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Performance appraisals are hated by employees, largely dreaded by managers and often described as ineffective by HR professionals. So why do organizations still engage in this annual exercise?

The primary objective, cited by 66% of respondents to a survey by Sibson Consulting, is to distribute rewards based on individual performance. By comparison, just over half (54%) said greater individual accountability is a primary objective. Only 46% identified talent development as the biggest factor.

Rewards distribution is key in other ways, too: It’s the biggest reason why employee-appraisal systems are failing to meet expectations. Proponents of tying rewards to appraisals argue that the overall organization will benefit if the best and the brightest see their pay or bonuses increase more than their average or below-average co-workers.

But what if the appraisal system itself is too subjective, untrusted and flawed? The linkage between rewards and appraisals would then only serve to magnify other problems with the performance-management system. And just as the overall organization was supposed to benefit when the evaluation system works, the entire organization suffers when the evaluation system fails.

And that’s exactly what is happening. The Sibson Consulting survey, which was conducted in mid-2010 with the HR association WorldAtWork, found rampant mistrust in performance management. The results weren’t limited to one country, industry or company. Some 750 people responded, representing a broad swath of industries and organizations around the world. Headcounts of respondents’ organizations ranged from fewer than 100 employees to more than 500,000.

Nine out of 10 respondents reported that their organizations have formal systems to rate the performance of individual employees, shape behaviors and, in theory, provide some sort of benefit to the organization as a whole. At the same time, only 43% of respondents rated their organization’s system as effective.

This article, which is one of three that looks at the epidemic of dysfunction in systems for assessing employee performance, will explore the fallacy of connecting performance with pay.

First, let’s examine what “rewards” are being distributed as part of evaluating performance. According to the Sibson survey, 80% of respondents’ companies tie performance to merit pay while 51% link it to short-term incentives and 31% connect it to long-term incentives. At the same time, at 65% of the responding companies, low performers receive significantly lower or no pay increases while, at 42% of the organizations, high performers received significantly fatter pay checks compared with average performers.

The result, besides cementing a dislike of appraisals, pits employees against each other – something that’s counterproductive to organizations that want employees to work collaboratively. In addition, employees are more likely to change their behavior to match the evaluation’s simplified criteria, which are typically not the overall goals of the organization.

Besides being a recipe for employee and team dysfunction, the connection between rewards and appraisals can strain the organization’s finances. Salaries can grow out of control, especially during economic slowdowns and recessions.

The reason? There is a disconnection between individual performance ratings and overall organizational performance. The Sibson survey found that only 20% of respondents said employee ratings declined in sync with the business’ overall performance. At first glance, this suggests managers may be inflating ratings. But there is more than meets the eye.

External factors – increased competition and the overall economy, to name a few – always impact a company’s performance, and employees can do little to change that. In addition, the business impact of declining performance among employees won’t necessarily be felt for a year or more as problem areas are temporarily glossed over by other employees, cash reserves and customers who continue to do business with an organization for no other reason than inertia. When this happens, an organization will find itself doling out more bonuses and pay raises just before revenue craters.

There is one final nail in the coffin of paying-for-performance: Research shows that it is generally ineffective at boosting employee productivity. Stanford University Professors Jeffrey Pfeffer and Robert Sutton, along with best-selling author Daniel Pink, have demonstrated that pay and bonus incentives are particularly ineffective when tasks are complex, require judgment and rely on collaboration with others. Are there any other types of jobs at today’s organizations?

The global doubts and dislikes of performance management suggest that systems need to be rebuilt from scratch. The best place to start is the link between rewards and what’s checked on the performance-appraisal form. Smart business owners will eliminate that link before it sinks their organizations.

References:

Allan, Leslie, (2010) “Top Leadership Perspectives on Performance Management”, Business Performance Pty Ltd
http://www.businessperform.com/articles/performance-management/leadership-performance-management.html

Pink, Daniel H., (2009) Drive: The Surprising Truth About What Motivates Us, Riverhead Hardcover

Pfeffer, Jeffrey, (2007) What Were They Thinking Unconventional Wisdom About Management, Ch. 11, Harvard Business School Press

Pfeffer, Jeffrey and Sutton, Robert I., (2006) Hard Facts, Dangerous Half-Truths and Total Nonsense: Profiting from Evidence-Based Management, Ch. 5, Harvard Business School Press

The Segal Group, (2010) Study on The State of Performance Management
http://www.sibson.com/publications/surveysandstudies/2010SPM.pdf

The Segal Group, (2010) Information About the Respondents to the WorldatWork/Sibson 2010 Study on The State of Performance Management
http://www.sibson.com/publications/surveysandstudies/2010SPMsupp.pdf