| Definition |
Pay-for-Performance systems tie compensation directly to specific business goals and management objectives. These systems try to improve individual accountability; align shareholder, management and employee interests; and enhance performance throughout the organisation. Setting measurable and controllable performance targets and appraisal mechanisms to meet corporate objectives lies at the heart of Pay-for-Performance systems. Pay-for-Performance presumes that rewarding people for meeting specific company goals will result in higher performance levels. |
| Implementation |
Pay-for-Performance systems consist of two components, performance measurement systems and compensation methods:
- Performance measurement systems:
For this tool to work effectively, a system must be developed that ties a companys strategic objectives to its performance measures.
These measures are classified into categories which focus employees on the most important activities. They include:
- financial indicators - such as ROS, ROA, ROE
- non-financial indicators - such as customer satisfaction, product quality, development speed, teamwork or cost reduction.
They also establish the importance of individual versus group performance. Group performance is measured at the team, facility, divisional and / or corporate level
There are many permutations of systems that can be used; the optimum choice depends on the corporate culture, company strategy and industry characteristics.
- Compensation methods:
In Pay-for-Performance systems, an employees compensation is composed of a fixed base salary and a variable pay component. The most commonly used variable pay methods are:
- Stock options - the quantity and strike price are typically based on a percentage of value added as determined by the performance measurement system
- Bonuses and gain sharing - these range from one-time awards for extraordinary accomplishments to other profit-related distributions
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| Purpose |
These systems are designed to retain top-performing employees, motivate the desired performance and control costs. These systems can be applied to many levels within an organisation, from executives to plant operators. Depending on the level within the company, different approaches are appropriate. |
