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Employee Performance, Appraisal and Compensation
Business Essentials · Chapter 10: Human Resource ManagementSection 10.4 · lesson 52 of 10514 min · free with a free account
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In this lesson
Judging work fairly, and paying for it on purpose.
- State the purposes of appraisal and their conflict
- Describe appraisal methods and rater errors
- Explain how a pay structure is built and run
- Design an incentive plan that survives a stress test
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Everything said in the video, section by section (2,014 words). Read along, or search it.
Human Resource Management
Employee Performance, Appraisal and Compensation
This section closes the chapter on human resource management with two connected jobs. Judging how well people work, and paying them for it. First, we look at what appraisal is for, and why its purposes collide. Second, the methods used to rate performance, and the errors raters make. Third, how a pay structure is built, and then run day to day. And fourth, how to design an incentive plan that pays for what the business actually wants. Along the way, we meet a fictional insurer's pay structure, and a sales bonus that backfired. Watch one idea throughout. Every rating and every pay rule teaches people what really counts.
Why Appraise?
4 Purposes, 1 Built-In Conflict
Performance appraisal is the process of evaluating an employee's work against standards, and communicating the result. It serves four purposes. The administrative one supplies a basis for pay, promotion, and retention decisions. The developmental purpose gives feedback on strengths and weaknesses, and identifies what to learn next. The documentation purpose creates a record that can support later decisions, and if necessary, defend them. The communication purpose makes expectations explicit, so the employee knows what good work looks like. In principle these are compatible. In practice they conflict. The central problem is that one conversation cannot easily serve both administration and development. If the rating sets pay, the employee has every reason to present the year favorably, and hide weaknesses. Nobody volunteers a development need that could lower their rating. And a manager hoping for an honest talk about growth finds the rating closes the employee down. Some organizations hold development conversations separately, or use different instruments for each purpose. Whatever the arrangement, the manager should know which purpose a conversation is serving.
The Criterion Choice
What Exactly Are We Measuring?
An appraisal must measure something. That choice, the criterion, shapes everything else. Traits describe what a person is. Dependable, creative, a strong leader. Behaviors describe what a person does, like answering customer inquiries within a set time. Results describe what a person produces, like sales closed or defects avoided. Each has a weakness. Traits are the weakest ground in any dispute. They are vague, they invite personal impressions, and they give the employee nothing to act on. After all, it is hard to change what you are said to be. Behaviors are more specific and controllable, but someone has to observe them. Results are the most concrete. But they are contaminated by factors outside the person's control. Territory, market conditions, equipment quality, and the work of colleagues all leak into the number. So a sound appraisal usually combines behaviors and results, and treats traits with caution.
Appraisal Methods
6 Ways to Rate Performance
A graphic rating scale marks each factor from poor to excellent. It is quick, and easy to compare. Its weakness is vagueness. Good means different things to different raters. A behaviorally anchored rating scale fixes that, by describing specific behavior at each scale point. Raters share a meaning, and employees see what to do differently. The cost is building anchors for every job. A critical incident record is a running log of effective and ineffective performance, noted as it happens. It defeats the recency problem, because the appraisal draws on the whole year. Narrative assessment is flexible, but hard to compare, and it depends on the writer's skill. Forced distribution places a fixed share of employees in each rating category, to prevent leniency. But it assumes every team has the same spread. A strong team must still hand out low ratings. It also discourages cooperation, because helping a colleague risks your own ranking. Three-sixty degree feedback gathers views from managers, peers, subordinates, and sometimes customers. It works well for development, because multiple perspectives reveal blind spots. But it fails as an administrative tool. Tie it to pay, and raters inflate friends, punish rivals, and trade favors.
Table 10.4.1
8 Rater Errors and What They Look Like
Ratings are made by people, and people make systematic errors. Each one has a name. Leniency rates everyone too favorably. Strictness rates everyone too harshly. Central tendency clusters every rating around the middle, avoiding both ends of the scale. The halo effect lets one favorable characteristic, like presentation skill, lift every other rating. The horns effect is its mirror. One weakness, like a lapse in courtesy, drags everything down. Recency gives too much weight to the last few weeks. Similar-to-me rates people more favorably when they share the rater's background, interests, or style. Contrast rates a person against the one evaluated just before, instead of against the standard. So an average employee appraised after an outstanding one looks weak. Here is the useful part. Each error leaves a recognizable pattern in the completed forms. And patterns across one manager's ratings can reveal errors that no single form shows.
Fixing the Ratings
Shared Standards, Written Down
Two practices reduce these errors more than any change of form. Calibration is a meeting where managers compare their ratings against common standards. That way a rating means much the same thing from one manager to another, and outliers get examined. Frame-of-reference training has raters practice on sample performances, with feedback, until their judgments match agreed standards. Both attack the root problem, which is the lack of a shared picture of good performance. Form-level fixes help too: anchors, incident logs, and rating one factor at a time. Now the documentation problem. Picture a manager with real concerns, who has recorded nothing all year. At review or termination, the decision cannot be supported. That costs twice. The employee was denied the fair warning that would have given a chance to improve. And a decision with no documented, consistent reason invites the inference that the real reason was discrimination or retaliation. Good documentation is contemporaneous, recorded at the time. It is specific, describing behavior, not conclusions. And it is consistent across employees. It should also record the feedback given, and the response.
Total Compensation
Everything an Employee Receives
Total compensation is everything an employee receives for work, and it has four parts. Direct pay is the base wage or salary. Variable pay changes with performance, through bonuses, commissions, and profit sharing. Benefits are indirect compensation, like health coverage, retirement contributions, and paid time off. And non-financial rewards include recognition, development, meaningful work, and flexibility. Benefits come in two groups. Some are legally required. Those include the employer's share of Social Security and Medicare taxes, and unemployment insurance taxes. They also include state workers' compensation, statutory leave, and, for larger employers, health coverage obligations. Voluntary benefits are the ones an employer chooses, like health, dental, and vision insurance, or retirement plans. Federal law does not require paid time off, though some states mandate paid sick leave. Rates, limits, and tax treatment change over time, so they must always be checked. The Bureau of Labor Statistics tracks how much of compensation cost goes to benefits. The share is substantial. So an offer that ignores benefits misstates its value.
Pay Design
3 Objectives That Routinely Conflict
Pay design pursues three objectives, and they routinely conflict. Internal equity is fairness among jobs inside the organization. A job worth more should pay more. Job evaluation sets that order. It rates jobs on compensable factors like skill, effort, responsibility, and working conditions. External competitiveness compares pay with what other employers pay for similar work. Market data from pay surveys sets that anchor, using benchmark jobs common enough to match elsewhere. Individual equity is fairness among people doing the same job, reflecting performance, experience, and contribution. Now the collision. A scarce skill can command a market rate that breaks the internal order. An information systems specialist can end up earning more than the manager who supervises that person. And rewarding individual differences erodes equal treatment of people in the same job. So there is no perfect pay system. There is only a series of compromises among the three.
Figure 10.4.1
Corvane Mutual's Pay Structure
Job evaluation and market data combine in a pay structure. That is a set of grades, each with a pay range and a midpoint, usually set at the market rate. Corvane Mutual is a fictional insurer, and these figures were built for the exercise. It scores three jobs at two hundred fifty, four hundred, and six hundred points. Market pay for them is roughly forty-eight thousand, sixty thousand, and seventy-five thousand dollars, which become the midpoints. Each range is set so the maximum is forty percent above the minimum. So Grade One runs from forty thousand to fifty-six thousand dollars. Grade Two runs from fifty to seventy thousand. Grade Three runs from sixty-two thousand five hundred to eighty-seven thousand five hundred. Notice that the ranges overlap. Omar earns fifty-four thousand dollars in Grade One. That is more than the Grade Two minimum. Priya earns sixty-six thousand, just above the Grade Two midpoint. The overlap is deliberate. Experienced people can keep growing without a promotion. It is also a source of pay questions, when people notice it.
Pay Administration
Where in the Range, and Why It Matters
Position within the range, not just the grade, tells a manager how much room is left. Placement is where a new or promoted employee starts in the range. It depends on experience, the market for the skill, and what current employees in that job earn. Someone still learning the job usually starts below the midpoint. The compa-ratio divides an employee's pay by the range midpoint. A ratio of one means pay at the midpoint. Omar's is fifty-four thousand over forty-eight thousand, about one point one three. Priya's is one point one zero. Increases often run through a merit matrix, which weighs performance and position in range together. A strong performer low in the range gets a larger increase than a strong performer near the top. The range maximum is the limit for the grade. Reach it, as Omar nearly has, and base-pay increases stop. Pay above the maximum is sometimes called red-circled, and it presents a problem. Common responses are freezing base pay until the range catches up, or paying lump sums instead. Or promote the person if the job has grown, or re-evaluate the grade.
Incentive Plans
Line of Sight and Failure Modes
An incentive plan ties pay to results, in order to influence behavior. Two features decide whether it works. Line of sight is how clearly employees see their own actions moving the measure they are paid on. The failure mode is the characteristic way a plan goes wrong. Commissions and piece rates have a very direct line of sight. They fail through quantity over quality. Unmeasured work and customer relationships suffer too. A target bonus has a strong line of sight. It fails through gaming, hoarding sales, and resentment when targets rise. Team incentives have a weaker line of sight, and fail through free-riding on others' effort. Gainsharing shares savings from measured productivity gains. It fails when the baseline erodes, or the measure is disputed. Profit sharing has a very weak line of sight, and pays nothing in a bad year, regardless of effort. Stock-based pay has the weakest line of sight below the top, and can encourage short-term focus or excessive risk. So run a stress test. How could the plan be met in a way nobody wants? Paid on contracts signed? Could someone sign contracts the customer does not understand? If the answer is yes, there is a gap. And people will find it.
Putting It Together
Paid by the Contract, and Paid Fairly
Here is the stress test, failed in practice. Alder Ridge Windows is a composite case. Hugo, the sales director, replaces a modest commission with a large bonus for every new contract. Within two quarters, contracts rise sharply. But customers arrive with unrealistic expectations about dates and features. Renewals and referrals fall, and complaints climb. The plan paid for signatures and nothing else. So honest expectations and follow-up became costs with no reward. That behavior was a rational response to the line of sight the plan created. The sound decision is adding a retention and satisfaction component, paying for what the business depends on. Finally, pay equity. Differences should reflect the job, experience, and performance, never protected characteristics. Employees compare their outcomes and inputs with others, so perceived unfairness cuts effort, whether or not it is real. Pay audits compare pay while adjusting for legitimate factors, then investigate what remains unexplained. Pay transparency is debated. Openness may expose unjustified gaps, while secrecy protects privacy and flexibility. Many states now regulate it, so check local rules. Next, chapter eleven turns to labor relations.
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