The premise of performance related pay schemes is that higher achievement, either individually or organisationally, will bring greater rewards (Thomson, 2005). Individual based performance related pay schemes reward employees for improvements in their personal performance. Types of individual based performance related pay schemes include:
- merit based pay;
- incentive pay;
- ownership and employee share schemes; and
- skill based pay.
Merit Based Pay Schemes
A retrospective remuneration initiative, merit based pay schemes reward employees on the basis of previous performance. A merit based pay scheme is the only type of performance related pay scheme which is built into an employee’s base salary.
Research into the effectiveness of merit based pay schemes has found that merit based pay has a beneficial effect on individual motivation and performance in the workplace (Metcalf in Corby, White and Stanworth, 2005). A 2006 study of truck drivers’ safety found that an increase in remuneration based on past performance decreased the numbers of traffic accidents (Rodriguez, Targa and Belzer).
Incentive Pay Schemes
Incentive pay schemes take the form of monetary bonuses for going above personal productivity targets or reaching pre-determined financial objectives for the organisation, these bonuses are additional to the employee’s base salary.
Predominately used where targets can be easily measured, incentive pay schemes can be applied to manufacturing settings and executive performance. Research has found that productivity improvements of 20% to 50% can be obtained through the implementation of an incentive pay scheme (Lazear, 2000; Bandiera, Barankuy and Rasul, 2007).
Ownership and Employee Share Schemes
A form of performance related pay that is not based on providing immediate monetary rewards is ownership and employee share schemes. In an employee share scheme, performance is rewarded through the issuing of stock options which allow the employee to purchase fixed price stock in the company.
Ownership and employee share schemes have traditionally been used to reward senior management for performance however during the dot.com boom; start up technology companies offered employee share schemes as a hiring incentive.
Research in the 1980s was unable to prove whether employee share schemes provided increased productivity however research by Rynes, Gerhart and Parks in 2005 found a productivity improvement as a result of employee share schemes that were available to employees beyond senior management ranks.
Skill Based Pay Schemes
Additional remuneration on top of base salary in skill based pay schemes is provided to employees who undertake training and up-skilling activities. In a skill based pay scheme it is not necessary for the employee to use the increased skills in their daily work environments.
Research in the field of nursing found that implementation of a skill based pay schemes led to initial dissatisfaction from nurses who had not undertaken additional skills training however when this dissatisfaction was removed when the characteristics of skill based pay schemes were fully explained (Thompson, 2005).
Performance related pay schemes provide increased remuneration for employees whose productivity is exceeds defined targets. Such schemes include merit based pay, incentive pay, employee share schemes and skill based pay. Performance related pay schemes have been found to improve employee productivity in various employment settings.
Sources
Bandiera, O, Barankay, I & Rasul, I, 2007, “Incentives for Managements and Inequality Among Workers: Evidence from a firm-level experiment” The Quarterly Journal of Economics, May 2007, pp 729-773
Corby, S, White, G & Stanworth, C, 2005 “No news is good news? Evaluating new pay systems” Human Resources Management Journal Vol 15 No 1, pp 4 – 24
Lazear, E, 2000 “Performance Pay and Productivity” The American Economic Review, Vol 90, No 5, pp 1346-1361
Rodriguez, D, Targa, F & Belzer, M, 2006 “Pay Incentives and Truck Driver Safety: A Case Study” Industrial and Labour Relations Review Vol 59 No 2 pp 205-225
Rynes, S, Gerhard, B & Parks, L, 2005 “Personnel Psychology: Performance Evaluation and Pay for Performance” Annual Review of Psychology, Vol 56 pp 571-600
Thompson, R, 2005 “Is Pay for Performance Ethical?” The Physician Executive, Nov-Dec 2005, pp 60-63
Tracey Lloyd - Based in Australia, Tracey Lloyd is experienced in management & strategic development of community projects and non-profit ...
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