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Stephen  Bevan

Performance-related pay and the rhetoric gap

Authors: Stephen Bevan Professor Stephen Bevan

12 November 2013

This week (11 November) I spoke at an event on the effectiveness of performance-related pay organised by the High Pay Centre. Among the panellists were Sir Philip Hampton, Chairman of the Royal Bank of Scotland and Frances O’Grady, General Secretary of the TUC. The question we were asked to address was: does PRP work? Some of the debate made it into Polly Toynbee’s column on the Guardian on Tuesday. Below is a summary of my own presentation.

The debate about the effectiveness of performance-related pay (PRP) has raged for many years. My friend Dr Ian Kessler of Oxford University once wrote that it was the area of people management where the gap between rhetoric and reality was widest. It’s hard to disagree with this conclusion given the weight of both academic and practical evidence. Some people will argue that PRP is like communism – a great idea that has never been implemented properly, while others will argue that it’s just a bad idea. My own view is somewhere in between – that it is a flawed idea because it is vastly overstates the motivational impact of pay on pretty much all aspects of job performance and, as a result, will always produce disappointing results. I think there are five issues worth examining in the current climate.

First, despite everything, we still aren’t good enough at measuring job performance. Faced with the question: ‘are we clear about what we mean by performance and the factors which drive it?’ most managers get into a muddle about whether they mean behaviour, outputs, attitudes or competencies. They know a good performer when they see one, of course, but being able to tie-down precisely which aspects of performance they want to incentivise or reward is notoriously hard to do consistently.

Second, in a knowledge-based economy, with more employees expected to be critical thinkers and with work more complex and focused on intangibles, a simplistic model of motivation with pay at the centre just won’t work. Those of you who have seen Dan Pink’s TED lecture on motivation will recognise that this truth about PRP is ‘one of the most robust findings in social science and also one of the most ignored’. Worse still, PRP can do real damage. As Jeffery Pfeffer argued in his famous article ‘Six Dangerous Myths About Pay’, PRP can erode teamwork, create an unhealthy focus on short-term results and reinforce the belief that pay is not linked to performance but to having the right relationships and an ingratiating personality.

Third, incentives can be perverse. Looking at the impact of incentive pay among bank staff in Chicago whose job it was to make loans to small businesses, Sumit Agarwal and Faye Wang found that the bank lost money by switching to incentive pay because, while it led to a 47% increase in the loan approval rate it also led to a 24% increase in the default rate. Essentially, these loan officers were approving more risky loans because of the incentive pay scheme. If we scale this up to so-called ‘casino banking’ I think we can begin to understand the potential damage that a carelessly calibrated incentive arrangement can have.

Fourth, fairness matters more. Several studies have shown that perceived fairness of the way pay is distributed can have much more impact on performance than PRP. This is an issue which Lancaster University, the CIPD and The Work Foundation looked at in some detail in a recent research paper on fairness in organisations. We found that 49 per cent of employees do not feel that rewards are distributed fairly and other research has suggested a strong link between these perceptions and employee engagement and discretionary effort.

Fifth, wide pay dispersion between senior executives and people at the lower reaches of organisations can undermine morale, motivation and innovation if employees don’t believe that top pay is justified by performance. This is a point I’ll be expanding on during our event with Business Secretary Vince Cable at The Work Foundation on 18th November. It’s clear that the perception of excessive top pay – regardless of the arguments about the labour market for CEOs – can undermine the employee engagement which so many businesses will need to help them grow.

Despite all the evidence, businesses and governments still exhibit a touching faith in the motivational power of PRP. In practice this means spending 95% of their time worrying about how they are going to spend less than 5% of their paybill. As Alfie Kohn, long-time critic of PRP and author of the book ‘Punished by Rewards’, argued businesses should pay people well, pay them fairly and then do everything possible to take money off people’s minds while they get on with their jobs.