performance management and compensation

Performance Management and Compensation

MANA 5322

Dr. Jeanne Michalski

[email protected]

Pay for Performance

Discussion

Linking Pay to Performance

U.S. organizations often use “merit” pay to determine employee pay increases

Straightforward logic: if pay is made contingent upon performance, then employee motivation to achieve high performance is increased.

Founded in motivational theories

Linking Pay to Performance

Expectancy Theory

Motivation = E X I X V

Expectancy: The connection between behavior and the outcome

Instrumentality: The connection between outcome and a reward

Valence: Is the reward something that the individual values?

People are motivated by intrinsic and extrinsic rewards they desire. People will only be motivated if outcome is possible. People will only be motivated if outcome is contingent on behavior. People will only be motivated if a reward is attached to the outcome.

“Line of sight” is the perceived link between individual behavior and the reward.

Equity Theory

Comparison of my input / reward ratio with that of similar others.

Merit pay should lead to improved performance because a pay raise is seen as a fair outcome for one’s performance input – the more one contributes to the organization the greater the pay increase

Pay Equity and Motivation

The greater the perceived disparity between my input/output ratio and the comparison person’s input/output ratio, the greater my motivation to reduce the inequity.

“Monkeys Demand Equal Pay”

A recent study shows brown capuchin monkeys refused to play along when they saw another monkey get a better payoff for performing the same work.

The monkeys were trained to trade a granite token for a piece of cumber. When the reward was the same for both monkeys, they took the cucumber 95 percent of the time.

But it was a different story when one monkey was given something better -- namely, a grape. Then, the other monkey often pitched a fit -- either throwing the token, refusing to eat the cucumber or giving it to the other monkey.

Associated Press 2003

Reinforcement Theory

Rewards reinforce performance “what gets rewarded gets repeated”

Merit pay should motivate improved performance because the monetary consequences of good performance are made known. The better one’s performance, the greater the pay increase will be.

Goal Setting Theory

Behavioral goals vs. Outcome goals Often easier to observe outcomes Gives employee discretion on how to achieve goals

Use Outcome Goals When: Workers know how to achieve the goals Workers have the necessary resources

Goal Challenge and Performance

Easy Moderately Difficult Extremely Difficult

High

Performance

Low

Performance

Note: Not to scale

Base Salary: $60k/yr. Mgr Quality Poor Health Benefits

Great Sr. Executive

Quality Fair

Pay Brings Talent into Organization

Job Offer #1 Job Offer #2 Base Salary: $45k/yr. Mgr Quality Great Health Benefits Great Sr. Executive

Quality Great

Candidates Value:Compensation and Benefits 4.3Development and Work Environment 3.85Work-Life Balance 3.57Company Environment 3.46

Corporate Leadership Council 2004

Pay Keeps Talent

Total Compensation Base Pay

Effect of Compensation on Discretionary Effort Connection - Performance and Raise 10.8% Connection - Performance and Bonus 9.9% Total Compensation Satisfaction 9.1% Base Pay Satisfaction 7.6% Cash Bonus Satisfaction 7.0%

Compensation attracts talent and plays a role in retention but has less impact on employee effort. Biggest impact on employee effort had to due with the role of the manager

Pay for Performance Requires

1. Definition of performance How are we going to measure and compare people?

2. Distribution of performance Can we distinguish high and low performers?

3. Decide the increase for each level of performance. How large a difference between high and low

performers?

Questions

Should low performers be paid an increase? Should average performers be paid an

increase? What about cost of living? What about existing difference in pay

distribution?

An accurate, reliable, and credible performance-appraisal program is the foundation of a successful merit pay program

Training for supervisors on how to: Plan performance that links individual efforts with

business plans and strategies Measure and evaluate performance fairly and

consistently Provide feedback Use merit matrix Communicate assessment of performance and the

allocation of rewards to employees

Merit Pay Increases

Fundamental feature is an established budget amount not-to-be-exceeded bottom line usually computed as a % of payroll

Key decisions: Size of the budget How to allocate to different business units

Factors that may influence budgets: Organizational financial results Cost of living/inflation rates Industry trends Cost of labor and the competitive position of the

organization’s pay in the marketplace

Merit Pay Policy – Merit Pay Matrix

Generally 3 alternatives for issuing merit increases Based only on performance Based on performance and position in range Based on performance and position in range using

variable timing

Merit Pay Matrix

Performance and Base Pay

PerformanceRating

Fixed Increase Amount

DiscretionaryIncrease Amount

Outstanding 8 % 6-10%

ConsistentlyExceedsStandards

5% 4-6%

Meets Standards 3% 2-4%

Does NotFully MeetStandards

0% 0-2%

Merit Pay Matrix

Increase as % of Base Pay

Employee Current Pay Rate Increase Percentage Increase Dollars

A $25,000 4% $1,000

B $35,000 4% $1,400

C $45,000 4% $1,800

Employee Current Pay Rate

Increase Percentage

Increase Dollars

Effective Increase Percentage

A $25,000 4% $1,400 5.6%

B $35,000 4% $1,400 4.0%

C $45,000 4% $1,400 3.1%

Increase as % of $35,000 Midpoint

Advantages of calculating merit increase based only on performance are: Simple to budget Easy to administer Straightforward to communicate

Merit Pay Matrix

Performance and Position in Range

Position in Range Before Increase

PerformanceRating

1st QuartileOr Below 2nd Quartile 3rd Quartile 4th Quartile

Outstanding 8-9 % 6-7% 4-5% 3-4%


6-7% 4-5% 3-4% 2-3%

Meets Standards 4-5% 3-4% 2-3% -------


0-2% ------- ------- -------

Advantages of merit matrix based on performance and position in range: Reduces the tendency to perpetuate tenure-based

pay inequities Likely to be deemed “fair” by the work force because

over time, employees with similar performance in same salary grade will tend to be paid comparably

Merit Pay Matrix

Performance and Position in Range with Variable Timing


Perf.Rating

1st QuartileOr Below

2nd Quartile 3rd Quartile 4th Quartile

Outstanding 8-9 %6-9 months

6-7%9-12 months

4-5%10-12 months

3-4%12-15 months


6-7%8-10 months

4-5%10-12 months

3-4%12-15 months

2-3%15-18 months

Meets Standards

4-5%9-12 months

3-4%12-15 months

2-3%15-18 months

-------


0-2%12-15 months

------- ------- -------

Advantages of performance and position in range with variable timing: Top performers receive bigger rewards with greater

frequency During tight budgets can still give “normal” increase

just granted at later interval Disadvantages

Much more complicated to administer Difficult to track and maintain budgets

Managing a Merit Pay Plan

Simple equation – significant performance yields significant rewards

Relies on trust – needs openness and candidness Recent move is to communicate more information

about company’s compensation program Needs balance between too little – and too much Employee needs enough information about merit

pay plan for it to serve as a performance motivator without breaching their right to privacy or restricting the organization’s ability to exercise management discretion

Communication of Compensation for Merit Pay General information about the performance

management process General information about the compensation

program (how pay is determined, how jobs are evaluated, salary ranges, etc.)

Specific information about merit pay program (budgets, performance rating distributions)

Size of the individual’s increase, minimum and maximum raises, and average size of merit increases

Merit Pay Matrix – Example for HW Assignment



PerformanceRating

1st QuartileOr Below 2nd Quartile 3rd Quartile 4th Quartile

Outstanding 9 % 7% 5% 4%


6.5% 5% 3.5% 3%

Meets Standards 5% 4% 3% 2%


1% ------- ------- -------

Multiply the performance distribution by the range distribution to obtain the percent of employees in each cell.

Multiply the increase percentages by the employee distribution for each cell

The sum of all cells equals the total merit increase percentage or the merit pool

Merit Pay Matrix



PerformanceRating

% ofEes per rating

1st Quartile

2nd Quartile

3rd Quartile

4th Quartile

(% Ees per Quartile)

15% 40% 30% 15%

Outstanding 5% .15x.05 .40x.05 .30x.05


15% .15x.15 .40x.15 .30x.15

Meets Standards 77% .15x.77 .40x.77 .30x.77


3% .15x.03 .40x.03 .30x.03

Merit Pay Matrix



PerformanceRating

% ofEes per rating

1st Quartile

2nd Quartile

3rd Quartile

4th Quartile


15% 40% 30% 15%

Outstanding 5% 9 % 7% 5% 4%


15% 6.5% 5% 3.5% 3%

Meets Standards 77% 5% 4% 3% 2%


3% 1% ------- ------- -------

Merit Pay Matrix – Example for HW

Performance and Position in Range (Position in Range Before Increase)

PerformanceRating

% ofEes per

rating

1st Quartile 2nd Quartile 3rd Quartile 4th Quar.


15% 40% 30% 15%

Outstanding 5% .15x.05x.09 .40x.05x.07 .30x.05x.05


15% .15x.15x.065 .40x.15x.05 .30x.15x.035

Meets Standards 77% .15x.77x.05 .40x.77x.04 .30x.77x.03


3% .15x.03x.01 .40x.03 .30x.03

Position In Range CALCULATION SECTIONLower Quart

2nd Quart

Third Quart

Upper Quart

Performance Rating Score

% of employees receiving perf rating 15% 40% 30% 15%

Lower Quart Calc

2nd Quart Calc

Third Quart Calc

Upper Quart Calc Total

Outstanding 5% 9.0% 7.0% 5.0% 4.0% 0.07% 0.14% 0.08% 0.03% 0.31%Exceeds Standard 15% 6.5% 5.0% 3.5% 3.0% 0.15% 0.30% 0.16% 0.07% 0.67%Meets Standard 77% 5.0% 4.0% 3.0% 2.0% 0.58% 1.23% 0.69% 0.23% 2.73%

Development 3% 1.0% 0.0% 0.0% 0.0% 0.00% 0.00% 0.00% 0.00% 0.00%Needs Improvement 0% 0.0% 0.0% 0.0% 0.0% 0.00% 0.00% 0.00% 0.00% 0.00%

Merit Budget % = 3.72%

Green colored cells reflect company AssumptionsBlue colored cells are potential merit increase amounts to yield the merit budget %

Costing Exercise

Focal Point Increase (Multiple Increases)

Your organization has 150 employees in the Engineering department, with an average employee pay of $50,000 annually. The department has a 5% merit budget with an April 1 focal-point review date. Then, due to competitive market pay movement, the company must grant a 4% market equity adjustment on July 1.

What is the cost in year 1 of these two increases?

Costing Exercise

Formula and Solution:

Eligible payroll x % increase x effective period

Eligible payroll = 150 x $50,000 = $7,500,000

Effective period of the merit increase = 9 months (April – December)

$7,500,000 x 5% x 9/12 = $281,250 (cost of the merit increase given in April)

Costing Exercise

Formula and Solution continued: After the merit increase, the eligible payroll rises to $7,875,000

since everyone has received a 5% increase ($7.5M x 5%)

Effective period of the market increase = 6 months (July – December)

$7,875,000 x 4% x 6/12 = $157,500 (cost of the market increase given in July)

Adding the two increases together gives a total cost of $438,750 ($281,250 + $157,500)

performance management and compensation

Documents

pay raise

repeatedmerit pay

improved performance

high performance

performance management

pay increasepay equity

better ones performance

ones performance input