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Pay for Performance

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Introduction

The private and public sectors characterize the current reforms by the introduction of typical business promoting incentive structures, particularly, the application of schemes, such as “pay for performance” in private and public organisations. The private sector, however, has some peculiar characteristics that may limit the naive implementation of pay for performance. This research studies whether the effect of pay for performance bounded to such situations and if this is the case, under which circumstances pay for performance leave negative or positive influence on performance.

The research analyzes this possibility in a meta-analytic appraisal of earlier experimental studies on the influences of pay for performance likely to result on performance. This study will also show how pay for performance can negatively influence personal efforts. With an experimental study, the research demonstrates (1) that motivation is preferably a significant impact on the outcome of performance related to pay on performance, and (2) pay for performance is usually much costly as it seems because it always generates hidden costs of compensation and rewards. The findings of this study help to highlight the moderate success of pay for performance in the private and public sectors.

1. Literature Review

There is a long term belief that the private sector should be more realistic in the operations and attitudes. As a result, characterization of current reforms in the private organisations are by the application of management techniques and practices originally designed for the business sector, for instance, market analysis, performance management, and budgeting techniques (Lane 1997; Moynihan 2006).The most key challenge is the application of incentive structures, the introduction of pay for performance techniques in the private as well as public organisations (Varone and Giauque 2001; Swiss 2005). Two third of member countries of OCED and many developing economies have implemented performance for pay practices, such as Mexico, Brazil, India, United Kingdom, China, and United States (Mookherjee 1998; OECD 2005).

The fundamental assumption is that effectively devised pay for performance techniques boost the efficacy of the organisation (Burgess and Ratto 2003) and positively influence workers’ motivation. The supporters of pay for performance focus on standard economics, especially, the economic principal agent’s view as suggested by Jensen and Murphy (1990). These theories strongly lean on the model of the self-interested homo oeconomicus. They consider it as a matter of fact that cash compensation must be adopted to provide substantial rewards for brilliant performance and a penalty for poor performance (Chenhall 2003).

The essentiality is that interests between the benefiter and principal must be synchronized via monetary benefits. The public, however, because of peculiar characteristics may limit the naive implementation of pay for performance. Moreover, incentive methods, which are efficient and effective, may be counterproductive or even ineffective when adopted in a different organisational context (Jensen and Murphy 1990).

Undoubting, experiences with pay for performance techniques in the private and public sectors are mixed as OCED (2005) analysis explains that there is no decisive empirical evidence, which supports such an approach effectively and helps to improve performance and motivation within the organisation. Secondly, Perry, Mesch, and Parlberg (2006) state that public and private sectors’ review suggests that performance related to pay methods is unsuccessful. 

The contesters of pay for performance challenge that theories built on self interest do not provide an ample base to analyze the motivation of workers, especially, that of employees in public sector (Vandenabeele and Hondeghem 2005). Their evaluation can be confirmed by modern psychological economies and motivation psychology, especially, self determination theory. These theories differentiate various types of motivations, such as intrinsic and extrinsic motivation. Various researches acknowledged that workers are invariably to a high degree intrinsically motivated, i.e. they perform jobs because of loyalty, an internal sense of duty, and satisfaction (Perry 2000). Intrinsic motivation, under certain circumstances, is recommended being undermined by pay for performance: Offering a performance monetary benefit to do some tasks they already enjoy may reduce his/her motivation to do it as the individual is then likely to consider its action as externally driven instead internally appealing. Such kids of incentives always generate hidden costs, which refer to as corruption effect, crowding out effect, or over justification effect, and hence, may negatively influence the performance. Conditions that are suitable to influence the performance and pay for performance are task type and organisational culture.

2. Objectives of the Study

The objective of the research is to study whether the effect of pay for performance bounded to conditions and such is the case, then under which situations pay for performance renders a negative or a positive impact on performance. While some researches clearly demonstrate a positive relationship for performance on actual performance, others clearly demonstrate a negative relationship. However, extremely few studies tried to throw light on this indecisive evidence by finding possible contingency factors. The study chose to follow Perry, Mesch, and Paarlberg (2006) by distinguishing task as a moderator of pay related to performance since there are high variations in the public, as well as private sector. The research examines with a meta-analysis the reassessment of earlier experimental studies on the impacts of pay for performance on performance.  

3. Study: Pay for Performance on Performance and Task Type

Hypotheses

The topic whether performance related to pay enhances productivity and efficiency is highly contestable. Two opposite views exist in the public and private sector. On one side, researchers stemming from behavioural management and standard economics theory contend that performance based pay increases individual performance in case of proper administration. Thus, these researches concentrate their efforts on debating the technically accurate implementation of performance based pay, such as how to overcome the problems of measurability. While on the other side, researchers with a self determination or psychological theory debate that beyond these adaptation problems there is a more underlying problem resulted in performance related pay: there is a proposition that this system of pay effects on individual performance in case of stimulating tasks.

Tasks are usually stimulating if they perceived to be purposeful, challenging, and enjoyable. These researches determine that task type is a significant moderator of the impact of pay for performance on actual performance. The consequences of this second perspective are potentially much harder than that for the private organisations for two reasons. Firstly, current reforms in the public sector largely target senior civil servants. However, senior civil servants are much possibly to work on captivating assignments than lower ranked public officials as their job criteria is likely to be more responsible, challenging and broader. Thus, there is a likelihood that performance related pay may be directed toward the non-deserving recipients.

Secondly, an efficiently managed organisation is likely to offer largely engrossing activities to derive benefit of advantageous self selection of workers. It is a common observation that people do not prefer the public service to enhance income; rather, they hope to receive stimulating work. Therefore, all organisations whether they are in private or public sector, require establishing differences in the level of compensation by offering non pecuniary gains, such as compulsive task for maintaining the high level of motivation factor.

Besides, recent formal theory uncovers institutional incentives, which explain why public organisations are better in retaining and attracting intrinsically motivated individuals:  Intrinsically motivated public service employees show a higher incentive to make investment in expertise knowledge rather than extrinsically motivated and thus, work as the organisational memory of public service. On the other hand, extrinsically motivated public service employees will only gain conditional expertise if their learning relates to material incentives and such a condition in the public organisations is difficult since not all appropriate expertise development can be constantly monitored. In this context, these two views will discuss more in detail.

4. Standard Economic and Behavioural Management View

Standard economic theory grounds on the assumption of selfish, rational, and extrinsic motivated people, the so-called homoo economicus, who react to external gains in a predictable manner. This implicitly grounds on the stimulus response theory that includes factors, which are only observable in a black box treatment. Behavioural changes trace back to changes in restrictions, but there should not be any change in preferences. As a result, human behaviour is likely to be guided through the selective deployment of sanctions or rewards. Individuals will accomplish best performance when the incentive system relates with rewards as closely as possible to performance. Behavioural management theory also supports this argument. This theory contends that pays for performance increases personal efforts and thus, enhances individual performance. Behavioural management researchers and standard economists have carried a number of studies to accomplish this argument, for instance, analysis of Safelight, the U.S biggest windshield manufacturer, in the 1990s replaced hourly wages by piece rates with a guarantee of minimum wage. It caused improvement in productivity by 45%. In the latest overview of studies, Rynes, Gerhart, and Parks (2005) establish that performance evaluation and pay for performance is two most significant tools in a firm’s motivational arsenal, and so powerful that one of the key challenges for executives is to make sure that their compensation rewards systems are not motivating the negative types of behaviour.

5. The Psychological Economics and Self-determination View

In comparison with the standard economics view, self determination and psychological theory contend that there exist different kinds of motivations, which are intrinsic, and extrinsic motivation and that performance of intrinsically motivated jobs is damaged by pay for performance. Self determination and psychological economics theory support that motivation is not a governing phenomenon.

Individuals do not only possess different levels of motivation, but also undergo different forms of motivation that depend on the specificities of the organisation context, and characteristics of the job. Extrinsic motivation provides satisfaction of personal needs, i.e., extrinsic motivation implies doing something since it will lead to separable outcomes, for example, monetary compensation. It is not possible to produce direct utility by money, but it enables to acquire the desired products. In contrast, intrinsic motivation satisfies needs directly by creation of an intrinsic reward for those people, who perform the tasks. Further, tasks are intrinsically rewarding if they perceive to be appealing, i.e. to be purposeful, enjoyable, and challenging. 

In the rest of this article, this task will be known as stimulating task. In short, self determination theory and psychological theory suppose that individuals can also obtain utility from the activity itself. Pay for performance proposed that under certain conditions may have a negative and crowding out impact on intrinsic motivation.

For such a reason, the performance of stimulating task is possible to suffer by the application of performance based pay. Numerous experiments and field studies in psychology and psychological economics support this argument. For instance, McCullers and McGraw (1979) depict that contingently rewarded people perform worse than their unpaid colleagues at stimulating tasks. A next study is the experiment conducted by Gneezy and Rustichini (2000a) that examines parental attitude to the application of a financial incentive to pick up their children from kindergarten. In kindergarten, parents had to pay a penalty for late coming. Contrary to the expected impact, this penalty did not initiate parents to collect their wards on time but rather led to a high increase in the number of latecomers. As a result, self determination and psychological theory suggest that pay for performance damages performance in the case of stimulating tasks. In contrast, behavioural management and standard economics theory suggest that pay for performance enhances performance, which is independent of the task involved. Hence, these two conflicting views direct to the following hypothesis:

H1a Pay for performance enhances performance regardless of the rewarded task.

H1b Pay for performance enhances performance in case of less stimulating tasks and reduces performance in case of stimulating tasks. In the next step, a meta-analysis performs the test of these competing hypotheses. 

6. Meta-analysis

Methods

In fact, there are few meta-analyses that focus entirely on the impact of pay for performance on performance, and to the knowledge of researcher, there exist one meta-analysis that pursues to test for the moderating impact of differentially motivating tasks. The research recommends that this meta-analysis requires to be supplemented for three reasons: Firstly, Jenkins et al. (1998) have main interests in the explained variance. They do not examine the flow of the impact of pay for performance on task efforts as they have no interest in the change of signs, second, the researchers focus entirely on outcomes found in organisational behaviours and psychology journals. There is no consideration of the findings published in economic journals, and hence, research neglect studies from psychological economics and standard economics. Third, their examination possesses a cut-off point, so the meta-analysis stops at that moment, when motivation studies in psychological economies were about to gain momentum.

Sample

The study applies following rules of inclusion: Focus on experimental studies that (1) address the impact of incentives on task performance and not on any other dependent variable, (2) report performance measures, which are hard (quality and quantity measures), (3) introduction of pay for performance at an individual level, (4) to have a control group, (5) use adult population, (6) provide sufficient information for determining the impacts of pay for performance on performance. The research identifies these studies through four search avenues.

At first, researcher conducts computerized database searches from the year 1971 to 2006 using key words, such as tangible rewards, pay for performance, monetary rewards, performance, performance contingent rewards, and intrinsic motivation. Secondly, the research includes manual searches of those journals, which featured prominently in database search, namely American Journal of Psychology, Academy of Management Journal, Journal of Management Accounting Research, Journal of Applied Psychology, Quarterly Journal of Economics, Journal of Personality and Social Psychology, Organisational Behaviour and Human Decision Processes and Organisational Behaviour and Human Performance. Third, then researcher examined the reference lists in several meta-analyses.

Finally, research made a query for unpublished papers in the discipline of economics. This query is necessary because, in this area, the search of studies is difficult as quite often economists do not report correlation coefficients, and F values required for computation in a meta-analysis. The five inclusion rules and four search avenues yielded 45 empirical studies (total sampling size of the 45 studies 527,525) with 156 usable subgroups samples (total sampling size of 156 subgroups samples 546,364). Table 1 in the appendix contains descriptive information of these studies.

Procedures

The meta-analysis took place by using the application of Hunter and Schmidt (2004). This meta-analysis permits the aggregation of outcomes across separate studies and hence, gives an evaluation of true relationship across two variables in population. By the sample size of study for calculating the mean, weighted correlation, the zero order correlations between the variables of interest are weighted. Then the standard deviation of the correlations is calculated to evaluate their true variability. Researcher then performs computation for the meta-analysis by using comprehensive meta-analysis.

This software package permits controlling three artefacts that are sampling error, range restriction, and measurement error, which cover true variability by implementing the artefact distribution formulas of Hunter and Schmidt.

Non independence and Outliers

As observed, many of the 45 studies point out more than one mean difference between the control group and the rewarded group. The study used the following criteria to make sure an acceptable level of independence with multiple subgroups among those studies. For a study of multiple independent samples, statistics include from each sample. If a sample reports more than one statistics for single statistics, then we combine these statistics. Moreover, researcher also plotted a study’s impact size against its standard error to find outliers. These studies then distributed symmetrically to know the combined effect size and indicate the absence of publication bias.

Moderator

Since the aim is to examine the overall relationship of pay for performance and also the relationship dependent on task type, this research conducts a moderator analysis. Researcher asks two coders independently to differentiate the experiments into two classifications: stimulating and non stimulating tasks. The selection of this coding is on the assumption that non stimulating tasks are more predominantly extrinsically motivated and stimulating tasks are more clearly intrinsically motivated. In 16% cases, there was no agreement among the coders; thus, a third expert approach was necessary to decide on the final ballot. Later, there was a further division of the total sample into two groups in relation to task type. For each single group, a critical ratio and separate net impact is possible to calculate.

7. Results and Discussion

Table 2 in the appendix shows the results of meta-analysis: In general, we notice a positive and significant net impact of pay for performance. Task type systematically moderated this impact: pay for performance enhances performance in case of non stimulating tasks, while in case of stimulating tasks, pay for performance decreases performance. Hence, the results of the meta-analysis confirm Hypothesis 1b.

On the grounds of these results, hypothesis 1a has to be negated. The outcomes contradict the results of the meta-analysis of authors Jenkins et al. (1998) as these experts cannot find a moderating impact of task type. It is possible to explain these differences by two facts. First, we have done data analysis to distinguish direction impacts, while Jenkins et al. (1998) looked for explained variance.

Next, Jenkins et al. (1998) suggest that there coding in extrinsic/intrinsic may be crude. They differentiate task types by pointing to the original grading by the researchers, who performed the experiment. Therefore, it is necessary to apply a different coding and cross checked self labelling with expert coder’s observation of the tasks studied. The researcher additionally tested if the publication outlet moderated the findings for controlling the validity of findings. Further, there is no moderator impact of the publication outlet i.e. studies published both in psychological and economic journals reflect a positive net impact of tangible rewards on performance. 

8. Implications and Limitations of Research

The meta-analysis clearly shows that the task type moderates on the impact of pay for performance. Pay for performance renders a strong, positive impact on performance in case of non stimulating tasks. However, pay for performance tends to render a negative impact on performance in case of stimulating tasks. The study reveals (1) why pay for performance undermines performance and (2) how pay for performance generates hidden costs that also need to be accounted.

The results help to describe the modest success of pay for performance in public as well as private organisations for five reasons. First, it appears that in these organisations, high intrinsic motivation is at stake. Hence, pay for performance can produce a strong crowding out impact. Secondly, public sector funding is more limited than private sector funding. As a result, the price impact of pay for performance in the public sector tends to be comparatively small, whereas the crowding out impact in case of stimulating, and hence, potentially intrinsically rewarding, tasks can weigh substantially. Third, pay for performance may decrease investments in policy decisions and select the wrong, inefficient workers. Fourth, the multitasking problem can create an additional difficulty for imposing pay for performance in the organisations: Pay for performance needs an accurate measuring of performance and the classification of this performance to individual effort has to be effective. 

The institutions, however, have to offer complex services and products, such as formal education or excellent health and specifying each aspect of these tasks is often not possible. As a result, extrinsically motivated employees, who are subject to pay for performance, have a powerful incentive to realize only what is possible to measure easily, i.e. the quantifiable performance based aspects of the task. What it is not possible to measure is disregarded, although it may be significant for realizing the tasks. An advanced subjective performance assessment can address the problem of multitasking but can lead to new problems. The subjective performance assessment methods are subject to systematic cognitive biases in assessment, and may be procedurally unfair because they cannot offer consistency in the same manner as objectives’ evaluations. In the light of current, limited, evidence, this research suggests that it would be wise to follow a proposition of Moynihan (2007) to maintain the positive effects of performance management, by blocking a pay for performance, which may offer more disadvantages than advantages. 

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