Benefits and Risks of Performance-based Compensation System

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The amount of the anticipated pay is crucial while making a decision to join an organisation. It determines customers’ buying power. It is also equally important to employers. When running a business, salary comes in as a cost of encouraging human resources to execute their designated tasks. In every organisation, salary or wage levels are incorporated in motivational programmes. This paper discusses performance-based pay system as an important strategy for basing employee compensation scheme.

It first identifies the benefits and risks of performance compensation systems for my organisation based on the synthesis of three scientific papers that address the issue. It then explains various components of the organisation’s new compensation system before presenting an action plan for the implementation of the new system. In the last section, the paper presents a short notice to be presented to the board of management explaining the decision to migrate from job-based to the performance-based compensation system, which can attract and retain key talent.

Benefits and Risks of Performance-based Compensation System


Performance-based pay is a system of payment in which people are remunerated or paid equivalently to their amount of work output. Payment of salespeople on a commission basis depending on the amount of sales they make is one of the best examples of this system. Borrowing from the claim that people work with determination and extra effort to earn optimally, some employers base their remuneration programmes on work performance. In the case of sales personnel, “they receive more pay for selling more, and low performers do not earn enough to make retaining the job worthwhile, even if they manage to keep the job” (Green and Heywood 726). Apart from the sales jobs, the concept of performance-related payment system applies to many other professions, especially where work measurement is done.

People’s needs are insatiable. Therefore, when they make more money, their needs increase to correspond to the increasing income. They also desire to remain within the established social class that represents their social status. This observation suggests that earning lower amounts of income in the future is tantamount to the erosion of the established social class status. Considering the insatiability and the desires to maintain a reputable social status, performance-based pay system encourages higher performance at work. Hence, employees will always desire to perform better for a better pay.

This strategy has the implication of rising the social status profiling. However, performance becomes a function of the level of outputs, but not necessarily the quality of the work done. Consequently, amid the benefits of increasing employees’ performance levels with the objective of making more money, which increases their purchasing power and their social status, performance-based pay system may present the risk of poor work quality.

The amount of compensation and the criteria for determining it are important sources of job satisfactions and increased employee performance levels. Indeed, in the recruitment process, the interviewing persons request the interviewees to state their anticipated wage or monthly pay. The logic behind posting this question is pegged on the scholarly contention that when the pay that is offered to successful candidates is too low with reference to their anticipation, it is likely that the job may be unsatisfying. Conversely, when the offered salary is too high compared to the candidate’s expected pay, a general interpretation is that the candidate is not sure of what the job entails. Performance-based pay system may help in eliminating this dilemma.

In organisations that deploy the performance-based system, wage or salary constitutes an important factor for enhancing worker motivation to achieve the employers’ goals. Various special factors are crucial to the enhancement of employee job satisfaction, although contentment with salary or wage levels is mandatory. The pressure that is exerted by the challenges of job satisfaction is essential in determining the appropriate administrative decisions. Drago asserts, “Dissatisfaction with the amount of pay leads to employees’ decreased job satisfaction and interest in working” (533). This claim implies that pay comprises an important factor in determining employee productivity.

Productivity is a crucial aspect of measuring employee performance. Workers are also more willing to learn, perform better in their organisational tasks, and/or reduce the rate of absenteeism, turnover intentions, and the actual turnover when organisations responds proactively respond to their payment grievances (Green and Heywood 721). Performance-based payment implies that rewarding schemes are based on other things, as opposed to an individual’s credentials and/or the experience that a person gains in a given profession.

Supporters of performance-based payment scheme such as Heywood and Wei (524) hold that the approach is a better and fair mechanism for remunerating people, as opposed to paying them equally, especially by noting that individuals report different performance levels for similar job elements. In addition to the motivation of higher performance behaviour, performance-based pay eliminates the incidents of favouring some people during the process of reviewing salaries and wage increments. Major criticisms on performance-based pay are based on performance measurements.


An accurate evaluation of performance poses challenges. Issues such as determining the performance from an objective approach and the enhancement of cooperation amongst various employees depend on the deployed criterion, which may not be applied homogeneously across different professions. In some professions, Green and Heywood (714) say that that the criterion presents the demerit of poor service delivery.

For instance, in a customer call centre, performance may be measured objectively through the average amount of time that a call centre worker utilises with customers. Although a higher average may reflect the performance of an employee, the quality of the offered service is not reflected in such a measure. A higher average does not also reflect whether the problem of the client is resolved or the customer is satisfied. Green and Heywood suggest, “performance-related pay may also cause a hostile work attitude…multiple employees may compete for the attentions of a single customer in times of low customer volumes” (727). In a situation where clients acquire help from more than one person within the sales department, resentments are highly probable when persons who make the actual sales take the commission.

Enhancing the performance of an organisation using performance-based remuneration system may give rise to problems in times of economic downturns.

Since their establishment, many organisations have been managed hierarchically through a bureaucratic system in which the pay level is a function of the position of an employee in the hierarchy. Adopting a performance-based pay system in such organisations entails creating a change. This move presents the risk of employees’ resistance to change. Drago says that people are generally resistant to change, especially when the desired change influences them negatively (527). The performance-based payment system encompasses one of the changes that may face a significant criticism by employees, especially those in senior levels in the hierarchical management protocol. Senior employees whose payment needs adjustment to meet their performance levels are most likely to object the system when subordinates who record high-performance level earn higher incomes.

Amid the resistance to change from people whose salaries and wages are reviewed downward after the adoption of the performance-based payment system, the subordinates may embrace the change. Consequently, implementing performance-based pay systems within an organisation may present the risk of creating conflicts between employees and their line managers and supervisors. Additionally, in the effort to earn higher pays, employees may work at unsafe speeds. This situation is undesired in tasks that involve compliance with details and/or the observation of high-quality standards.

Performance-based compensation system may increase earnings risks. Payment schemes may fail to incorporate employee wage demands. Basic estimates of job satisfaction assume that earning is constant. This claim implies that any recorded impact of earning risk is replicated in the decreased levels of satisfaction. Heywood and Wei evidence that people who have high tolerance levels to risks possess higher probabilities of selecting jobs that are remunerated based on their performance (525).

This observation suggests that performance-based pay is only appropriate to people who have high-risk tolerance levels. Nevertheless, although performance-based pay relates to a higher risk of earning, it does not imply that people who are remunerated based on their work performance are unsatisfied with their jobs. The risk of tolerance is a personality perspective that varies across different people.

Components of the New Compensation System

In the organisation, a performance-based system for rewarding employees who improve their performance needs to conform to the current behavioural principles. However, such a payment plan needs to ensure high productivity at low labour costs. To this extent, the organisation must define the objectives that workers need to pursue. The system needs to define a means of measurement of performance in a transparent way to eliminate claims of unfair remuneration. It also needs to define risk-averseness for employees together with whether they need to work in teams or individually.

The first component of the performance-based payment system for the organisation defines the goals of the system. Before taking actions in changing the job-based performance pay system to the performance-based system, determining the realistic objectives and goals is important. Despite the fact that the organisation can improve recruitment, motivation, and retention functions via the new system, considering other necessary priorities is necessary.

For example, performance-based pay system needs to ensure equity and equality through the provision of high compensation to the highest performers. Considering the effects of the new system on the organisation’s cultural values is also crucial. For instance, some work structures require collaboration through teamwork. Therefore, addressing the effects of the new system on competition among work team members in the quest to achieve higher rewards is crucial. This strategy underlines the importance of the next component of the performance payment system, namely determining who needs to be paid based on performance.

Performance-based pay system can be inclusive or non-inclusive. While determining the preferred coverage, it is necessary to have a mechanism for selecting who needs to be remunerated on the performance basis. Part of this component entails screening messages that need to be sent to workers through the performance-based pay system. Two options are available: ensuring comprehensive coverage of all employees through the system to ensure unification of the workforce in the effort to pursue common objectives and goals, and limiting its applicability to workers who are responsible for its core functions and results. Limiting its application to only a few employees can induce appropriate employees behaviour while at the same time creating conflicts. Therefore, the first option is the most preferred.

Performance-based payment system underlines the importance of establishing the criteria for determining performance levels for a corresponding amount of remuneration. Thus, the incorporation of a measurement and appraisal system for performance cannot be negated. A measurement component responds to the interrogative on what needs to be rewarded by the new system. Care should be taken to ensure reinforcement of the desired outcomes through a performance-based system.

The outcomes should not be counterproductive. A performance appraisal system needs to define the anticipations of the employees in good time, despite possibilities of variations along the process. Clear goals help in constructing a road map. Where performance outcomes are beyond the control of workers, supervisors and line managers can help in making comparison across different workers to help in the evaluation of performance. Multiple systems of measurement are important to ensure sufficient capturing of all accomplishments.

The performance measurement needs to reinforce organisational behaviours such as collaboration and teamwork. This requirement underlines the necessity of considering the perspectives of individual work teams and organisations’ productivity and performance while developing performance-level measures and evaluation systems. Such a system needs to have a component of ensuring integrity that is tied to the appraisal system.

Acceptability of a performance pay systems in the long term requires the incorporation of safeguards to mitigate compensation based on low-performance thresholds and/or on the employee tenure. Such safeguards include allowing the participation of employees or the involvement of unions in setting a performance-based system and permitting supervisors to play a role in the evaluation of the appraisal and performance measurement.

However, this claim does not imply that the challenge of leniency may not emerge. In the effort to maximise the benefits that employees get, some supervisors may rate some of the employees favourably. This behaviour is common in situations where work teams compete for a jackpot of money in which a supervisor rates all work team members as outstanding performers. The move underlines the necessity of balancing evaluation and compliance with the principles of integrity and transparency. This plan can also eliminate the challenge of discrimination, which can lead to a higher remuneration of underperformers due to discrepancies in the measurement and appraisal system arising from preferences on some people.

Implementation of the performance-based payment system in the organisation will consume organisational resources (time and money). Thus, in its development, consideration of the component of cost management remains critical to its success. Indeed, the system does not mean that the organisation resolves the problem of inadequate financial and time resources. To ensure that the systems remain within the constraints of the available resources, various techniques such as forced distribution, rewarding people at different levels using dissimilar percentages, and creating control points in the system can be deployed as some of the cost management strategies. Control points can constitute an important strategy for ensuring the control of the total salary costs within my organisation. This approach creates growth of individual employees’ salary, which serves as a break in the progression of the total organisation’s wages and salary costs.

Action Plan for the Implementation of the New System

Considering the benefits of the performance-based payment system, my organisation needs to implement it. An action plan for implementing the new system should guarantee the attainment of higher organisational results by encouraging employees to achieve higher results in their respective responsibilities and tasks. The action plan needs to reflect various organisational behavioural principles as discussed below.

Action Description Time Resources
Develop objective measures The system should replace various subjective measures of performance with objective measures. Job-based performance reviews rely on the perception of workers’ performance, as opposed to the attainment of objective results. Thus, it is necessary to eliminate perceptions such as likeability, conformance, and prejudice in the new approaches to measuring performance. 2 days Input from all departmental heads
Develop performance-based pay mechanisms The system should incorporate pay based on performance in the place of bonuses. Bonuses are discretionary rewards for work well done. Although they are appropriate, they do not sustain and/or improve performance. In their awards, workers are not informed on what they need to do to receive them. 2 days Input from the finance advisor
Develop monthly performance measures It should adopt frequent measures instead of yearly performance measures. Measurement of performance requires the deployment of objective data to arrive at performance ratings. Yearly measurement of performance simply calls for supervisors to use old data to conduct ratings. 1 day Input from all departmental heads
Develop a system of measuring personal or smaller work team performance A performance-based system that is based on the performance of large groups has the challenge of making workers incapable of controlling outcomes. It is also uncertain with respect to personal efforts since it fails to clarify on what individual employees need to do to benefit from the reward. 1 day Input from all departmental heads
Establish actionable measures instead of undifferentiated financial measures It should put in place Employees should only get rewards for results that can be directly related to them or which they have influenced. Measures such as the return on equity and shareholder returns are an inappropriate basis for performance-based payment. The organisation needs to ask what behavioural changes are necessary to improve the measured results. 2 days Input from all departmental heads, including the finance advisor
Create a balanced plan for measuring performance Unintended results may accrue from one-dimensional performance-based payment plans. For instance, paying commissions to salespeople based on revenue creation may compel them to market some things that customers may not pay for and result in unrealistic productions demands. 1 day Input from all departmental heads

Short Notice

Our organisation has a need to ensure increased performance. Thus, we have been scrutinising an array of options that can help to boost its performance. After studying various resources that can be harnessed to achieve this concern, I identified employees as one of the most important available resources. They can encourage a continuous success of the organisation through their talent. Therefore, issues such as their attraction and retention are important. In particular, retaining the top talent is necessary for the organisation to increase its productivity.

I write to bring to your attention the need to change our job-based pay system to performance-based system. I notify you on this decision considering that our organisation deploys evidence-based success strategies. Consequently, I have reviewed the evidence on the risks and benefits of the newly proposed system. Based on the review, I believe our organisation has the capacity to overcome the risks by following an appropriate action plan for the implementation of the new system.

Works Cited

Drago, Richard. “Workplace transformation and the disposable workplace: employee involvement in Australia.” Industrial Relations 35.6(1996): 526-543. Print.

Green, Colin, and John Heywood. “Does Performance Pay Increase Job Satisfaction?” Economica 75.5 (2008):710-728. Print.

Heywood, Johnston, and Xavier Wei. “Performances pay and job satisfaction.” Journal of Industrial Relations 48.7(2006): 523-540. Print.

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