Performance-based pay is no longer in fashion, but even in a recession, high-level employees have to be motivated

LAST THURSDAY, the Economic and Social Research Institute’s (ESRI) 50th anniversary Geary lecture was on the impact of linking pay and remuneration to performance targets.

Earlier in the day, the Chartered Institute of Personnel and Development heard about the difficulties in motivating high-potential employees in a recessionary environment where performance-based top-ups are out of favour.

For much of the last decade, there was a belief that any potential bonus needed to be at least 40 per cent of basic salary to motivate high-level performance. In the financial sector, greed and hubris pushed these bonuses to multiples of already inflated base salaries for executive directors.

In Ireland, we brought it to a dizzy height as hundreds of senior executives, politicians, public servants and semi-State company chiefs informally benchmarked themselves against counterparts in large economies running vastly bigger organisations.

Their cover was that we operated in a competitive world with a global war for talent. The reality is that few job offers ever arrived from major foreign institutions seeking to hire the services and expertise of “lifers” at the top of most Irish organisations.

Now the pendulum has swung in the opposite direction and legitimate use of performance pay and verifiable bonus schemes are out of fashion. Unfortunately, this is at a time when we need more performance-based pay regimes and the setting of performance input and output targets.

Is Pay for Performance Effective? was the theme of the Geary lecture given by academic economist Canice Prendergast of the University of Chicago Booth School of Business. Prof Prendergast is no stranger to our ways, having studied economics as an undergraduate at Trinity College Dublin in the early 1980s and later spent two years as a researcher with the ESRI before building an international reputation.

He was too polite to refer to the bonus greed of the high-fliers who have bequeathed us this fiscal and banking millstone of debt.

Instead, he looked at the effectiveness of performance-related pay in general. He quickly burst the traditional balloon that people work mainly for money, underlined by many economic studies of productivity increases of 25-35 per cent with increased compensation accounting for about half of this output boost.

“Sales workers, sports players, teachers and many other occupations all show gains when commission, piece rates or bonuses are used rather than salaries. On the other hand, there have also been a number of studies suggesting that aligning pay to performance are likely to backfire so that it should not be used at all.”

He identified two classes of concern: economic measurement issues and psychological responses to performance pay.

There is an argument that bonuses which are too large can have negative effects on the basis that you might be more likely to miss a putt for €10,000 than one with just €1 riding on it. But alternatively, when it comes to professional golfers, there is no evidence that their putting success diminishes when playing the final hole for high prize money. Prof Prendergast cautioned that you must account for the psychological response of a person skilled and used to their job from the nervousness of the ambitious amateur.

A key problem with performance is in the measurement and which outputs are selected as well as identifying motivating factors. He cited the example of Los Angeles police department which introduced a scheme, where 2 per cent of all drug-related money confiscated was shared between drug squad staff. The result was that the amount of money taken soared but the quantity of drugs captured fell dramatically. The police let the buyers go to concentrate on the sellers to get at the money rather than the narcotics.

He also cited president George W Bush’s No Child Left Behind initiative, which was intended to get a majority of school students above a set standard for each year linked to measuring teachers performance.

The result was that in a class of 20 students, the teachers largely ignored the brightest five, who were ahead of the standard, and also gave little attention to the children who were struggling.

Instead, they focused on the middle group to get a majority over the new standard and overall teaching standards declined.

The lesson he noted is that “performance measures often don’t capture important parts of an individual’s productivity and performance measures only a subset of the activities of the agent”. In addition, performance measures often do not reflect the individual’s actions and may be linked to overall organisational performance such as with profit-share schemes or team-based compensation.

His overall theme was that the successes of pay for performance schemes are limited to a small class of agency settings that do not seem to generalise to other settings. Second, the literature has now begun to consider instruments other than pay as the most natural way to align interests. Finally, there is controversial literature in psychology that now challenges the basic assumptions of this strand of economic literature.

More focus needs to be given to the intrinsic motivation of the job and the selection method of matching a person to a role.

At the institute’s conference, Kevin Empey covered a related issue of “sustainable employee engagement” on the basis of asking: “Am I motivated, enabled and energised to deliver my best performance?” He noted that there is “a movement towards greater employee personal responsibility for aspects of work and well-being” linked to individuals having more scope to manage their career, development and job.

This cannot be based on a few satisfaction surveys or an annual box-ticking review and assessment and can easily be undermined by weak senior management and the lack of clear strategies and energised change.

It is a long way from the practices we see at high levels of our public service.

Over the weekend, a health manager sighed in despair at the fallout of the rushed redundancy forced through over the past four weeks. “There was no selection. It was as if they said ‘you are all a bunch of wasters and the more of you who leave the better’ irrespective of skills, motivation or contribution to effective frontline healthcare and planning.”

This belated and indiscriminate redundancy scheme came from the senior Civil Service ranks that abused the concept of performance pay.

Earlier this year, they were able to threaten legal action on the basis that since they all got an 8 – 12 per cent bonus, it was really part of basic pay and unrelated to their individual performance.

They managed to avoid some of the pay cuts imposed on the other 300,000 State employees for whom they decide policy and allocation of resources.

Abuse of performance-based pay and bonuses was not confined to discredited bankers. The issue still has to be faced up to if we are to recover from the economic and governance crisis.