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Image Credit: <heatseeker.com

Image Credit: <heatseeker.com>

As we enter merit season, organizations are looking at how to allocate merit budgets in a way that maximizes return on investment and drives business success. How much do merit increases drive employee performance, though? For that matter, what is the correlation between total compensation period and business results?

I recently had a conversation with a fellow 1. Long, midly rambling thought stream coming in 3, 2, 1….comp guy about just this topic. 1 We tried to answer the question: Does more pay equal better performance, and if so how consistently can we measure it?

This is just a working hypothesis, but I believe that while pay *does* drive performance… it only does so to the extent that people are unlikely to give their best effort if they don’t feel they’re being paid competitively. Once people feel they’re being paid fairly for what they do, however, additional extrinsic rewards aren’t likely to be strongly correlated with markedly higher performance. As such, when employees are paid competitively total compensation should just be a hygiene factor.

…Of course, in practice this issue is a bit more complex: When people say they want to be paid “fairly” or “competitively”, what they actually mean is that they want their pay to be aligned with their performance, relevant knowledge base, and experience. As such, the notion of pay driving business results is really about making people feel like they’re receiving remuneration in line with their efforts more so than it is about dangling additional carrots to 2. Put another way: A sales person with an uncapped commission doesn’t need unlimited earnings potential because he’ll only be happy if he makes “X” dollars… he needs it to keep score – although as a side *side* note (hah!) once an org uncaps commissions it is difficult to cap them again. So while more pay doesn’t equal higher performance in an absolute sense, if employees don’t feel they’re being fairly compensated over time that will eventually be reflected in the form of diminished effort (and in turn diminished business results).incentivize them to work harder. 2

Okay… so if the above is true then how do we identify high performers and make them feel like their total rewards package is aligned with their impact on business results? For many roles performance is actually very difficult to measure (particularly within staff functions where the value of a job often isn’t fully understood unless or until the person doing it is gone). To this point, manager subjectivity plays a huge role in the performance review process (with that subjective element often making meaningful pay differentiation between top and bottom performers difficult or impossible).

…Perhaps the answer to tackling this challenge can be found in embracing the imperfection of performance measurement. No matter how much time and how many resources we dedicate to analyzing and quantifying performance, there will always be a subjective element. This means that communication and messaging are integral components to ensuring employees feel their pay is aligned with performance.

…To the above point, one of the primary roles of a compensation department should be to effectively generate buy-in across an employee population that the organization is paying competitively/fairly. This requires a delicate balance between pay transparency and maintaining competitive advantage. This balance is often difficult to strike, but when done effectively should get employees less focused on compensation and more focused on driving business results.

…Lastly, I know this is merit season but compensation teams shouldn’t lose sight of non-monetary rewards when thinking about how to attract and retain talent. The right intrinsic rewards are often their own form of remuneration. Most people are very motivated by money, but there are other 3. This is one of the many reasons why I think analytics is going to play such a huge role in maximizing the return on human capital going forward. Organizations that can identify what motivates their people (and how that aligns with their values and business objectives) will have a huge leg up over competitors as it concerns the ability to recruit the right people and retain them.things they find just as valuable. 3

As always, please share your thoughts in the comments section.