Although a growing body of evidence links effective pay-for-performance programs to a company's overall success, employers still face tough choices in crafting the best compensation programs, benefits experts say.
Companies often get their performance-pay systems wrong, and that can mean serious effects for the overall business, says Dow Scott, professor of human resources and employment relations at Chicago's Loyola University and author of the book Incentive Pay: Creating a Competitive Advantage.
"Highly effective companies do tend to have a bit more variable rewards," he says. "But there's no one-size-fits-all model. ... Business models change and companies have to change their compensation systems to align with that. It's the biggest investment that a business has—compensation. So when you talk about that piece called pay-for-performance or merit pay, you have to fit it properly. For some people, a 10 percent bonus is a lot of money. For others, it's not enough."
Recent studies conducted by the Seattle-based Institute for Corporate Productivity, or i4cp, highlight the problems. More than 90 percent of organizations tied salary increases and annual bonuses to specific performance measures, up from 78 percent in 2009, a September 2011 report by i4cp shows. However, the study also found that many companies aren't successfully executing their strategy to achieve the results they want.
In May, i4cp released a new report, Performance Management Playbook: Managing Critical Performance Challenges, which offered examples of companies that had achieved better results with their pay-for-performance plans, and presented guidelines for successful programs.
Among the things companies should do is, simplify goals and establish specific objectives, then clearly tie them to the company's most important mission, says the report's author, Amy Armitage, i4cp's director of member research programs.
"People really need to get back to the things that add value and keep a laser focus on what impacts the business," Armitage says.
Among the companies profiled was Pittsburgh-based PNC Bank, which recently rolled out a comprehensive performance management program that established clearer and more standardized guidelines for companywide employee success. Managers talk with employees about their performance throughout the year rather than just during a one-time annual performance review. Constant feedback gives the company a better chance of rewarding the employees who consistently meet and exceed their goals, says Michael Zumwalt, vice president and project manager for talent management at PNC.
"We have developed our own performance management training program for managers to help them focus on this ongoing conversation and give them the tools they need to understand, track and discuss their employees' performance throughout the year," Zumwalt says.
Still, even with the best-designed programs, companies face challenges in making incentive and merit-pay programs effective in today's economy, says Kerry Chou, senior practice leader for compensation practices at Arizona-based WorldatWork, a nonprofit human resources research and advocacy group. Chou says that incentive pay is still critical in driving a company's success, but the systems have to be clearly thought out.
On one hand, high unemployment in some sectors makes some company leaders less interested in boosting incentive pay. Yet there are severe shortages in other sectors, such as programmers for the high-tech industry, that may require more attractive incentive and bonus programs, Chou said.
At the same time, fallout from the financial crisis has many concerned about incentive programs that may encourage employees to take on questionable, or even immoral, practices, to win huge bonuses.
"Along that line, many organizations are taking a closer look at their goals ... certainly the financial services industry is ... in terms of making sure that the goals they set are not incentivizing people to take on undue risk," Chou says.
Another critical feature of an effective incentive program is to make sure managers single out high performers, Chou says. Too often, managers don't want to make the tough calls and end up giving only small pay differentials to the highest performers. Especially with tight budgets, Chou says, "sometimes managers have to make tough calls and give nothing to lower performers and then give the highest performers a 6 or 7 percent increase."
In some cases, adds Loyola's Scott, companies simply need to communicate better.
"Pay secrecy can sometimes get in the way of compensation systems," Scott says. "If you're giving people bonuses for excellent performance yet you're not telling anybody, how does anyone know what their hard work is really worth?"
Scott says progressive companies are also starting to look more closely at which workforce sectors should have incentive-pay programs.
"We've started to push variable pay and incentive pay lower and lower in organizations, but can we really measure performance at those levels?" he says. "What if it causes someone to lose their car? If you're at a $30,000 salary and all of [a] sudden, you don't get $5,000, that's a serious issue for you financially. You have to question that."
Meg McSherry Breslin is a writer based in the Chicago area. Comment below or email firstname.lastname@example.org.