Should Compensation be Tied to Performance Reviews?

For decades, many organizations have approached compensation adjustments in pretty much the same way. At the end of the year, an employee’s work contributions and their personal development are assessed. If their superiors feel that they made sufficient progress over the year, the employee gets a commensurate bump in pay. If not, their salary stays the same.

Many think that’s the old way of doing things. Just listen to what the Harvard Business Review has to say about the matter:

• Performance reviews that are tied to compensation create a blame-oriented culture. It’s well known that they reinforce hierarchy, undermine collegiality, work against cooperative problem solving, discourage straight talk, and too easily become politicized. They’re self-defeating and demoralizing for all concerned. Even high performers suffer, because when their pay bumps up against the top of the salary range, their supervisors have to stop giving them raises, regardless of achievement.

Imagine an employee has gone above and beyond for the entire year, consistently over-delivering. So, they get a stellar performance review. Unfortunately, the economy has been on a downswing, and your company didn’t perform as well as you projected it would. As a result, there’s no room in the budget for pay increases, however well deserved they may be. After learning they won’t be getting a pay bump, the positive review is essentially a letdown for the employee. Despite working extremely hard for the last year, that employee is probably not going to be inspired to keep producing.

Source: GIPHY

Performance reviews are meant to help employees improve over time. Traditionally, managers tell employees what they have been doing well and what they could do to become even better workers. When money enters the equation, it quickly consumes the process. Employees don’t necessarily pay as much attention to what their managers have to say about their performance. Rather, they are interested in whether they’re getting a raise.

Additionally, when compensation is tied to performance, employees may feel the need to compare their raises with one another. If an employee finds out that a colleague got a bigger raise than they did, they may feel they were treated unfairly. Employees who feel slighted by the size of their pay increase won’t be motivated. They also might develop some animosity towards their coworkers who got larger raises.

If your company ties employee compensation to performance reviews, you may want to reconsider your approach. You can either tie pay increases to market conditions, giving your employees raises when the company is doing well and withholding them during slumps, or you can give raises based on length of service. That way, all of the guesswork is removed from the equation — meaning employees will actually listen to what their managers have to say during their performance reviews.

While you’re at it, consider dropping the annual performance review altogether. Thanks to modern performance management platforms, managers can provide timely feedback to their employees quickly. They can also solicit feedback directly from their team, which enables them to identify problems that may be developing so they can address them before they spiral out of control.

By decoupling wage increases from performance reviews, companies can focus the review process on making sure their employees are developing new skills and becoming better workers. That’s how you build a stronger, more effective organization.

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