Pay for Performance – Definition

Cite this article as:"Pay for Performance – Definition," in The Business Professor, updated April 5, 2019, last accessed September 26, 2020,


Pay for Performance Definition

Pay for Performance is a compensation strategy that uses salary, bonuses, or other benefits to directly incentivize employee performance.

Employee Performance is generally measured by pre-defined metrics or qualitative evaluations (performance appraisals).

A Little More on What is Pay for Performance

Pay for Performance (PFP) compensation plans are very helpful for a company if it implements them effectively. It can meet the following objectives:

  • Employ and retain the best quality workers
  • Convey and reinforce the goals, values and motives of the company.
  • Engage workers in the success of the company
  • Benefit value creators

Moreover, the rewards policies instituted by a company should assist employees in understanding:

  • Company Vision: where the organization heads. e.g. foxfire
  • Company Strategy: how is the business going to reach them
  • Employee Expectations and Roles: what kind of role is assigned to each employee in the plan and what does the company expect from him/her.
  • Employee Rewards: how employees get financial benefits and rewards from the expected achievements linked to their roles.

Academic Research on Pay for Performance

Early experience with payforperformance: from concept to practice, Rosenthal, M. B., Frank, R. G., Li, Z., & Epstein, A. M. (2005). Jama, 294(14), 1788-1793. The staff of a company has a great interest and optimism in the Pay for Performance strategy. This paper is based on an evaluation of healthcare quality. The authors examine the admin reports of California Physician Groups and a contemporary comparison group, Pacific Northwest Physician Groups. Quality improvement records were collected from Oct 2001 to April 2004. They were distributed in almost three hundred big companies of physicians.

Does payforperformance improve the quality of health care?, Petersen, L. A., Woodard, L. D., Urech, T., Daw, C., & Sookanan, S. (2006). Annals of internal medicine, 145(4), 265-272. Many hospitals and physicians get the same payment, no matter what the quality of healthcare is. It generates no incentives rather disincentives for quality in some situations. This paper reviews the performance of medical staff and the Pay for Performance strategy is proposed to be implemented. Effect of this plan is analysed in terms of improvement in performance.

Pay for performance in commercial HMOs, Rosenthal, M. B., Landon, B. E., Normand, S. L. T., Frank, R. G., & Epstein, A. M. (2006). New England Journal of Medicine, 355(18), 1895-1902. This paper contains a survey of two hundred and fifty-two HMOs (Health Maintenance Organizations). The authors examined the Pay for Performance plans which have developed a great interest and discussion in employees. The Centers for Medicare & Medicaid Services adopt it for their sector. Though there are a number of claims for the effectiveness of this plan, the national penetration is still unknown.

Corporate governance and payforperformance: The impact of earnings management, Cornett, M. M., Marcus, A. J., & Tehranian, H. (2008). Journal of financial economics, 87(2), 357-373. The authors investigate whether the impacts of Pay for Performance boost the passion and abilities of the employees. Institutional shares ownership, investor representation and outside directors all decrease the discretionary accruals. They greatly offset the effect of option compensation that contributes to earnings management. Consequently, it enhances the significance of governance variables and declines the effect of compensation on the performance of corporate.

The payforperformance dilemma, Meyer, H. H. (1975). Compensation Review, 7(3), 55-62. Pay for Play plan is good but it comes with some problems as well, such as many employees start thinking that their performance is outstanding. The administration cannot give incentives to all of them. Consequently, the self-esteem of such employees threatens. They demean the job importance and think negative about the boss. Also, PFP shows a direct relation in the performance of job and dollar rewards eliminating their intrinsic motivation. It is better to focus on rewards for personal development.

Does pay for performance increase or decrease perceived self-determination and intrinsic motivation?, Eisenberger, R., Rhoades, L., & Cameron, J. (1999). Journal of personality and social psychology, 77(5), 1026. This paper makes a comparative analysis of good performance reward with intrinsic motivation. The results are that the pay for performance has a positive impact on the self-determination of college students. On the other hand, self-determination acts its role in the relation in Pay for performance and organizational support, job performance, and at work, a positive mood. On further study, Pay for Performance positively developed the interest of employees in the job activities.

Payforperformance: will the latest payment trend improve care?, Rosenthal, M. B., & Dudley, R. A. (2007). Jama, 297(7), 740-744. This article makes a discussion on the Pay for Performance, its merits and demerits. Further research is carried out on an investigation that the latest payment tendency will improve care or not. It may or may not be effective because which era we are talking about, matters.

Pay for performance? Government regulation and the structure of compensation contracts, Perry, T., & Zenner, M. (2001). Journal of Financial Economics, 62(3), 453-488. From 1992 to 1993, the Securities & Exchange Commission asked for enhanced disclosure on the compensation. The US Congress implied tax legislation to deduct the compensation of non-performance IRCS 162(m). The authors evaluate the impacts of these variations. Many companies reduced wages in response to this section. After 1993, compensations and bonuses are potentially sensitive to shares returns. On the whole, the results show that some firms reduce wages in response to this legislation. Due to this section, the Pay for Performance has gone high for firms affected by section 162(m).

Pay for performance in the public sector—Benefits and (hidden) costs, Weibel, A., Rost, K., & Osterloh, M. (2009). Pay for performance in the public sector—Benefits and (hidden) costs. Journal of Public Administration Research and Theory, 20(2), 387-412. Recent public sector reforms are attributed to the Pay for Performance strategy. This paper examines, whether the effect of this plan is subject to specific conditions. If it does, it is positive or negative. The authors review the experimental studies. The motivation has a primary impact on the performance. These incentives are usually expensive as they consist of hidden costs. Thus, the success and failure of PFP have been analyzed.

Is pay for performance detrimental to innovation?, Ederer, F., & Manso, G. (2013). Management Science, 59(7), 1496-1513. Previous studies reveal the fact that the Pay for Performance compensation is effective in accelerating struggle and productivity. This is economic analysis. Whereas the psychological analysis states that these benefits limit innovation and creativity. If the employees show tolerance in case of failure and rewards are provided in the long run, then it is effective in motivation and innovation. The threat of dismissal can hinder the incentives. Golden parachutes will relieve the effects of the reduction in innovativeness.

Sorting and incentive effects of pay for performance: An experimental investigation, Cadsby, C. B., Song, F., & Tapon, F. (2007). Academy of management journal, 50(2), 387-405. If the interests of workers and owners are not aligned perfectly, there are chances of losses in productivity. This is Agency Theory and its solution is the Pay for Performance strategy. The authors compare fixed compensation with performance-based compensation. The results show that performance-based compensation yields more productivity. However, the risk-averse persons are less interested in choosing the Pay for Performance and they are not as responsive to the performance-based incentives.

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