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8 Min Read

Should Performance Reviews be Tied to Compensation?

HR tech writer Amanda Cross
Amanda Cross

Performance and compensation management can be scary. Sitting down with your manager to go over your performance for the last year and getting feedback is nerve-wracking but essential for employees who want to grow in their careers. For 35% of individual contributors, the annual performance review is the only time they get clear feedback from their managers. Since feedback is hard to come by, separating compensation and focusing on performance during the review process is necessary. 

Should you tie compensation and performance reviews together?

For nearly 60% of organizations, compensation and performance decisions are made simultaneously. While this decision can save hours for the manager, it’s not always the best use of you or your direct report’s time.

For your direct reports, tying these conversations can be demotivating and can lead to perceived unfairness. Most of all, it makes it difficult to think about the real issue at hand, which is performance. Compensation is almost always an extensive conversation. Comp plans can be hard to digest, even at the executive level. Conversations that include compensation can quickly get complicated and it can be challenging to refocus. If you want to provide extensive feedback (good or bad), you likely won’t have time to dive into deep discussions around compensation.

Based on the purpose of the conversation (promotion vs. performance), direct managers tend to take in and utilize different sets of information. For example, managers tend to make decisions about promoting team members “based solely on the employee’s bad behaviors.” If managers go into reviews based on whether they’d like to promote an employee, they might focus too much energy on why an employee doesn’t meet expectations. On the other hand, if managers go into a review thinking about performance, they focus on good and bad behaviors.

Companies should take the time to decouple performance reviews and compensation. For the 50% of companies concerned about their performance review process being fair and equitable, this is a simple strategy to create a better performance review experience.

How to make the best decision for your employees

Only 58% of employees feel like their performance reviews are growth and development focused. HR leaders and managers paint a rosier picture of this process at 78% and 72% finding the process to be growth and development focused, respectively. Separating the performance review from compensation may be the best way to close this gap, but it probably won’t be easy. You might have a lack of buy-in from colleagues. Moving to a new system isn’t simple, and your organization may have a “this is the way we’ve always done it” mentality.

If you would like to decouple these two discussions, try working with a small group of employees first. Run a few performance reviews with a separate compensation conversation. Survey those team members and ask them to compare their experience to their last performance review period. Did they notice a difference? What about your managers? You can make a case for what works for your employees when you have this data.

Be transparent with your compensation strategy with employees

Transparency is the cornerstone of a fair and effective compensation strategy, especially when it comes to performance reviews. In today’s dynamic workplace, where talent and skills are highly valued, employees want to know that their contributions are recognized and fairly rewarded. One way to achieve this is by making your compensation strategy crystal clear to your workforce. Internally available salary bands and skills matrices are powerful tools in this regard. By sharing these, you not only ensure that your employees understand the parameters that govern their compensation, but you also provide them with a roadmap for career growth and development. When employees know how their performance and skills align with the company’s compensation structure, it fosters trust and motivation, creating a win-win scenario for both the organization and its workforce.

Beware of monetary rewards giving perverse incentives

Perverse Incentives can lead to unforeseen negative outcomes resulting from individuals’ actions aimed at obtaining the incentive. This issue is particularly evident in performance evaluations that are based on quotas or specific activities when compensation is tied to these metrics. The Wells Fargo scandal serves as a stark reminder of the dangers associated with such incentives, where employees, driven by the promise of financial rewards, opened unauthorized customer accounts to meet unrealistic sales targets, leading to serious ethical and legal repercussions. In the pursuit of these monetary rewards, individuals might lose track of broader strategic matters, focusing solely on short-term gains. Thus, it’s essential for organizations to strike a balance between rewarding employees for their performance and ensuring that incentives do not inadvertently promote detrimental behaviors or harm the overall mission and integrity of the institution.

Five strategies for companies who want to make the most of performance reviews and compensation

The truth is that performance has a significant impact on compensation. Companies give more bonuses and raises to employees who perform well. Decoupling these ideas during the performance review helps you focus energy on employee development and growth. The following strategies will help you reframe how your organization thinks about these two topics.

1. Host frequent talks about performance

It can be challenging to fix behavior that doesn’t meet expectations if you leave performance conversations to once per year. You might be rewarding negative behavior and costing the company money. Negative behavior that you don’t address will fester and become routine for your team members.

Companies that host regular performance conversations can address negative behavior when it starts, reward positive behaviors, and simplify the performance review process. If you always have performance discussions, the annual review becomes a summation of known facts vs. new information that upsets your team members.

2. Hold an adverse impact study to determine the value of your performance reviews

During a recent webinar on compensation and performance reviews, Glizcel Ditto, Director of Client Solutions at HRSoft, shared, “If you are tying [performance reviews and compensation] very closely, you’re assuming that your performance process is in good shape.”

All of the experts on our panel encouraged companies to run an adverse impact study on performance reviews because it can be eye-opening for your company’s leaders. Adverse impact studies can help you determine the worth of your reviews and ensure that “neutral” decisions don’t harm protected groups in your workplace.

Laura Morgan, webinar panelist and Managing Partner at MorganHR, shared that adverse impact studies don’t have to be negative. Instead, you may find that your process works as intended and that knowledge can help you tie performance to increased compensation.

3. Provide manager training and resources to remove bias and help your leaders provide stellar performance reviews every time

Getting a title as a manager doesn’t come with excellent bias reduction and feedback skills. Great managers are self-aware and understand where their limitations are. Companies must help their employees fill in the gaps with training and resources to improve the process for everyone.

4. Spread the wealth past your highest performers

When you tie performance to compensation, motivating employees who aren’t top performers can be difficult. Spending too much money on employees at the top leaves little for employees who could become top performers. As even the best employees leave for different roles and opportunities during The Great Resignation, you must empower employees who meet their work expectations.

5. Take a look at your company’s compensation philosophy

An employee compensation strategy should go beyond defining base pay, commission, and quarterly bonuses. Consider these questions: 

  • What sets your organization apart from the competition?
  • Are there opportunities for growth and development that make your organization a great place to work?
  • What benefits do you offer your employees?

Work with your executive team to create an effective compensation strategy that speaks to your employees’ needs, experiences, and motivations. Your compensation plan should help you reward your best employees while providing competitive pay. As Sheila Sever, Senior Manager at Deloitte Consulting LLP, added during our recent webinar, “It’s table stakes to pay competitively.”

15Five employee compensation strategy playbook

Conclusion: Focusing on employee growth during performance reviews

If you are like many leaders who want to facilitate employees’ personal and professional growth through performance reviews, you need to reconsider your processes. Are you helping your team grow by tying compensation to performance reviews? Would having those conversations a couple of weeks apart create a smoother process for everyone involved? We think so.

Do you want to continue this conversation? Watch our recent webinar on whether compensation should be tied to performance reviews.