The end of the cozy relationship between performance evaluation and compensation > Insight

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Since modern times, as human resources management techniques have been systematized along with corporate enlargement/globalization/division of labor, managers all over the world have been contemplating how to efficiently utilize manpower to achieve higher performance. Numerous economists and social scientists have repeatedly researched to give an answer to this field where managers' demand has exploded. Based on these studies, modern companies checked labor behavior by hour and evaluated performance and then linked these to compensation. 

They also distinguished the factors for motivation from factors for satisfying the minimum level of satisfaction and managed these factors differently.

GE is perhaps the most famous example of a company that improved its business performance by evaluating people. 

Former GE CEO, Jack Welch, undertook intensive restructuring to save GE from financial difficulties. In the process, the results of restructuring were maximized through the so-called ‘10% rule’, which expelled those in the bottom 10% of performance every year.

Since then, the method of separating lower performers through relative evaluation has become the performance evaluation method of all organizations. Most companies rated their employees on a five-level evaluation scale. And like GE, high-ranking evaluators were given promotions and high rewards, and low-ranked evaluators were given a low level of compensation or job transfer almost equivalent to dismissal.

However, in recent years, the workforce within the company has been segmented and specialized, and the organizations within the company have become smaller and more flexible. This made it difficult to relatively evaluate the members of all organizations. Nevertheless, many organizations are still unable to abandon this relative evaluation system.

The end of traditional performance management

The most important reason that many companies still maintain the traditional valuation method is not because it is the best, 

but because there is no alternative. Organizations have changed, jobs have been segmented, and millennials have come to form the majority of the talent pool, but companies still have not given up on traditional evaluation methods. 

Changes that are accelerating the concerns of companies related to performance management are appearing recently. 

The most representative one is the emergence of 'agile organizations'. Agile organizations have the form of a ‘party’ in a fantasy novel, created by gathering professionals from various fields. They are responsible for the value chain that from the development of a single product/business/service to sales and management in a team unit. Teams are given a common, visible goal, and these goal-oriented teams are grouped to manage people and resources at the business unit level. The goal of a team changes every moment according to the progress. They focus on creating products/services that can actually be delivered rather than reviewing documented methodologies or making decision through the multi-step decision-making processes. 

From this, they look for improvement and find the point they have been aiming for. What moves them is the commitment to common goals, specialized role division, and Agile management techniques (Scrum, Kanban, etc.) that share these in real time and manage the team.

Such organizational change requires a much more flexible performance management method than it is now. 

If the interim findings(or early results) are completed quickly and evaluated frequently, the establishment and management of goals cannot be fixed in the current annual evaluation method. In addition, if manpower specialized in each field gathers and works like an agile organization, the leader cannot grade each of these manpower's contribution levels through a common standard. 

Also, since these organizations have a common goal, the level of each member’s achievement of the goal cannot be quantified. 

Keep up with this phenomenon, OKR (Objectives & Key Results), which is famous as Google's performance management method, is attracting attention in the field of performance management. The biggest difference between the traditional performance management method MBO and OKR is ‘flexibility’. 

OKR facilitates the achievement of frequently occurring atypical results (Key Results). Through continuous CFR (Conversation, Feedback, Recognition) in daily working, it further accelerates the progress toward goals in the mid- to long-term direction. Monitoring occurs naturally in this process, and this monitoring is considered important thing. This provides a different level of flexibility than the MBO method in which quantitative goals are planned and measured for a given period (annual or semi-annual). In other words, the evaluation system based on continuous performance management, led by OKR, is a more suitable method for evaluating recent work patterns in which work results occur frequently and atypically.

However, the pace of this generational change is still not fast enough. Even in the United States, where advanced HR management was born, only 10-20% of Fortune 500 companies abandon the annual performance review and try to introduce an absolute evaluation system based on employee development and growth¹ . In Korea, this phenomenon is even stronger.

Even though the environment has changed, the majority of companies view traditional performance management as a golden rule. What is the problem? 

What we wanted to gain from the evaluation, 

and misconception about evaluation 

The point is that changing performance management cannot solve the problems. Performance management is already playing an important role in the human resource management of companies. This is because the inputs for promotion, placement, and compensation all come from evaluation, and performance management is the basis of evaluation. 

Promotion, placement, and compensation cannot be operated without evaluation results. And these are all issues in which limited resources must be allocated to someone. Even if everyone's evaluation results are good, any organizations can promote everyone or give bonuses to all employees. It was the ‘Rating System’ that was able to solve the problem of allocation of limited resources so easily. By adopting the relative evaluation method, even if every employee worked hard and overachieved their work, it was possible to increase compensation for only the top 10% members. In addition, only those with an S rank could be given a promotion opportunity.

However, since compensation and promotion are everyone's concern, evaluation for these has not been conducted properly. 

For smooth communication with employees, managers gave higher ratings to those who had been on the team for a long time or had a higher age, so new employees have been received lower ratings. In particular, for ordinary employees with average performance, grades were roughly allocated to meet the guidelines, even though there was no clear evidence to explain the difference in performance.

These errors that appeared in the rating system made the employees distrust the evaluation. Relative evaluation methods have not been around for a long time, but have never been successful, and now only 14% of employees surveyed believe that the results of the appraisal are reliable and help them achieve better performance. Recently, there is also a study showing that the relative evaluation result itself causes a decrease in motivation in members².

Moreover, the relative evaluation of traditional performance management already has a gap from reality by itself. Traditional performance management assumes that the distribution of achievement of members will follow a bell-shaped normal distribution. However, according to many studies, there are very few people who actually achieve high performance, and the majority of the remaining people show almost similar level of achievement. The problem is to force them to be divided into five levels, and to separate the middle performers who are not very different from the rest of the top performers/low performers.

Was it necessary to pay differential compensation so thoroughly? 

Since the evaluation that lost trust was strongly linked to the reward, the differential compensation also did not provide a sufficient motivation to the members. In this situation, in order to improve their performance, companies began to strictly monitor the evaluators and control their evaluations. Despite having to focus on ‘what performance will be managed?’, companies that have become too sensitive to noise are starting to focus on ‘how to use only quantitative and objective performance?’ 

As a result, all indicators for evaluation were required to be quantified, with a focus on objectivity. The level of the goal was set at 

a level of difficulty similar to that of colleagues and other similar organizations. In the process, disputes continued between practitioners and the HR department over the challenge and feasibility of the goal. We believed that this should be the case to restore trust. All this was because we had to seek to maximize the performance of our members through differential compensation.

The motivating effect of differential rewards, which we believed to be true, has its roots in an old management theory. 

Herzberg (F. Herzberg) divided the factors that motivate people to work and defined them as the unpleasant factor (hygiene factor) and the factor that causes more motivation (motivation factor). It was common knowledge that compensation would be one of the motivating factors. However, according to a recent study, compensation has the nature of a hygiene factor that causes people to leave the company when it is insufficient. However, it is unclear whether it has the characteristics of a motivating factor that induces more performance when there are many rewards³. In other words, the belief that differential compensation can motivate people and maximize performance may be wrong.

To verify this, people have recently collected various pieces of evidence. According to Glassdoor's 2019 survey, more than half of 5,000 office workers chose culture, not reward, as the most important factor in job satisfaction. According to another study, 

only 20% of the respondents said that differential compensation helps improve performance⁴.

So, what could be the most important thing that motivates members? Frequent communication and timely feedback can make them work. According to Gallup's research, when feedback was given once a week, the rate of receiving feedback as meaningful feedback was 5.2 times higher than that of reporting grades once a year. With this feedback, motivation for work performance increased by 3.2 times, and commitment to work and motivation to continue working increased by 2.7 times. It reminds us of the common saying, 'Praise breeds willingness'. 

Regular performance management can contribute to performance improvement by itself, not through compensation.

To put evaluation and compensation where they belong for everyone 

However, efforts are still needed to establish a new system. In order to introduce agile performance management, 

an infrastructure is needed not only to change employees' perceptions, but also to monitor frequently occurring performance and track atypical performance details. Without this infrastructure, it has been difficult to implement agile performance management in recent years. However, recent various tools are helping to perform agile performance management through computer and mobile along with powerful data analysis techniques. 

The last remaining question is 'what should be the factor determining the compensation'. It is an unresolved problem that many companies are still looking for an answer, but we can refer to the following methods to see what kind of attempts are being made.

Compensation based on market competitiveness 

As highly specialized jobs emerged and their values began to form a 'job market', an important criterion for compensation became the value in the job market. The job market is being formed around rapidly growing industries in Korea as well as overseas where the job market is highly developed. In organizations that use value in the job market as a determining factor in compensation, 

the scarcity and marketability of talent's job competency and skills determine compensation. Evaluation will act as a motivator for capacity development.

Even in traditional industry-based companies with little job diversity, there are cases where it is more positive to focus on maintaining compensation competitiveness rather than focusing on differentiation. 

In the case of Lear, an American auto parts maker, as a result of eliminating all traditional evaluations for 110,000 employees and cutting the link between compensation differentials and evaluations, collaboration and work commitment increased⁵.

Expansion of discretion

Focusing on the fact that a small number of high performers perform differentially, while others perform at the same level, some companies have chosen to give their managers compensation discretion so that differential compensation is applied only to those who produce some special performance. Watching the Silicon Valley stars who left them, Microsoft realized how many excellent talents had to leave because of the continuous relative evaluation and differential compensation. They eventually opted for a new compensation distribution method to focus on a small number of super performers.

Use of autonomous compensation decision-making methods 

A collaborative study between SHRM and Globoforce found that peer evaluation was 35.7% more positive for corporate performance than vertical evaluation by managers. In the same study, there is also a result that when a company spends more than 1% of their total wage on mutual recognition and encouragement, 85% of organizations enjoy a tangible increase in engagement. Taking a hint from this, some organizations give their members a reward budget that can be given to others as a sign of recognition. Centered on Start-ups with a horizontal culture, organizations have emerged that distribute reward decision-making rights to members and operate them in a gamification method.

The purpose of performance management is to motivate employees through goal determination and management, and the purpose of compensation is to keep competent employees in the company. The union of these two has been tied up each other, now it is time to let each one find their own place.

1) “Separating Performance Management From Compensation: New Trend For Thriving Organizations”, Forbes, 2016.

2) “Kill your performance ratings”, David Rock et al., 2014.

3) “Managing for Success: Practical Advice for Managers”, Steven R. Smith, 2014.

4) “Purpose-driven pay for performance”, Willis Towers-Watson, 2019.

5) “The Case for Decoupling Performance Reviews from Salary Talks”, Michael Sica-Lieber, 2020.