Should Compensation and Performance Be Linked?

You want to inspire your employees to do their best work, and one of the best ways to get your employees to perform is to link their performance to their compensation. Performance-based compensation models are extremely popular, particularly for sales-based roles. But they often raise several important questions as well: What are the pros and cons of tying compensation to performance? If you do decide to link performance and compensation, how can you effectively link the two? And are there ways to inspire your employees to perform at their highest level that aren’t directly tied to their compensation package?

Let’s take a closer look at all these issues to help you determine which structure is right for your organization.

Benefits of Linking Compensation and Performance

There’s no denying that paying your team more when they perform at a higher level (for example, when they make more sales or move the needle on company goals) can be a powerful motivator. The promise of earning more money can inspire people to work harder, and when they get paid more, it can also act as indirect feedback that they’re doing their job well.

“Compensation can be looked at as a motivator and also a feedback tool,” said David Chaudron, PhD, Managing Partner of organizational consulting firm Organized Change. “Money usually lights up people’s eyes, especially if the rewards are a result of their efforts.”

Linking compensation and performance can also help your employees see, in a tangible way, the benefit they bring to your company and its operations.

“When compensation is linked to performance, employees see the direct value of their contributions,” said Anthony Babbit, a change management consultant and business strategist.

There are also definite benefits to linking performance and compensation from a company perspective. When you pay your team based on performance, you only increase their pay when their performance justifies that increase. This will prevent your company from investing too much cash or too many resources into low performers or people who aren’t cut out for the job in the long-term.

Drawbacks of Linking Compensation and Performance

Linking compensation and performance has clean benefits, but it’s not without its drawbacks. First of all, there are a lot of people — and that likely includes a good portion of your employees — who don’t want their performance and compensation linked.

Some people are more risk-averse than others and value stability above all else. So even if there’s the potential to make more money by moving to a performance-based compensation structure, they’d prefer the comfort of a steady, reliable paycheck.

“Many people do not like the idea of pay being linked to performance,” Babbitt said. “Changing compensation to an unknown, even if it could amount to higher pay, can be unsettling for many people.”

Linking performance and compensation can also create a highly competitive environment, which could adversely affect your corporate culture.

“Performance-based compensation structures are known to create blame-focused cultures and increase fear and negativity throughout the company,” said Elizabeth Louis, a management consultant.

And finally, when employees know their compensation is directly tied to performance metrics, it could lead to dishonesty. For example, if your employees are paid based on how many accounts they open, some might be incentivized to create invalid accounts to increase their numbers — and increase their compensation in the process.

“You want to avoid incentivizing the wrong thing,” Chaudron said.

What You Need to Consider

If you do decide that linking performance and compensation is the right structure for your business, there are a few things you’ll want to keep in mind to make the transition as smooth as possible.

1. Choose the right positions for which to link compensation and performance.

Certain positions lend themselves better to a performance-based compensation model, while others do not.

“Any position with a direct correlation to revenue increases or expense reduction will support such a plan,” explained Babbitt. “Conversely, positions that tend to be directly overhead are harder to implement. IT departments and accounting, typically pure overhead, do not have a direct path between performance and sales increases or expense reductions.”

So, for example, sales positions are great roles for using a performance-based compensation model: The more the salesperson sells, the more they’re paid. But paying commission to your receptionist or data entry clerk wouldn’t make sense because there’s no direct way to link their performance with compensation.

Make sure that if you decide to link performance and compensation, it makes sense for the role.

2. And choose the right employees.

When moving to a performance-based compensation structure, you need to do it for the right roles — and, just as importantly, for the right people.

“There is tremendous benefit in linking compensation to performance for individuals who are extroverts with high ambition, endurance, boldness, and autonomy psychometric scores [a psychological metric that measures skills, personality, and ability],” said Louis. “Such psychometrics help create what we call a high performer. They are fearless, competitive, and risk-taking individuals who enjoy the hunt, and are ideal for compensation-only jobs.”

But while that type of personality would thrive in a performance-based compensation role, someone who is more introverted or risk-averse would likely struggle. It’s important to get to know your team, and before making the decision to link compensation and performance, ensure that it’s the right fit for your employees.

3. Consider offering a base salary as well.

A 100% commission structure can be tough on salespeople in general, but particularly if your sales cycle is a longer one, it’s not a feasible option for your employees.

Your employees need a certain amount of money to get by day-to-day. If it takes them, on average, a month to close a sale, they need a base salary to cover their expenses while they work on the prospect, close the deal, and wait to get paid out. Otherwise, linking performance and compensation can actually have the opposite effect — discouraging them and making them want to look for a job with a better pay structure.

“When an employee has to play a ‘long game’ in closing deals or sales, it’s important to provide them with a base salary so they don’t get discouraged,” Louis noted.

How to Motivate Your Team If You Don’t Link Compensation and Performance 

If you decide that linking compensation and performance isn’t right for your company, there are still other ways to inspire and motivate your team, one of which is to shift the focus from performance to employee growth.

“Many people see work as a place to perform all the time. Realistically that is unfair and unobtainable,” said Louis. “Think about sports teams: They spend more time practicing, learning, interacting, and bonding with one another than continually performing. No athlete can perform their best for 40 hours a day, five days a week, for 52 weeks. And no employee can do that either.

“Encourage your employees to see work as a place where they practice their techniques and learn. Let the office be a place where your employees learn, practice, and develop their skills.”

Telling your employees how they fit into the big picture of your business, and how their work has a ripple effect on your organization, can also be extremely motivating.

“Clearly and explicitly let your employees know where they fit in…Explain to them why and how their work and responsibilities fit into the bigger picture,” advised Louis. “People want to feel like more than a number — they want to feel important, appreciated, and like what they do matters. Let them know how their work benefits the company.”

When it comes to linking performance and compensation, there’s no right or wrong answer. There are pros and cons to a performance-based compensation structure, and it’s up to HR and leadership to determine whether such a structure is right for your organization.

But keep in mind that while there’s nothing wrong with using compensation to motivate your employees, when building your team, you want to look for employees who are motivated to do a good job — no matter how you structure their compensation.

“HR departments should be looking to find people who are intrinsically motivated to do a good job, regardless of compensation [structure],” said Babbitt. “Intrinsically motivated people always outperform employees [who are just] ‘working for the weekend.’”