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❶Though piece rates offer the most potential for accurate performance measurement and are thus the best indicator of actual individual performance , the cost of successfully implementing them under these organization conditions might be prohibitive.

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However, few examples of group plans that add payouts into base salaries exist cell d in Figure More common are plans that tie payouts to work group, facility such as a plant or department , or organization performance measures and do not add pay into base salaries cell c.

There are many variations on profit-sharing plans, but most link payouts to selected organization profit measures and often pay out quarterly. A cash profit-sharing plan, for example, might specify that each employee covered will receive a payout equal to 15 percent of salary if the company's profit targets are met. Gainsharing plans, like profit-sharing, come in many forms, but all tie payouts to some measure of work group or facility performance, and most pay out more than once a year.

Traditional gainsharing plans, such as Scanlon, Rucker, or. Improshare plans named by or for their inventors , commonly provide a monthly bonus to workers of a production line or plant. The bonus is based on value added or cost savings, defined as the difference between current production or labor costs and the historical averages of these costs as established by accounting data.

Savings are split between employees and management; the employees' share of the savings is then typically allocated to each employee as some uniform percentage of base pay. Our choice of matrix dimensions was deliberate; they distinguish the major differences between merit pay and other types of pay for performance plans, and they reflect distinctions made in the research we reviewed. We refer to the matrix throughout our review of research to help distinguish the four types of pay for performance plans and the research findings related to each.

Organization pay objectives include motivating employees to perform, as well as attracting and retaining them; the fair and equitable treatment of employees; and regulating labor costs. We are interested in research on how pay for performance plans influence an organization's ability to meet these objectives and in the conclusions we can draw—particularly regarding merit pay plans.

Obviously, the pay objectives listed are related, and organizations will face trade-offs in trying to meet them, whether a particular pay for performance plan or no pay for performance plan is adopted. We deal with these trade-offs in a subsequent section. Do pay for performance plans help sustain or improve individual and group or organization performance? Research examines this question most directly, and we review it first.

The research most directly related to questions about the impact of pay for performance plans on individual and organization performance comes from theory and empirical study of work motivation. The social sciences have produced many theories to explain how making pay increases contingent on performance might motivate employees to expend more effort and to direct that effort toward achieving organizational performance goals.

Expectancy theory Vroom, has been the most extensively tested, and there appears to be a general consensus that it provides a convincing if simplistic psychological rationale for why pay for performance plans can enhance employee efforts, and an understanding of the general conditions under which the plans work best Lawler, ; Campbell and Pritchard, ; Dyer and Schwab, ; Pinder, ; Kanfer, Expectancy theory predicts that employee motivation. Employees understand the plan performance goals and view them as "doable" given their own abilities, skills, and the restrictions posed by task structure and other aspects of organization context;.

There is a clear link between performance and pay increases that is consistently communicated and followed through; and. Employees value pay increases and view the pay increases associated with a plan as meaningful that is, large enough to justify the effort required to achieve plan performance goals. Goal-setting theory Locke, ; Locke et al. According to Locke et al. In addition, feedback, supervisory support, and a pay for performance plan making pay increases—particularly "meaningful" increases—contingent on goal attainment appear to increase the likelihood that employees will achieve performance goals.

Taken together, expectancy and goal-setting theories predict that pay for performance plans can improve performance by directing employee efforts toward organizationally defined goals, and by increasing the likelihood that those goals will be achieved—given that conditions such as doable goals, specific goals, acceptable goals, meaningful increases, consistent communication and feedback are met.

Among the pay for performance plans displayed in our matrix Figure , cell b , individual incentive plans, such as piece rates, bonuses, and commissions, most closely approximate expectancy and goal-setting theory conditions. Individual incentive plans tie pay increases to individual level, quantitative performance measures. It is generally believed that employees view individual-level measures as more doable, because they are more likely to be under the individual's direct control.

This is in contrast to group incentive plans cells c and d in Figure , which are typically tied to measures of work group, facility, or organization performance. Similarly, quantitative measures are seen as more acceptable to employees because their achievement is less likely to be distorted and more directive because they dictate specific goals. This is in contrast to merit plans cell a in Figure , which are typically tied to more qualitative, less specific measures of performance see Lawler, , , for a more detailed analysis of these points.

Given that individual incentive plans meet several of the ideal motivational conditions prescribed by expectancy and goal-setting theories, it is not surprising that related empirical studies tend to focus on individual rather than merit or group incentive plans. In reviews of expectancy theory research, Campbell and Pritchard , Dyer and Schwab , and Ilgen all agree that these studies establish the positive effect of individual incentive plans on employee performance.

The studies reviewed include both correlational field studies and experimental laboratory studies, with the correlational studies predominating. While these studies were primarily designed to test specific components of expectancy theory models, they all show simple correlations, ranging from. Cumulative studies primarily laboratory also support goal-setting theory predictions that specific goals, goal acceptance, and so forth, will increase employee goal achievement—in some cases, by as much as 30 percent over baseline measures Locke et al.

A laboratory study by Pritchard and Curts also reported that individual pay incentives increased the probability of goal achievement, but only if the incentive amount was meaningful. In this study "meaningful" was three dollars versus fifty cents versus no payment for different levels of goal achievement on a simple sorting task.

Only the three-dollar incentive had a significant effect on individual goal achievement. Similar findings have been reported by others see Terborg and Miller, There are also some early field studies of piece-rate-type individual incentive plans conducted in the wake of claims made by Frederick W.

Taylor , the prophet of "scientific management" and inventor of the time and motion study. The more methodologically sound studies generally compared the productivity of manufacturing workers paid by the hour and those paid on a piece rate plan, reporting that workers paid on piece rates were substantially more productive—between 12 and 30 percent more productive—as long as 12 weeks after piece rates were introduced Burnett, ; Wyatt, ; Roethlisberger and Dickson, Viewed as a whole, these studies establish that individual incentives can have positive effects on individual employee performance.

But it is also important to understand the restricted organizational conditions under which these results are observed without accompanying unintended, negative consequences. Case studies suggest that individual incentive plans are most problem-free when the employees covered have relatively simple, structured jobs, when the performance goals are under the control of the employees, when performance goals.

There are a number of case studies that document the potentially negative, unintended consequences of using individual incentive plans outside these restricted conditions. Lawler summarizes the results of these case studies and their implications for organizations.

He points out that individual incentive plans can lead employees to 1 neglect aspects of the job that are not covered in the plan performance goals; 2 encourage gaming or the reporting of invalid data on performance, especially when employees distrust management; and 3 clash with work group norms, resulting in negative social outcomes for good performers. Babchuk and Goode reported an example of neglecting aspects of a job not covered by plan performance goals.

Their case study of retail sales employees in a department store showed that when an individual incentive plan tying pay increases to sales volume was introduced, sales volume increased, but work on stock inventory and merchandise displays suffered.

Employees were uncooperative, to the point of "stealing" sales from one another and hiding desirable items to sell during individual shifts. Whyte and Argyris provided examples of how individuals on piece rate incentives or bonus plans tied to budget outcomes distorted performance data.

Whyte described how workers on piece rate plans engaged in games with the time study man who was trying to engineer a production standard; Argyris described how managers covered by bonus plans tied to budgets bargained with their supervisors to get a favorable budget standard.

Many studies of individual incentive plans—from the Roethlisberger and Dickson field experiments to case studies like those of Whyte—have shown clashes between work group production norms and high production by individual workers, which led to negative social sanctions for the high performers for example, social ostracism by the group.

These studies also suggested that development of restrictive social norms had some economic foundation: Restrictive norms were also more common when employee-management relations were poor, and employees generally distrusted managers.

These findings suggest the dangers of using individual incentive plans for employees in complex, interdependent jobs requiring work group cooperation; in instances in which employees generally distrust management; or in an economic environment that makes job loss or the manipulation of incentive performance standards likely. Indeed, a recent study by Brown reported that manufacturing organizations were less likely to use piece rate incentives for hourly workers when their jobs were more complex a variety of duties or when their assigned tasks emphasized quality over quantity.

It is not difficult to view merit pay plan design as a means of overcoming some of the unintended consequences of individual incentive plans. This is especially true when merit plans are considered in the context of more complex managerial and professional jobs. As we document in the next chapter, merit pay plans are almost universally used for managerial and professional employees in large private-sector organizations. The most common merit plan design is a "merit grid" that directs supervisors to allocate annual pay increases according to an employee's salary grade, position in the grade, and individual performance appraisal rating.

The type of performance appraisal most commonly used for managerial and professional jobs involves a management-by-objective MBO format in which a supervisor and an employee jointly define annual job objectives—typically both qualitative and quantitative ones. The rating categories or standards generated from MBO appraisals are usually qualitative and broadly defined. Most organizations use three to five categories that differentiate among top performers, acceptable performers one to two categories , and poor or unsatisfactory performers one to two categories , with the acceptable category or categories covering the majority of employees Wyatt Company, ; Bretz and Milkovich, ; HayGroup, Inc.

This addition of payouts to base offers the potential for cumulative long-term salary growth not typical of other salary plans. The use of an objectives-based performance appraisal format might be reasonably viewed as recognition that it is difficult to capture all the important aspects of managerial and professional jobs in a single, comprehensive measure such as "sales volume"; multiple measures, quantitative and qualitative, might be developed in such appraisal formats, thus decreasing the probability that important aspects of a job will be ignored.

The choice of a performance appraisal format may also assume that the perspectives of both supervisor and employee are needed to set appropriate objectives and avoid gaming. The broader performance appraisal rating categories typical of merit pay plans may also tend to decrease clashes between work group norms and an individual performer,.

The relatively smaller payouts and their addition to base salaries could also make merit plans seem less economically threatening than individual incentive plans. Merit plan design characteristics, intended to diminish the potentially negative consequences of individual incentive plans, can, however, also dilute their motivation and performance effects.

Performance appraisal objectives are typically less specific than the quantitative ones found under individual incentive plans. Employees may thus see them as less doable and more subject to multiple interpretations, and their attainment may be less clearly linked to employee performance. Pay increases are smaller and may be viewed as less meaningful; the addition of pay increases into base salaries may also dilute the pay for performance link Lawler, ; Krzystofiak et al.

Many management theorists have suggested that employers focus on the process aspects of performance appraisal and merit plans in order to enhance their motivational potential see Hackman et al. For example, employee-supervisor interaction and bargaining during performance appraisal objective-setting could increase an employee's commitment and understanding of goals and feelings of trust toward management. Training both supervisors and employees in how to use performance appraisal objective-setting, feedback, and negotiation effectively is recommended.

Communication of merit pay plans as a means of differentiating individual base salaries according to long-term career performance is also suggested as a means of helping employees to see these plans as providing meaningful pay increase potential.

Our review of merit pay practices in the next chapter shows that some organizations are following these recommendations. There is very little research on merit pay plans in general nor on the relationship between merit pay plans and performance—either individual or group—in particular.

In a recent review of research on merit plans, Heneman reported that studies examining the relationship between merit pay and measures of individual motivation, job satisfaction, pay satisfaction, and performance ratings have produced mixed results. The field studies comparing managers and professionals under merit plans with those under seniority-related pay increase plans, or no formal increase plan, suggest that the presence of a merit plan positively influences measures of employee job satisfaction and employee perceptions of the link between pay and performance.

In several of these studies, the stronger measures of job satisfaction and of employee perceptions of pay-to-performance links found under merit pay plans were also correlated with higher individual performance ratings Kopelman, ; Greene, ; Allan and Rosenberg, ; Hills et al.

However, other field studies, notably those of Pearce and Perry and Pearce et al. Heneman's review and the reports of the other researchers cited all point out the many methodological limitations on the few existing studies: Although many of these limitations probably reflect organizational reality, it is impossible to draw conclusions about the relationships between merit pay plans and performance from this research.

The research also offers no means for comparing the short- or long-term performance effects of merit plans with those of other incentive plans. The adoption of group incentive plans may provide a way to accommodate the complexity and interdependence of jobs, the need for work group cooperation, and the existence of work group performance norms and still offer the motivational potential of clear goals, clear pay-to-performance links, and relatively large pay increases.

Most of the group incentives used today—gainsharing and profit-sharing plans—resemble individual incentive plans; they are tied to relatively quantitative measures of performance, offer relatively large payouts, and do not add payouts into base salaries.

While group incentive plans might reasonably be predicted to offer some motivational potential for performance improvements, such a prediction requires a sizable inferential leap from the expectancy and goal-setting literature. Two of the three conditions of expectancy theory—that goals be doable and that the link between employee performance and pay be clear—are not well satisfied. The major motivational drawback to group incentives appears to be the difficulty an individual employee may have in seeing how his or her effort gets translated into the group performance measures on which payouts are based.

Academics and other professionals experienced in the design and implementation of group incentive plans emphasize the importance of organization conditions that foster employees' beliefs about their ability to influence aggregate performance measures O'Dell, ; U.

Examples of such conditions include the following: All of these suggestions seem reasonable but are largely the product of expert judgment, not empirical studies. Renewed interest in gainsharing, profit-sharing, and other types of group incentives during the s although not necessarily accompanied by increased adoption of such plans, as we document in the next chapter has led to several reviews of research on group incentives Milkovich, ; Hammer, ; Mitchell et al.

Two methodologically rigorous gainsharing studies examined the productivity effects of traditional gainsharing plans covering nonexempt employees in relatively complex, interdependent jobs in manufacturing plants. Schuster's a was a controlled, longitudinal study five years examining the effects of introducing gainsharing plans on measures of plant productivity; he reported that for half of the 28 sites, there were immediate, significant productivity gains over baseline measures and continued effects over the study period.

He noted that less successful plans tended to be in sites where many different plans were adopted to cover work group teams instead of a plant-wide plan, when infrequent bonus payments were made, when union-management relations were poor, and when management attempted to adjust standards and bonus formulas without employee participation. Much of the research on gainsharing is based on single case studies lacking rigorous methodological controls.

There are few reports of gainsharing "failures. Indeed, there is an emerging case study literature supporting this view see Beer et al. Some go so far as to suggest that organizational context should be the only focus of productivity improvement efforts; that pay for performance plans will ultimately. The research evidence cannot confirm or deny any of these alternatives. Gainsharing plans have been most common in manufacturing settings, covering mostly nonmanagement employees, and the research on gainsharing is thus restricted to these private-sector settings and employees.

They note that the limited case study research available suggests that profit-sharing plans are less likely than gainsharing plans to improve performance of nonmanagerial employees.

Expectancy and goal-setting theories would predict this result because it is difficult to see how these employees would translate their job efforts into organizational profit improvements. Advocates of profit-sharing plans Metzger, ; Profit-Sharing Council of America, , however, point out other potential benefits of plan adoption, most notably the improved employee commitment to the organization and understanding of its business that can emerge when information relevant to profit generation is shared with employees as part of the plan.

As we noted for gainsharing plans, it is possible that these benefits would result from organization conditions like information sharing absent a profit-sharing plan. Profit-sharing plans and managerial bonus plans have traditionally been used as part of executive and middle management compensation packages; typically they tie payments to organizational financial outcomes such as return on assets, return on equity, and so forth.

Most of the studies of executive compensation reviewed by Ehrenberg and Milkovich, , however, examine the relationship between overall compensation levels and firm performance, not between profit-sharing and firm performance. However, a recent study by Kahn and Sherer explored the impact of managerial bonus plans on the performance of managers in the year following a bonus award.

The company studied had a bonus plan for which all middle-to higher-level managers were eligible, but which in practice targeted critical higher-level managers for the most substantial performance payments. Targeted managers were eligible for bonuses representing 20 percent of base salaries; other managers were eligible for 10 percent bonuses. The bonus plan was tied to a management-by-objective appraisal system that used some common individual-level behavioral and outcome measures for all managers.

Controlling for pay level, previous performance, and seniority, Kahn and Sherer found that the targeted critical managers had significantly higher performance ratings in the year following bonus payment than less critical, nontargeted managers. They suggested that higher potential payouts were highly correlated with higher performance effects.

Another recent study by Gerhart and Milkovich analyzed five years of firm performance and compensation data for 16, mid-level managers and professionals in large corporations. They controlled for individual, job, and. Specifically, every 10 percent bonus increase was associated with a 1. This association, while not statistically significant, is certainly not trivial in absolute terms. Although the study did not control for prior profit history, these results suggest that profit-sharing plans may have a positive impact on organizational performance among the higher-level managerial and professional employees whose jobs are most directly related to financial outcomes.

However, another study by Abowd qualifies these results, suggesting that profit-sharing bonuses for higher-level employees will be more likely to improve firm performance when economic conditions make such improvements realistic.

Most of the research examining the relationship between pay for performance plans and performance has focused on individual incentive plans such as piece rates. By design, these plans most closely approximate the ideal motivational conditions prescribed by expectancy and goal-setting theories, and the research indicates that they can motivate employees and improve individual-level performance.

However, the contextual conditions under which these plans improve performance without negative, unintended consequences are restricted; these conditions include simple, structured jobs in which employees are autonomous, work settings in which employees trust management to set fair and accurate performance goals, and an economic environment in which employees feel that their jobs and basic wage levels are relatively secure.

Because these conditions—especially the job conditions—are not found collectively in many organizations and do not apply to many jobs, some researchers suggest that organizations might adopt merit pay plans or group incentive plans in an effort to avoid the potentially negative consequences of individual incentive plans while still reaping some of their performance-enhancing benefits.

Merit pay plans have some design features, such as the addition of pay increases to base salary, and the use of individual performance measures, including both quantitative and qualitative objectives, that can help avoid some of the negative consequences of individual incentives plans; these characteristics may also dilute the plans' potential to motivate employees.

Organizations, however, can take steps to strengthen the motivational impact of merit plans. Delivering Finest Quality On Time. Providing Research Paper Globally. Satisfying Clients with our Excellence. Lets Start Place Order! Welcome To Research Paper Town. Click Here To Chat. When you are ready to pay someone to do your research paper, ensure that they offer the following benefits: A free anti-plagiarism report will be created using plagiarism detection tools.

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