Performance Management and its Implications on Pay

Performance Management and Performance Appraisals

Many organizations have a performance management process that is used to ensure that each employee, team, and the overall organization are meeting specific goals. Performance management systems outline the tasks and outcomes that each employee will be evaluated on during their performance appraisals. There are many potential outcomes from a performance appraisal such as compensation adjustments, merit bonus, performance improvement plans, promotions, or even terminations. Although there are benefits to performance management systems, they are also not as impactful on compensation as once believed. If used improperly, performance management systems can even cause legal repercussions.

Subjectivity in Performance Appraisals

Performance appraisals require supervisors to rate their employees on their performance. Best practices require that the ratings be based on objective measurable results, however, oftentimes the ratings are based on the supervisors’ subjective opinions of the employee and their performance. For example, a supervisor could give someone a higher rating because they simply like the employee or because they don’t want to cause conflict by providing a low rating. Personal prejudices or unconscious biases can also negatively affect how an employee is rated. Since performance ratings are used to determine many employment-related decisions, subjective ratings can lead to disparate impact and any associated legal issues. Ensuring that a performance appraisal method is based on objective measures is imperative, especially when the results are being used to make compensation and other employment related decisions.

How Impactful are Performance Appraisal Ratings on Pay?

As mentioned above, a common outcome of performance appraisals is to help determine compensation adjustments (i.e., raises). A common misbelief is that performance appraisals help ensure that high performers are paid more, however, starting pay is the most influential decision that can impact an employee’s compensation. Look at the example below:

Sally, an engineer with 5 years of experience was hired with a starting salary of $80,000. Harry gets hired at the same time and has the exact same background, but he negotiated for a salary of $100,000. Sally is rated as a star performer every year and gets a 5% raise increase every year. Harry is rated as an acceptable performer every year and gets a 3% increase every year. It would take 12 years for Sally, the star performer, to make the same amount of money as Harry, the acceptable performer.

As the example shows, starting salary decisions are a huge factor in an employee’s compensation throughout their tenure. Since men are more likely to negotiate than women, the example above also shows how these starting decisions can end up leading to pay disparity within an organization. It is often believed that hiring an employee at a lower rate than what the organization is willing to pay is a good business decision because it is saving the company money, when in fact it can result in disparate outcomes in compensation as demonstrated above.

Performance management systems are very helpful with determining individual, group, and organizational goals, but it is imperative that the method for evaluating employees uses objective measures to reduce as much subjectivity and potential bias as possible. It is also important to keep in mind that starting pay decisions are the real deciding factor for how impactful raises and incentives are for star performers.