ofcontrolling behaviour and orienting it to managementrequirements. One challenge to this thinking was that it is notclear whether it is past reinforcements that affect behaviour orthe expectation of future reinforcements that is key. Anotherchallenge was that the Taylorist perspective was not onlyeconomic, but also employer-centred. It did not consider howemployees viewed the employment relationship.

2003 © The Institute for Employment Studies2

In contrast, the expectancy and goal-setting theories put anemphasis on cognition, ie the thought processes people gothrough as they decide to participate and perform in theworkplace. Goal theorists pursued this point by saying thatfuture goals (or ‘anticipated outcomes’, ‘desired future state’or ‘expected reinforcement’) can be used to influencebehaviour and motivation. The mere existence of goals canlead people to behave in ways that mean that they will reachtheir goals.

Latham and Locke demonstrated the value of specific andrelevant goals in a study of timber workers in North America.An important finding of their work was that the lumberjackswere motivated by the setting of goals and feedback onperformance, without any financial reward for goalachievement being provided. They argued that this was thecase because the workers trusted the management and saw thegoals as reasonable — they had the means to meet them. Thesetheories, even though they were criticised as being more of a‘technique’ than an actual theory, were influential in the MBO(management by objectives) approach that was popularduring the 1970s. This emphasised that meeting objectives wasthe key, not how the objectives were achieved. It stemmedfrom research that suggested giving employees latitude inhow they worked towards their goals was more motivatingthan determining the process for them.

However, goal theory was refined in a number of waysthrough expectancy theory. Porter and Lawler, building onearlier work by Vroom, for example, made the important pointthat motivation will only come if outcomes have psychologicalvalue (or ‘valence’) for people. Effort would be made wherepeople expected to be rewarded for it.

Another strand of social psychology took issue with Skinner’stheories, and that came from the ‘needs’ theorists. Maslow isthe best known advocate of this approach. His view was thatthere are various levels of human needs, both physiologicaland psychological. People have to satisfy basic (physiological)needs before being motivated by higher level psychologicalneeds. Hertzberg picked up this notion, but refined it. Hethought that the determinants of job satisfaction were differentto those leading to job dissatisfaction. Negatively changing thedeterminants of job satisfaction would mean less or no jobsatisfaction: it would not produce dissatisfaction. Relevant tothe role of pay, Hertzberg talked of reward being a ‘hygienefactor’ or a ‘dissatisfaction avoidance’ mechanism, in additionto working conditions and relationships with managers. Incontrast, such things as the job itself, recognition, a sense ofachievement, responsibility and personal growth were themeans to become satisfied. There were others (eg McGregor’s


Theory Y) who argued that effective performance will befound in organisations that motivate people throughparticipative or involving management styles and processes.

These insights led to the observation that there was more tomotivation than in Skinner’s world. It is not just the extrinsicreward for performing the task that is motivating but theintrinsic task itself can be rewarding. This suggestedemployees take part actively in decisions based on informationthat they receive from the work environment, rather thansimply responding to economic ‘carrots’, or, in the view ofexpectancy theorists, relying on individual needs (assuggested by Maslow). This is also more likely to be true whenthe individual initiates his/her own behaviour, rather thanbeing dictated to by others (consistent with Theory Y), andwhere the individual feels competent to perform a task. Soexternal punishment, goal imposition, zero sum competitionand such like are said to reduce motivation. Whereas, beingable to set one’s own goals and receive non-evaluativefeedback are likely to increase motivation.

Combining several of these theories, Deci and Ryan set out aself-determination theory that claims that: ‘human needsprovide the energy for behaviour; people value goals becausethe goals are expected to provide satisfaction of their needs’.

A final line of criticism of the Skinner approach concernscoercion. It is suggested that people may resent the controllingof their behaviour: not only is self-determination absent, butalso expectations of behaviour are externally imposed.

Another line of psychological thinking that is relevant here isthat of equity. Equity theorists claim that people seek balancebetween their inputs and the reward outcomes. In otherwords, rewards need to match effort. If the reward is too smallor unimportant for the effort involved, an individual ‘willminimise increasing inputs’, and vice versa. Thesecommentators have also asserted that people areuncomfortable about being better rewarded than others. This,however, seems to depend on the social setting. Adams, forexample, argued that whether input and reward is in balanceis determined on the basis of feelings/perceptions comparedwith others in relation to social norms. Tyler and Bies came upwith related research evidence that suggests that it isprocedural justice, the process of how the individual is treated,that is the key element in felt fairness. Distributive justice, theoutcome of the reward, is relatively less important.

Summarising this brief review of motivation in the workplace,one can say that staff are more likely to be motivated where:


work is challenging and satisfying (intrinsic motivation)

rewards are contingent on the completion of a task(extrinsic motivation)

the size of the reward, in terms of the relevant social andcultural norms of the organisation, is appropriate to theperformance level that justified it

there is a clear ‘line of sight’ between action and reward

employees value the reward on offer

staff are set clear, specific goals to be achieved over alimited time horizon

goals are ‘challenging yet reachable’

staff have significant influence over their goal setting

individuals believe themselves competent to perform theirtasks

staff have sufficient resources to undertake the activity

employees are allowed to determine for themselves howthey meet their objectives

managers give regular and positive feedback on employeeperformance, acting as a coach not judge

employees are involved in the evaluation of their ownperformance (nb: research suggests that employees aretougher markers of themselves than their managers).

It should be emphasised that many of the theories reportedabove have weak empirical support. Most have been criticisedas untheoretical, derived from flawed interpretations of theirdata or based on evidence from outside the work environment.Moreover, few looked specifically at the role of money as amotivator, seeking out other areas that lead to motivation atwork.

The next section looks more closely at the link between moneyand motivation via pay schemes.

Performance and pay

The ideas on motivation we have reported clearly show up inmanagement thinking on performance-related pay. We havealready referred to Scientific Management and the MBOmovement. The principles of Human Resource Managementalso featured the incentivisation of performance as a keyfeature of the well-run enterprise. Through the 1980s and1990s there was growing interest in and practice of individualperformance-related pay based on the belief that it would leadto both improved productivity and a cultural change in the


working environment. The next question to ask is whether inreality money seems to motivate employees.

Various researchers (eg Wallace and Szilagyi, and Gupta andShaw) contend that money is indeed a motivator. This isbecause it can be seen by individuals as a goal in itself, as ameans of giving satisfaction, and as a symbol of (internal)recognition or (external) status.

There is a counter view, however, that there is no real researchevidence that money does indeed motivate employees. Kahnhas argued that extrinsic rewards damage intrinsic job interest.Employees lose focus on the needs of the job in hand and aredistracted by the promise of the reward. Performance-relatedpay has a tendency to produce temporary compliance ratherthan sustained improvement. It does not change attitudes orbehaviour, merely a superficial conformity with what theorganisation signals to be important. At worst, a simplistic payfor performance approach is coercive. The risk is that it mayalso produce the wrong sort of behaviour. For example, asPfeffer says, individual performance-related pay emphasisesindividual contribution, whereas the task might requireteamwork; it might lead to short-termism when you need alonger-term perspective, or it may encourage conformity whenyou need challenge.

In truth it is hard to construct the evidence that proves thatindividual performance-related pay works. It is very difficultto identify a causal link between pay and a desired outcome —there are so many intervening variables. The generalconsensus, however, as expressed for example by Brown andArmstrong, is that such schemes clearly work in somecircumstances, but not in others. Results depend on theoccupational group and their work setting. You can only reallyeffectively pay performance if you can measure performance,and do it in a consistent manner. As Armstrong pointed out:‘When PRP fails, it is often because the assessment process isflawed.’ This fits with Lawler’s research in the USA in the1970s. In a survey of employees he found that objectivemeasures had much more credibility in the eyes ofparticipants than did managerial ratings. Increasedtransparency of decision making also provided credibility. Ofcourse, objective and verifiable measures are much easier tocommunicate than the subjective judgements of managers.This understanding gives credence to the commonly held viewthat a sales force is motivated by the possibility of increasedbonuses, whereas this is not true for research scientists. Thismay be partly due to the different personality traits involvedin occupational selection, but it certainly has to do with thecontrast in the nature of work satisfaction and the fact that


sales results are unambiguous, whereas research outcomesmay be complex.

Reviewing the practice of performance-related pay in the early1990s, our former colleague Marc Thompson argued that it‘does not serve to motivate (even those with the highperformance ratings) and may do more to demotivateemployees’. This may relate to an observation by ex Ernst andYoung consultant, Barry Leskin, that many PRP schemes are infact, zero sum games: my gain is your loss. Thompsondescribed how procedural justice was poorly observed inmany of the organisations he surveyed. If this is so, then afeeling that rewards have been unfairly distributed will bemagnified.

Much of this sort of attack on performance-related pay hasbeen based on evidence from the public sector. Marsden andFrench, for example, found in a survey of public sectororganisations, that only for a minority (between one-tenth andone-third of staff depending on the organisation) hadperformance-related pay been an incentive to work harder.For the rest, not only had it not motivated, it had damagedrelationships between colleagues and hindered teamworking.

Research for the CIPD by David Guest suggests that there is amore complex process at work. The result of his surveysuggests that 50 per cent of respondents thought that thepossibility of more money would motivate. The other half saidit would make no difference to them. Finally, there was a clear,and more or less even, split between those who believed thatstaff who perform well in their jobs should be better rewarded,and those that disagreed with that proposition. These resultsbear out our own experience in focus group discussionsespecially in central government organisations. There tends tobe a small minority wholly opposed to a link betweenperformance and pay. A somewhat bigger group isenthusiastic about individual performance-related pay. Thelarge proportion sitting in the middle tend to believe thatperformance levels do vary within their organisation and thatin principle, those who work harder or contribute more oughtto be better rewarded. The problem they have is with the skillsof managers to exercise their judgement in a fair andconsistent manner. They fear favouritism and ignorance.

In a sense for many organisations, particularly private sectorcompanies, it does not matter whether individualperformance-related pay motivates. They have seen it as a wayof communicating corporate goals and emphasising theimportance of delivering results. They regard it as aneconomic necessity in a world of intense competition andturbulent change. They need the flexibility to adjust pay to suit


economic circumstances, but also individual situations. Thusperformance-related pay has been used implicitly or explicitlyto retain key staff. Differential pay increases allow resources tobe concentrated on those who it is vital should be retained.Extra remuneration can be used to signal corporateapprobation, and to lock these individuals to the organisationwith golden handcuffs. Success can also be measured throughbroader indicators of change in the organisational climate,evidenced by increased employee satisfaction and reducedabsence and turnover.

Whilst many organisations (and indeed the government) inthe 1980s and 1990s saw individual performance-related payas a strategic lever to effect cultural change, it seems as if theinterest in such schemes is now past its peak. Even thensurveys suggest that only 40 per cent to 50 per cent ofmanagers and only between a quarter and one-third of otherstaff were covered by such systems. The original performance-related pay approaches were not seen to be delivering theright results. There have been problems in objective settingand assessment, especially for jobs whose outcomes are notclear-cut. So what we have seen more recently is themodification of schemes so that they refer to inputs ratherthan outputs of performance (competence-based pay) or bothinputs and outputs (contribution-based pay). Otherorganisations have focused on variable or team-based pay.Market considerations have also become more prominent,particularly for managerial staff.

These changes (apart from the new market focus) seem to usto be largely a question of relabelling. Organisations are stilltrying to relate performance to pay, but they have a moresophisticated sense of performance. Many of the problems thatseem to have dogged individual performance-related pay maywell apply to other schemes. Necessarily, you are emphasisingindividual contribution over team effort, and this may or maynot reflect your work organisation. Whatever the scheme, youstill need to find an effective mechanism that links some formof performance assessment with a pay increase. For mostorganisations this has to be done in a way that motivates thebest performers without demotivating the perfectlysatisfactory but not exceptional staff. And for the topperformers, differential reward is difficult in a low inflationaryenvironment, especially if the organisation is committed to acost of living floor to their annual pay increases. A lot of effortmay go into a system that produces only a small marginbetween what the best and worst performers receive. And,whatever the system, it needs to meet equal pay requirements.


Implications

So after stating all this difficulty, what can organisations do?Clearly they will want to create the environment whereemployees are motivated, since this should lead to betterperformance and outcomes in terms of productivity or quality.Charles Fay of Rutgers University has shown how reward canlift not only employee satisfaction and engagement, but it canlead to business success. To achieve this, organisations need toreflect on the circumstances that will produce motivation, andthese are likely to differ by employee group and even byindividual. This suggests a segmented approach to reward,different for different groups. This indeed is a feature of thejob family approach that is becoming ever more popular. Andit suggests that to a degree, reward should be tailor made to fitindividual preference — a feature of flexible reward systems.

Pay is likely to be important to attract and, in some cases,retain staff, at least in the private sector. Regarding the linkbetween pay and performance, for some groups, clear andmeasurable objectives can be set and these can be related topay. This may incentivise people to work harder or moreeffectively, but if the incentive is too small (in amount) or toodistant (in time) it will only have a limited impact. Even if theconditions of a good incentive are met, you cannot expectpeople to be sustained by it for long.

There is a greater recognition these days that how the job isdone is almost as important as the result. The pensions mis-selling fiasco is just the most obvious example. This argues fora contribution-based approach, where performance is judgedon both inputs and outputs. But with respect to the objectiveselement of the scheme, you would be advised to note thepoints made at the end of section 1.2. In particular, it is worthreflecting on the fact that there is a strong preference in manycompanies to cascade objectives down through theorganisation. This has the effect of disempowering staff,preventing them from fully participating in objective selection.This is likely to be counter-productive if the aim is to lift levelsof engagement.

For other types of staff, the nature of the job content is muchmore likely to determine the quality of performance. AsHerzberg said, ‘If you want people motivated to do a good job,give them a good job to do’. For staff in situations such asthese, it may be difficult to set clear and measurable targets,and the assessment process may be difficult. So differentialrewards are hard to justify. Effort instead should be put intogood job design and getting the work environment right.Giving staff recognition for their efforts in other ways thanmoney may be more productive.


This point may be particularly relevant to the public sector. Arecent (2002) Audit Commission survey found that staff joinedthe public service ‘to make a positive difference’, to dointeresting and rewarding work, and as a vocation. Financialrewards, unsurprisingly, did not feature. Moreover, the PublicServices Productivity Review Panel (2002) reported that staffin the public sector rarely mentioned pay as a motivator intheir survey. Indeed, they more often stressed that they werenot ‘in it for the money’. Finally, according to the AuditCommission, pay was amongst a number of factors that affectsthe decision to leave the public sector, but it is issuesconcerning the job and the working context that seem to driveresignations. It is the bureaucracy, paperwork and targets, thelack of resources and workloads, a lack of autonomy workingon an imposed and irrelevant change agenda, and a feeling ofbeing valued internally and externally, that come before pay inthe list of reasons to leave.

But readers from private sector organisations should notdismiss the public sector messages as irrelevant to their ownsituation. The January special issue of the Harvard BusinessReview on motivation reveals that , even in the USA, there isdisquiet at the way the link between motivation and reward isinterpreted in many organisations. Chip Heath at StanfordUniversity, for example, reports that managers are generallypoor at judging what motivates people, but they tend to havean ‘extrinsic incentive bias’. In other words, they tend to thinkthat people are more motivated by money than they are.Survey evidence in the USA suggests that pay ranks third inimportance in the minds of employees, behind factors thatrelate to job satisfaction. This mirrors a TUC survey in the UK,that also found that money was not the prime issue for people.

In any organisation, pay has to be of a certain level in order toattract and retain staff, however, if intrinsic motivation is whatstimulates people, then attention should be focused on howjob satisfaction may be encouraged, rather than spending toomuch time on reward mechanisms that incorporate a strongincentive element.

Positive features in any sound remuneration system willinclude the fact that it is transparent, and therefore staff cansee how it operates. This will put a premium on consistentpolicy application, that in turn should encourage a sense of feltfairness. Simplicity tends to go with transparency. This helpsunderstanding and allows a ‘clear line of sight’ between actionand reward. Finally, to meet the requirements of equity, thereward should be proportionate to the activity.

Good design, and even more importantly, goodimplementation, will make the difference between success and


failure. Indeed, the US Consortium for Alternative RewardStrategies concluded from their research that implementationrather than good design was the key to success. In this,communication is critical. Senior management needs to showcommitment and staff be allowed to express their views.

So even before implementation, an involving process will tendto gain employee understanding and commitment. Thissuggests that change in remuneration has to be positioned assomething that will produce real, not synthetic, benefits tostaff. Fay found this in his research. Process has to fitobjectives and objectives have to resonate with the workforce.He also argued that reward approaches needed to align withbroader business aims. At the strategic level, as Porter pointedout, if your business objectives are cost containment then theHR systems, including reward should reflect this. If yourbusiness imperative is to innovate, your reward approach willbe very different. In complex organisations, this reinforces thepoint that different business units may different remunerationstrategies.

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