Ohio

Eye on Education

Lessons on Performance Pay from the Private Sector

Performance pay may be a new concept for Ohio teachers, but not for many of the state’s private-sector workers. Those who have lived with merit pay for years says the keys to making it work include picking the right performance measures, ensuring employees trust the system and preparing managers to spend quality time doing evaluations. And they warn that while linking employment to on-the-job performance can boost an organization’s overall performance, setting up a system with the wrong incentives can have dire consequences.

Changes and Realities

Policymakers including Gov. John Kasich and GOP lawmakers want to move the current system of basing teacher pay and layoffs on seniority to one under which they’re tied to classroom performance.

For most private sector, non-union employees, pay and often their continued employment are tied to evaluations of their on-their-job performance. But how much and how performance is measured varies widely among professions, companies and industries. And the consequences of poor performance vary, too, from companies that rarely fire employees to those with a regular pruning process.

Best Practices

Harvard Business School Assistant Professor Ian Larkin

Building an effective evaluation and compensation system begins with considering what type of behavior an organization wants to reward, said Harvard Business School Assistant Professor Ian Larkin. It includes looking at the types of behaviors the organization is worried about rewarding, and how employees actually do their jobs.

Larkin advises companies on compensation, performance measurement and incentive-system evaluation.

He said employees should have a say in selecting performance measures and setting goals.

“If you set goals and employees don’t understand where the goals come from…they’re actually demotivating. They lead you to cheat more often,” Larkin said. “Whereas, if the goal is set in a way that you actually buy into it, you’re actually less likely to cheat and more likely to work hard to meet it.”

(See, for example, the Atlanta Public Schools cheating scandal.)

Larkin points to Silicon Valley as one example of incorporating employee input. Some tech firms give product managers — the people who manage the development and marketing of a particular product — the ability to set their own performance goals. Bonuses are based on things such as focus-group feedback and what others in the organization think of their work.

It’s hard to find a single objective measure of these employees’ performance, Larkin said, so a more subjective, individualized approach works better.

Measuring Success

Many successful evaluation and compensation systems include both subjective measures, such as evaluations from colleagues, and objective measures, such as sales.

At General Electric under CEO Jack Welch, for example, line managers had broad authority to manage their product lines. They were evaluated both on their product line’s profits and losses and on subjective areas such as how well they worked with others. Every year, the company ranked people with similar job descriptions, asked the bottom 10 percent to leave and rewarded the top 20 percent with a great bonus.

And at many large law firms, junior lawyers are commonly subject to annual performance reviews in areas such as problem solving, leadership and teamwork and are responsible for billing a certain number of hours each year.

Bo Hudson of Cleveland sells life insurance.

Still, in sales-based positions, employees’ evaluations and paychecks are often based on a single measure. That’s the case for Bo Hudson, a 27-year-old life insurance salesman from Cleveland. Every Monday, each salesperson’s results are announced at an office-wide meeting. The system works for him, he said, but it’s not for everyone.

“The people who don’t do well get weeded out or leave,” he said.

Carrot and Stick

Higher pay or other benefits such as increased authority or flexibility can be used as a carrot. But Linda Barrington, managing director of the Institute for Compensation Studies at Cornell University ‘s ILR School, said the ability to remove employees is important too.

“If people don’t perform, they get fired,” she said.

Sheila Jones, 50, works today in the Cleveland State University admissions office. Even as union workers, she and her coworkers are evaluated regularly. But she said the consequences for receiving low marks are basically a block on promotions or transfers. Most employees get raises regardless of their evaluations.

But in Jones’ former career as a commercial bank teller, the consequences of receiving high or low marks were more serious: as much as a 5 percent raise for doing well and getting fired for doing poorly.

“I think we need more of that business mindset here,” Jones said.

Not About the Benjamins

Often, performance pay works better as a way to get good people to come work for a company and stay there than as a way of getting existing employees to work harder, Harvard’s Larkin said.

“You get people to work harder, work more efficiently, but most of the productivity gain comes from getting a better match, he said. “You’re able to attract better employees.”

Gail Bromley, associate dean of academics at the Kent State University’s College of Nursing

For nurses, the link between performance and pay isn’t direct. In general, clinical nurses are evaluated annually or more often, by their supervisor based on their clinical knowledge, said Gail Bromley, associate dean of academics at the Kent State University’s College of Nursing. Nursing managers also review patient outcome data regularly, looking to see if there’s a rise in the number of post-hospitalization infections, for example.

Nurses can earn more money by moving up a career ladder, with moves dictated both advanced education and demonstrations that they can perform particular procedures. Bromley said the requirements and the salary increase tied to each move up the ladder vary by institution.

Bromely who is a proponent of the career-ladder system. “I think it makes a difference if people realize they’re being validated for the valuable work they’re doing. It’s not just the money. It’s just realizing that if I am progressing up the career ladder, I’m becoming more respected at my institution.”

Cautions

But choosing the right performance measures and incentives is tricky.

There are some “really massive exceptions” to the theory that performance-based pay is the way to go, Larkin said. See, for example, Enron. Or the mortgage crisis. In those cases, the incentives for employees weren’t aligned with the right outcomes, leading mortgage issuers, for example to focus on sheer volume rather than loan quality.

And effectively evaluating people often takes a lot of time, particularly from senior managers, and needs to be revisited and revised over time, Larkin said. In some organizations, senior executives spend as much as 20 to 30 percent of their time evaluating employees.

No Free Lunch

Under a performance-pay system, the total amount a company pays its employees can be higher than non-performance based systems, according to Cornell’s Linda Barrington.

In the private sector, the impact of increased productivity of employees spurred on by the promise a raise or bonus shows up relatively quickly in higher corporate revenue. While a company may face higher payroll costs, it also makes more money.

But in the public sector, and particularly in schools, the benefits of improved teacher performance are more abstract — and delayed. Research shows that a community’s property values rise as its schools improve. But there’s a long lag time between a teacher doing a better job teaching high school chemistry and a school district collecting more property tax dollars. And other factors can influence how much a school district benefits financially from doing a better job of educating students.

Even beyond questions about costs, the private sector’s lessons on performance pay show that it’s not a quick and easy fix, and that an effective performance pay system can’t be built in isolation from other parts of an organization.

“It’s about motivating and changing behavior; it’s about recruiting and changing talent,” Cornell’s Barrington said. “You can’t separate (that from) the culture.”

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