BONUS SCHEMES
Support for use of strong pay-for-performance relationship with bonus
Do bonuses really motivate better performance? Yes, is the only conclusion to be drawn from a new study by Cornell University on the effects on employee performance of base-pay levels, merit increases, and lump-sum bonuses.
The study by Michael C. Sturman, associate professor at Cornell University’s School of Hotel Administration, shows that both "how much" is paid – the amount of the reward – and "how" the money is paid – the relationship that exists between performance and pay – influence employees' future performance levels.
%ADVERT%
Data was obtained from a large organisation involved in diversified service-related businesses in the United States. The analysis covered employees’ performance from 2001 to 2004.
How much you pay
As expected, the results show that how much you pay is important. As Sturman explains: “Even though the absolute level of one's salary was not related to future performance, relative pay levels made a considerable difference”.
Giving employees a 1% increase in base pay was comparable to the benefit from a 3% bonus. “At the same time, though, managers have to assess the value of merit plans, since these increase base pay permanently, as compared to bonuses. One might conclude that the lower immediate return for bonuses may be justified by the cost savings compared to merit raises.”
How an employee is paid
Perhaps most important, the study also shows that how an employee is paid can also influence performance. Sturman says: “For merit raises, the link between pay and performance was unrelated to future performance. However, the extent of the pay-for-performance relationship with bonuses was significantly related to future performance - provided the link between pay and performance is clearly established.”
Improving the merit pot by one percentage point, but otherwise not making any allocation changes, boosts performance by roughly 2%. If the same amount of money was applied to pay-for-performance bonuses, the analysis projects a performance increase of more than 15%.
But the study suggests that “changing the way bonuses are allocated had considerable effects on performance levels”. So providing a “strong pay-for-performance link for bonuses” rather than merit awards had the greatest potential benefit, improving employee performance by nearly 20%.
Sturman concludes: “In particular, bonuses appear to be the most effective pay-for-performance tool. Raises also increase performance, but tying raises specifically to performance levels does not seem to drive performance in the way that bonuses do.”
Want to know more?
Title: “Using your pay system to improve employees' performance: How you pay makes a difference”, by Michael C. Sturman, Cornell Hospitality Research, vol. 6, no. 13, October 2006.
Availability: To download the report visit www.hotelschool.cornell.edu/chr/research/abstract.html?repid=14241
For over 70 years the School of Hotel Administration at Cornell University has “served the hospitality industry through its commitment to timely research”. In 1992 the The Center for Hospitality Research was established as a “forum in which scholars and industry professionals can work together in pursuit of common research goals”. For more details visit www.hotelschool.cornell.edu