In a pay-for-performance (PFP) system, compensation is linked to job performance: individuals who perform at a higher level earn more. These systems are growing in popularity and are being implemented in a variety of industries. Most notably, the healthcare industry has used PFP systems in an attempt to eliminate waste and improve patient outcomes. This has led PFP systems to face increasing scrutiny, with the most intense scrutiny focused on situations where PFP begins to breaks down.
PAY-FOR-PERFORMANCE AND UNDERPERFORMERS
Previous research assumes that PFP systems motivate employees regardless of their performance level; however, there are reasons to believe that this is false. Consider how PFP systems usually manage underperforming employees. Typically, an organization divides the year into a series of periods. When employees underperform in one period, the organization has two options: (A) apply a penalty—making employees carry that debt into the next period; or (B) not apply a penalty—allowing employees to start fresh during the next period. Option A—applying a penalty—could cause underperforming employees to lose motivation. They may believe that they are “so far in the hole” that no amount of effort will help them get out, perpetuating their underperformance. Option B—not applying a penalty—could also cause a loss of motivation, as employees may conclude, “I can’t meet my targets during this period, so there is no point in trying harder for now. I’ll just wait until the next period starts and then start over.” Again, this perpetuates their underperformance.
With few obvious options, most literature recommends simply replacing underperforming employees. Of course, this is easier said than done, as replacing an employee requires time and significant turnover costs. An alternative solution utilized by many organizations is to create a PFP exception. These organizations place underperforming employees in debt to the system, but if their debt level increases to a level where it is negatively impacting motivation, the debt is removed. It is unclear what effect these exceptions (or debt-removals) have on employee performance. On the one hand, employees may interpret this as an act of mercy and kindness by the organization, increasing their sense of obligation to their employer and increasing their motivation to do well in their job. On the other hand, this exception breaks down the perceived relationship between performance and compensation, and as a result could weaken the motivational effects of the PFP system.
PAY-FOR-PERFORMANCE EXCEPTIONS
Researchers (Maltarich, Nyberg, Reilly, Abdulsalam, & Martin, 2017) studied how PFP exceptions impact underperforming employees. Using data from a for-profit healthcare organization, they examined how PFP and PFP exceptions impact the performance of medical practitioners. The results showed that the PFP system effectively incentivized medical practitioners to perform at a higher level, but when a practitioner went into debt to the PFP system, the system’s ability to motivate performance steadily decreased. When a PFP exception was granted, the PFP’s motivational effects were restored, but this positive effect decreased over time and disappeared after approximately two months. This suggests that the positive effects of a PFP exception are brief. Interestingly, practitioners with a high level of system “debt” responded to the PFP exception much more positively than those with low levels of “debt.”
PRACTICAL IMPLICATIONS FOR ORGANIZATIONS
Overall, the results of this study indicate that PFP exceptions do help restore motivation for underperforming employees, but the exception is only effective for a short time. Forgiving the debt accrued by an underperforming employee may cause the employee to develop positive feelings toward their employer, but those feelings are not enough to result in a long-term improvement in performance. In addressing an underperforming employee, managers should consider PFP exceptions as one strategy, but they should also recognize that other strategies—such as additional training, increased feedback, and altered performance goals—may be necessary to address the issue.
Maltarich, M. A., Nyberg, A. J., Reilly, G., Abdulsalam, D., & Martin, M. (2017). Pay-for-performance, sometimes: An interdisciplinary approach to integrating economic rationality with psychological emotion to predict individual performance. Academy of Management Journal, 60(6): 2155-2174.