Does Pay for Performance Work? It Depends

Pictured: A hand holding a stick with a carrot tied to it/iStock, chameleonseye

Models that reward employees with higher compensation for good work performance are used throughout most industries, including biotech and pharma.

“There are multiple forms of pay for performance,” said Tony Kong, an associate professor of Organizational Leadership at the CU Boulder Leeds School of Business. “It can be that company or supervisors allocate the pay or rewards based on individual performance, either appraised by a supervisor or measured in some way that is more objective. It can also be paid for team performance. And sometimes some companies actually pay for organizational performance in the form of profit sharing.”

The model is fairly common in biotech and pharmaceutical companies, said Liz Nguyen, an advisor to emerging biotech companies who previously worked as the senior vice president of Talent and Culture at Surrozen.

Much evidence in organizational journals has indicated that the “incentive effect” works to motivate employees to work harder, according to a 2023 Academy of Management Journal study coauthored by Kong. But some recent studies argue that these models can actually backfire and cause employees to become overly stressed, anxious and even depressed, leading them to withdraw from their work or quit. One 2020 study conducted in Denmark even found that when pay-for-performance models were introduced, there was a 4–6% increase in the usage of antidepressant and anti-anxiety medication among employees.

The problem is, there are really no other alternatives to this model for motivating performance in the workplace, Kong said. “If someone has the idea, that’s a million-dollar idea,” he said.

Kong’s research is focused on refining the pay for performance model so that it works how it’s intended to, without the negative side effects of stressing employees and causing them to withdraw from their work or in more serious cases, negatively affecting their mental health. His research seeks to answer the age-old question: How can a company get employees to engage in, rather than withdraw from, work and thus perform well under pay for performance models?

In the study published earlier this year, Kong and his colleagues looked at more than 250 pairs of full time employees and their leaders (defined as direct managers or supervisors who were responsible for evaluating the employee’s performance) in 234 different companies that use pay for performance models in more than 40 industries in south China. Employees were surveyed about their views on pay for performance as well as their leaders’ warmth and competence, as well as their own work engagement and work withdrawal, meaning their tendency to disengage or detach from their work role and lack focus on their performance. Leaders were surveyed on the employees’ task performance.

In determining whether people viewed pay for performance as a threat and withdrew from their work or were more motivated and engaged with their work, the two biggest factors that emerged as contingencies were leader warmth and competency. If employees felt appreciated and that their supervisor was warm and friendly, they were less likely to view pay for performance as a threat. Warmth is really about friendliness, trustworthiness and support and is instrumental as a stress-coping mechanism for employees, Kong said. And if employees viewed their leaders as competent, they were more likely to feel that they could hit milestones and be rewarded commensurately for their efforts under the pay for performance model.

“We think about leadership as a critical contingency,” he said. “In the end leaders are doing the implementation of pay for performance, they allocate resources, they appraise the performance of employees, and they also set goals and help employees achieve the goal. All of that suggests that leaders play a critical role in the whole process.”

Michael Dahl, one the authors of the Danish study and a professor of Strategy and Organization at the Aalborg University Business School, said that the results of Kong’s study are in line with his research. When firms introduce pay for performance, they risk losing top employees, who likely have many other options, he noted.

“Fairness and trust are very important in organizations,” Dahl told BioSpace. “Introducing pay for performance is a likely threat to these factors, so it is important that managers are transparent and build trust for the introduction to be successful.”

The Importance of Transparency and Consistent Communication

In her experience, other key factors for these models to work are transparency, consistency and communication throughout the year, Nguyen said.

“A key ingredient in terms of a successful pay for performance model is that it happens throughout the year, meaning employees get feedback throughout the year on how they're tracking against their goals and objectives, but also gaining feedback around their leadership and behavioral competencies and values,” she said.

Companies can also incorporate feedback from other people in addition to an employee’s direct manager, such as stakeholders or other people the staff member works closely with, Nguyen said. This can help to make the pay for performance model feel more objective.

“If that’s happening throughout the year, when you get your compensation it shouldn’t be a surprise because it should line up with the feedback you’ve been getting from your manager and also from your stakeholder feedback throughout the year,” she said.

This type of feedback has become even more important in a post-COVID, more hybrid and remote world, Nguyen said.

“Normally, before COVID, you could stop by your manager’s office and say, ‘Hey, how am I doing?’ Or can you clarify a note or review,” she said. “We don’t have that same experience now. So that could exacerbate employees feeling depressed or lonely because they don’t have that interaction the way they used to.”

Companies need to have a common framework for pay for performance models that is clearly defined, with consistent performance reviews throughout the year so that employees aren’t confused as to why one person is awarded compensation and another isn’t. If this isn’t in place, she said, it can cause disruptions in the workplace as employees try to navigate the nuance.

“If you don’t have that, it does cause turnover,” Nguyen said.

The Dark Side of Pay for Performance

In addition to its potential negative effects on employee wellbeing and morale, another possible unintended side effect from pay for performance is that employees might feel an increased sense of competition with each other, Kong said.

“The downside of pay for individual performance, because it’s so cutthroat, is that competitive people might cut corners to achieve [a] performance goal . . . [for example] people could just behave questionably or lie in order to get their money,” he explained.

It’s important to build a healthy and productive system at work in order to avoid that, Kong said. For him, that again comes down to promoting leaders who are warm and competent.

“Leaders need to treat their employees as entities with feelings and also take a more caring approach to their leadership rather than just see everyone just as a means to their company’s goals,” he said. “In every industry, the workplace is ranked last among all the places that people want to spend time at. So we really need to promote a grateful workplace and an appreciative workplace so employees feel meaning in their work and want to stay in their workplace.”

Mollie Barnes is a freelance science writer based in Los Angeles. Reach her at mollie@100yearsco.com. Follow her on Threads and Instagram @shejustlikedtogo and see more of her work at molliebarnes.contently.com.