CHAPTER 9 EMPLOYEE BENEFITS LEARNING OUTCOMES After studying Chapter 9, students should be able to: Explain why employee benefits are such a significant component of total compensation. Discuss key issues in benefits planning, design, and administration. Describe three important functions in benefits administration. Summarize 1) the legally required benefits in Canada and 2) the other common employee benefits offered by organizations. Explain the difference between defined benefit and defined contribution pension plans. Describe the two general strategies for controlling medical benefit costs. CHAPTER SUMMARY Employee benefits have been increasing in cost for the past 50 years, and now constitute a significant amount of compensation expense in all Canadian organizations, in the order of 40 percent of payroll. Key issues in benefits planning and design are: (!) the role of benefits in a compensation package, such as attracting and/or retaining employees, (2) external competitiveness with benefits offered by other organizations, (3) benefits adequacy to meet the needs of employees and their families when facing serious medical problems, retirement or other life issues, and (4) cost effectiveness. Key administrative issues include (1) who should be included in these plans, the level of flexibility in employee choice regarding their benefits, and (3) employee-employer cost sharing. Three important functions in benefits administration are benefit communication, claims processing, and cost containment. There are three legally required benefits in Canada, in addition to government-sponsored healthcare plans: Workers’ Compensation, Canada/Quebec Pension Plan, and Employment Insurance. In a defined benefit pension plan, the employer agrees to provide a specific level of retirement pension, the exact cost of which is unknown. In a defined contribution pension plan, the employer agrees to provide specific contributions but the final benefit is unknown. The two general strategies for controlling medical benefit costs are: (1) motivating employees to change their demand for health care through changes in the design or administration of the plan, and (2) the promotion of preventive health programs. LECTURE NOTES INTRODUCTION TO EMPLOYEE BENEFITS Employee benefits are part of the total compensation package, other than pay for time worked, provided to employees in whole or in part by employer payments, such as life insurance, pension plan, worker’s compensation, vacation etc. We do know that employee satisfaction with benefits is positively associated with job satisfaction, but we are not sure about more specific payoffs. WHY THE GROWTH IN EMPLOYEE BENEFITS? There has been a rapid rise in employee benefit costs, moving from about 15 percent of payroll costs in 1953 to the 40 percent range today. Government Impetus Three employee benefits are mandated by either the provincial or federal government: workers’ compensation (provincial), employment insurance (federal) and Canada/Quebec Pension Plan (federal and Quebec). In addition, most other employee benefits are affected by such laws as the Income Tax Act, Human Rights Acts, Pension Benefits Acts, etc. Unions Unions have fought for the introduction of new benefits and the improvement of existing benefits. Largely through the efforts of unions, several benefits common today were given their initial impetus: pattern pension plans, supplementary unemployment compensation and extended vacation plans. Employer Impetus Employers also increased benefits in an effort to improve employee satisfaction and productivity. For example, rest breaks were introduced to reduce the possibility of accidents and mistakes in the production process. Many benefits introduced by the employer were done for the purpose of altering the perception of the employer by the employees. Cost Effectiveness of Benefits Cost advantages also led to the increase in benefits. Benefits offer three types of cost advantages: most benefits are not taxable in order to avoid income tax implications; many group-based benefits, like health and life insurance, and can be purchased at lower rates for group participants through the employer than done individually; benefit premiums and pension contributions are tax deductible up to limits given in the Income Tax Act. THE VALUE OF EMPLOYEE BENEFITS Most studies of the relative importance employees attached to different types of benefits show fairly consistent results. Employees expect benefits as part of their total compensation, but often take them for granted and do not understand the true value of those benefits. Employees do have preferences in what types of benefits they want, but when asked what benefits they receive, often cannot list all of them. Also, when asked to place a value of their benefits, employees often undervalue the benefits because they are taken for granted. KEY ISSUES IN BENEFITS PLANNING, DESIGN AND ADMINISTRATION Benefits Planning and Design Issues The first step in designing a sound benefits package for an organization is to examine the role the benefits will play in the total compensation package. For instance, will the benefits be used to attract employees, or will they be used to help reduce turnover? The benefits planning process must next ensure that the benefits are externally competitive with other organizations. In order to determine the adequacy of benefits, organizations try to determine whether the costs of the benefits are justified. Third, the benefits must be deemed adequate from a financial liability perspective. This is a difficult task but significant especially when considering medical expenses and benefits. Administration Issues Three major administration issues arise in setting up a benefits package: Who should be protected or benefited? How much choice should employees have among an array of benefits? How should benefits be financed? Employers can answer a series of questions in order to decide on the benefits coverage. Some issues to consider include whether probationary periods should apply before employees are eligible for benefits and what dependents should be covered by the benefits. These considerations include: Probationary periods Dependents Retirements Survivors of deceased employees Disabilities Layoffs, leaves of absence, strikes Benefits for all or some The issue of how much choice employees should have could be answered through the adoption of a flexible benefits plan. Organizations using such plans must incorporate tax and non-discriminatory requirements in order to comply with existing laws. The issue of financing the benefits is a decision of whether the benefit will be non-contributory, where the employer pays the cost; contributory, where costs are shared between employer and employee or employee financed, where the employee pays the total cost for some benefits, like long-term disability. FACTORS INFLUENCING BENEFIT PLANNING Employer Preferences There are six factors: (1) Relationship to Total Compensation Costs; (2) Costs Relative to Benefits; (3) Competitor Offerings; (4) Role of Benefits in Attraction, Retention and Motivation; and (5) Legal Requirements. See Exhibit 9.1 on page 194 to review the factors that influence the choice of a benefits package. Relationship to Total Compensation Costs - considers the costs of the benefits as part of the total compensation package. The organization examines whether the money spent on each benefit would be better spent elsewhere. Examining Costs Relative to Benefits - requires organizations to take a broader perspective with benefits and calculate the present and anticipated future costs of benefits in order to determine whether the organization can afford to maintain a particular level of that benefit in the future. This is especially true with health insurance, where employers have found it increasingly difficult to maintain the same level of health insurance coverage without increasing the required contribution by employees to that coverage. This supports a cost containment practice that allows the benefit to be offered but on a cost-sharing basis. Competitor Offerings – benefits must be considered relative to competitors in order to maintain external equity and maintain the pay policy objective of leading, matching, or lagging the market. Frequently, benefits surveys are used to assess benefit packages being given by competitors. Role of Benefits in Attraction, Retention and Motivation - Although organizations hope that benefits will help attract and retain productive employees, researchers debate the role of benefits in attraction, retention and motivation. Little evidence shows that benefits do in fact attract, retain or motivate employees. Since many benefits increase with years of service, they may aid in retention. Research on the role of benefits in employee satisfaction shows that satisfaction with benefits has declined in recent years. Few studies show any relationship between benefits and increased productivity. The exception would be employees who have stock options as benefits (See Chapter 11). Legal Requirements - Employers must ensure that their benefits programs comply with legislation. Vesting is the waiting period for entitlement to the employer-paid portion of pension benefits. Absolute and Relative Compensation Costs- must both be assessed in order to determine the costs of the total benefits package and the competitiveness of the package compared to the packages offered by competitors. Employee Preferences Employee preferences for various benefit options are determined by individual needs. Benefits perceived to best satisfy individual needs are most highly desired. In part these needs arise from feelings of perceived fairness. The Fairness perceptions of employees must be anticipated when choosing benefits as part of the total benefits packages. Perception of inequity may exist if employees believe that they are not receiving benefits provided by other employers. Personal Needs of Employees must be considered when choosing benefits that will be part of the total benefits package. Demographic differences in employees can lead to differences in preferences for various benefits. For instance, older workers might rate the importance of a pension plan higher than would younger workers. In order to determine employee needs, employers could infer the needs based on demographic characteristics of the workforce, or they could survey employees to determine employee preference for different benefit options. A flexible benefits program could also be used to allow employees to choose the benefits they prefer. ADMINISTERING THE BENEFITS PROGRAM The administrative time is spent on three functions requiring further discussion: (1) communicating the benefits program, (2) claims processing and (3) cost containment. Employee Benefits Communication The most frequent method for communicating employee benefits today probably is the employee benefits handbook. A typical handbook contains a description of all benefits, including levels of coverage and eligibility requirements. To be most effective, this benefits manual should be accompanied by group meetings and videotapes. A more typical approach involves one-on-one discussions between the benefits administrator and an employee seeking information on a particular benefit. Posting the details of benefits plans can be done on the intranet and internet. The content of the communications package must be complete, clear, and free of the complex jargon which so readily invades benefits discussions. Claims Processing A claims processor first must determine if the claim is valid. Approximately ten percent of claims are denied. The second step involves determining whether the employee is eligible for the benefit. If payment is approved at this stage, the claims processor calculates the payment level. Cost Containment Employers are auditing their benefits option for cost containment opportunities. The most prevalent practices include: probationary periods, - an initial period where the employee is not eligible for benefits benefit maximums – some benefits like disability premiums have maximum coverage periods coinsurance – percentage of insurance premiums paid for by the employer deductibles – a specified dollar amount of claims paid by the employee each year before insurance benefits begin coordination of benefits – the reduction of benefits by any amount paid under a spouse’s benefit plan administrative cost containment – this includes such things as competitive bids for program delivery See Exhibit 9.2 on page 198 to review the primer of cost-containment terminology. TYPES OF BENEFITS See Exhibit 9.3 on page 198 to review the main categorizations of benefits. Legally Required Benefits It is important to know which benefits are covered by legislation. Legally required benefits include CPP/QPP, EI, Workers’ Compensation, and government-sponsored healthcare. Workers’ Compensation Workers compensation is a form of no-fault insurance that covers injuries and diseases that arise out of, and while in the course of employment. Workers’ Compensation is legislated by each province and territory, but the variations in benefits and costs are relatively minor. The focus of Workers’ Compensation has been shifting from the provision of compensation to injured workers to prevention of accidents through promoting occupational health and safety and facilitating recovery and return to work for injured workers. Canada/Quebec Pension Plan (CPP/QPP) The Canada/Quebec Pension Plan is a government-sponsored plan designed to replace employment income in case of retirement, death, or disability. All employees and self-employed persons must contribute to the plan, and employers match their employees’ contributions equally. CPP and QPP are not static and will continue to evolve according to the changing demographics in Canada. Employment Insurance (EI) Employment insurance provides workers with temporary income replacement as a result of employment interruptions due to work shortages, sickness, non-occupational accidents, maternity leave, parental or adoption leave or compassionate care leave. It does not apply to workers who are self-employed. Benefits are not payable when an employee is terminated for just cause or quits without good reason. EI is not static and will continue to evolve according to the changing demographics in Canada. Supplementary Unemployment Benefits (SUB) Plans and Work Sharing Programs SUB plans are voluntary, self-insured employer plans to supplement benefits received under the EI plan. Maternity, parental, and compassionate care SUB plans can supplement up to 100 percent of earnings, and all other SUB plans can supplement up to 95 percent of earnings. Retirement Pension Plans Pension plans provide income to an employee at retirement as compensation for work performed now. The security motive and certain tax advantages have also fostered this growth in pension programs. The vast majority of employers choose to provide this benefit as part of their overall package. Two types of pension plans will be discussed: (1) defined-benefit and (2) defined-contribution plans. See Exhibit 9.4 on page 201 to review the high cost of frequent job changes relative to pension contributions and pension eligibility. See Exhibit 9.5 on page 202 to see a summary of advantages for the both types of pension alternatives. Defined –Benefit Plans An employer agrees to provide a specific level of retirement pension, which is expressed either as a fixed dollar or percentage-of-earnings amount that may vary (increase) with years of seniority in the company. The firm finances this obligation by following an actuarially determined benefits formula and making current payments that will yield the future pension benefit for a retiring employee. Defined-Contribution Plans This plan requires specific contributions by an employer, but the final benefit is unknown, depending on the investment success of those charged with administering the pension fund. Pension Legislation Each province across Canada (except Prince Edward Island), as well as the federal government, via the Canada Revenue Agency, has legislation regarding pension benefits. In addition, the Income Tax Act has detailed requirements regarding pension plans that must be met in order for employer and employee contributions to be tax deductible up to the limits provided in the Act. Life Insurance One of the most common employee benefits offered by organizations is some form of life insurance. Typical coverage is a group insurance policy with a face value of one to two times the employee’s annual salary. Most plan premiums are paid completely by the employer. Some employers provide additional life insurance on an optional employee-paid basis. Others provide retirees with life insurance at little or no cost. Two other common forms of life insurance are dependent life and accidental death and dismemberment insurance. Medical Insurance Employer-sponsored medical insurance provides coverage for expenses not payable under the mandatory, legislated plans. This includes some medications and prescription drugs which can represent upwards of 75 percent of employer medical costs in Canada. Health Care: Cost Control Strategies - There are two general strategies available to benefit managers for controlling the rapidly escalating costs of health care. First, organizations can motivate employees to change their demand for health care, through changes in either the design or the administration of health insurance policies. Things to include in the control strategies here include: deductibles, coinsurance rates, maximum benefits, and coordination of benefits. The second cost strategy involves promotion of preventive health programs. Wellness initiatives as given in Exhibit 9.6 on page 204 are typical of those found in organizations in Canada. Dental Insurance - Dental care plans typically cover the full cost of basic preventive maintenance such as checkups and fillings; and 50 to 80 percent of major restorative work. Benefits payable are usually linked to the dental fee guide in each province for the current year or a previous year. Vision Care - This benefit has spread throughout the private and public sectors. Most plans are non-contributory and cover part or all of the costs of eye examinations, lenses, frames and contact lenses. Income Security: Disability Plans Although many employees in precarious employment will never qualify for income security plans, the rate of those who do qualify is increasing steadily according to Statistics Canada. These plans include: short-term disability plans - employer-sponsored plans that provide a continuation of all or part of an employee’s earnings when the employee is absent from work due to an illness or injury that is not work-related; sick leave plans- employer-sponsored plans that grant a specified number of paid sick days per month or per year, and long-term disability planes – provide income protection due to long-term illness or injury that is not work related. The payments begin after 26 weeks of disability. Pay for Time not Worked These include the following benefits: Paid rest periods, lunch periods, wash-up time, travel time, clothes-change time, and get-ready time benefits Paid vacations Paid holidays (statutory and other) Other (jury duty allowances; bereavement pay/ paid personal leave; paid time for community volunteer work) EMPLOYEE ASSISTANCE PLANS (EAPs) An employee assistance plan is an employer-sponsored program that provides employees with confidential counselling and/or treatment programs for personal problems including addiction, stress, and mental health issues. OTHER BENEFITS Childcare Services In response to the changing demographics of the workforce, many employers now offer day care benefits for employees. Employers view the provision of day care facilities of funds for day care as an important tool in the attraction and retention of employees. One fast-growing employee benefit is emergency child care. Eldercare Given longer life expectancy than ever before and the aging of the baby-boom generation, one benefit that will become increasingly important is eldercare assistance. Members of the aging workforce are increasingly assuming caregiver roles for their elderly parents. As an example Great West Life in Winnipeg has eldercare specialists on staff to help employees manage their situations. FLEXIBLE BENEFIT PLANS A flexible benefit plan is one where the employee is provided with a specified amount of money and then chooses which benefits to spend the money on, according to their attractiveness and cost. Many companies like flexible benefit plans due to the cost savings and the ability to constrain the costs employees can spend. They also offer diversity in benefits to employees so that they can customize them according to their lifestyles. See Exhibit 9.7 on page 209 to see an example of the options that might be available in a flexible benefit package. See also Exhibit 9.8 on page 209 to review the advantages and disadvantages of a flexible benefit program. CHAPTER 10 PAY FOR PERFORMANCE: PERFORMANCE APPRAISAL AND PLAN DESIGN LEARNING OUTCOMES After studying Chapter 10, students should be able to: Identify the three factors that employee performance depends on. Briefly describe the difference between motivation theories that focus on content and those that focus on the nature of the exchange, and those that focus on desired behaviour. Discuss the ways in which compensation motivates behaviour. Explain three strategies to better understand and measure job performance. Describe at least five common errors in the appraisal process. Discuss the key elements of an effective performance appraisal process. Explain the three factors that determine the effectiveness of a pay-for-performance plan. CHAPTER SUMMARY The three factors on which employee performance depends are: Ability Motivation to performance, and The environment Content theories focus on human needs that influence behaviour. Motivation theories that focus on the nature of the exchange look at the cognitive process used to assess a situation and choose behaviour that yields the most satisfactory exchange. Goal-setting theory focuses on desired behaviour. Compensation motivates behaviour because it affects decisions about whether to join a firm, to stay or leave, to agree to develop job skills, and to perform better. Three strategies to better understand and measure job performance are: Improving the appraisal format Selecting the right rates Understanding how raters process information, and Training raters to rate more accurately. Common errors in the performance appraisal process include: the halo error (overall high rating due to one characteristic), the negative halo error (overall low rating due to one characteristic), first-impression error (rating based only on first impression) recency error (rating based only on most recent impression) leniency error, strictness error, central tendency error (rating all employees as average) similar-to-me error (high ratings for individuals similar to the rater), and spillover error (low ratings related to poor performance in a prior rating period). The key elements of an effective performance appraisal process are: A sound basis for establishing performance dimensions Involving employees in developing performance dimensions and building measurement scales Ensuring the raters are trained Ensure raters are motivated to rate accurately Ensuring that raters maintain a diary of employee performance Having raters accept a performance diagnosis to identify solutions for performance problems Both merit and promotional increases are examples of pay for performance. The three factors that determine the effectiveness of a pay-for-performance plan are: Efficiency in supporting corporate objectives Fairness, and Legal compliance LECTURE NOTES WHAT BEHAVIOURS DO EMPLOYERS CARE ABOUT? LINKING ORGANIZATION STRATEGY TO COMPENSATION AND PERFORMANCE MANAGEMENT In this section of the book we argue that organizational success ultimately depends on human behaviour. Our compensation decisions and practices should be designed to increase the likelihood that employees will behave in ways that help the organization achieve its strategic objectives. First, we identify the four kinds of behaviours organizations are interested in. Then, we note what theories say about our ability to motivate these behaviours. And finally, we talk about our success, and sometimes lack thereof, in designing compensation systems to elicit these behaviours. There is growing evidence that employee performance depends on three general factors: Employee performance = f (A, M, E) where A = Ability M = Motivation to perform E = Supportive environment BUT: performance of individuals can vary, external environment can vary, overall corporate performance can vary and objectives may change. All these factors affect the ability to link individual pay to compensation strategy. See Exhibit 10.1 on page 219 to review the ways in which performance measurement relates to compensation strategy. WHAT DOES IT TAKE TO GET THESE BEHAVOURS? WHAT THEORY AND RESEARCH SAY Motivation is a process involving the determination of what is important to a person, and offering it in exchange for desired behaviour. The most significant motivation theories include: Maslow’s Need Hierarchy Herzberg Two-Factor Theory Expectancy Theory Equity Theory Reinforcement Theory Goal Setting Theory Agency Theory See Exhibit 10.2 on pages 221-222 to review the motivation theories above. Some of the theories focus on content, which means, identifying what is important to people. Maslow and Herzberg, for example, both fall in this category. People have certain needs, such as physiological, security, and self-esteem, that influence behaviour. A second set of theories, best exemplified by expectancy theory, equity theory and agency theory, focus less on need and states and more on the second element- the nature of the exchange. Expectancy Theory is a motivation theory stating that people cognitively evaluate potential behaviours in relation to rewards offered in exchange. According to this theory, we choose behaviours that yield the most satisfactory exchange. Equity Theory is a motivation theory stating that people are concerned about fairness of the reward outcomes exchanged for employee inputs. It focuses on the notion that people are highly concerned about equity, or fairness of the exchange process. Employees look at the exchange as a ratio between what is expected and what is received. Agency Theory is a motivation theory stating that employees and management/owners both will act opportunistically to obtain the most favourable exchange possible. Performance-based pay is the optimal compensation choice for more complex jobs where monitoring employee’s work is difficult. Performance targets should be tied to organizational goals. Use of performance-based pay will require higher total pay opportunity. WHAT DOES IT TAKE TO GET THESE BEHAVIOURS? WHAT COMPENSATION PEOPLE SAY Typically the socialization process would teach new employees the culture that is supported within the organization. Examples include eating lunch at your desk, working long hours, not taking breaks and so forth. Compensation professionals did not get involved in how this culture and behaviours might be motivated. Progressive companies ask the question, “What do we want our compensation package to do?” “How, for example, do we get our product engineers to take more risks?” Compensation then is designed to support this risk-taking behaviour. TOTAL REWARD SYSTEM: OTHER RWARDS BESIDES MONEY INFLUENCE BEHAVIOUR! A total reward system includes all financial and nonfinancial rewards provided by organizations to their employees. Compensation is but one of many rewards that influence employee behaviour. Workers highly value such other job rewards as empowerment, recognition, and opportunities for advancement. At least 13 general categories of rewards are provided by organizations as part of their total reward system. See Exhibit 10.3 on page 224 to review the thirteen components of a total reward system. See also Exhibit 10.4 on page 225 to see the definitions for many wage components and the level of risk to employees. It is important to consider the risks to employees because risk-averse employees will not choose high-risk wage components. DOES COMPENSATION MOTIVATE BEHAVIOUR? The role of compensation can motivate four types of behaviour: the decision to join, to stay, to develop skills, and to perform well. Do People Join a Firm Because of Pay? That level of pay and pay system characteristics influence a job candidate’s decision to join a firm should not be too surprising. Evidence suggests talented employees are attracted to companies that have strong links between pay and performance. Personality will often drive the employees’ desire to have greater or lesser toward rewards which motivates them to join a firm. Do People Stay in a Firm (or Leave) because of Pay? There is clear evidence that poor performers are more likely to leave an organization than good performers. Actually, the evidence on pay and retention is mixed. Turnover is much higher for poor performers when pay is based on individual performance. Conversely, group incentive plans may lead to higher turnover of better performers. Equity theory supports the notion that fairness is important to some employees more than others. If there are instances of unfairness then this will motivate employees to leave more than pay. Do Employees More Readily Agree to Develop Job Skills Because of Pay? The answer to this question is not apparent. Skill-based pay (Chapter 6) is intended, at least partially, to pay employees for learning new skills - skills that hopefully will help employees perform better on current jobs and adjust more rapidly to demands on future jobs. Evidence is starting to accumulate that pay for skill may not increase productivity, but does focus on people on believing in the importance of quality and in turning out significantly higher quality products. Do Employees Perform Better on Their Jobs Because of Pay? Typically, linking pay to behaviours of employees results in better individual and organizational performance. Evidence exists to support that management and workers alike believe pay should be tied to performance. The role that performance levels should assume in determining pay increases is less clear-cut for blue-collar workers. Unionized workers prefer seniority rather than performance as a basis for pay increases. Part of this preference may stem from a distrust of subjective performance measurement systems. When we turn to the impact of pay on group performance, the evidence is somewhat clearer. Pay matters! Most well controlled studies where companies base part of pay on some measure of corporate or division performance report increases in performance of about 4-6 percent per year. Sometimes failure arises, ironically, because the incentive works too well, leading employees to exhibit rewarded behaviours to the exclusion of other desired behaviours. THE ROLE OF PERFORMANCE APPRAISALS IN COMPENSATION DECISIONS A performance appraisal is a process of evaluation or appraising an employee’s performance on the job. Unless performance can be measured through objective, quantifiable results, the subjectivity involved in measuring performance can result in problems and a performance appraisal that does not accurately measure what was intended to measure. It is important to realize that professional judgement derived from experience, education and critical inquiry is necessary when generating performance appraisal information. STRATEGIES TO BETTER UNDERSTAND AND MEASURE JOB PERFORMANCE There are many strategies that are suitable for measuring job performance including: improve evaluation formats select the right raters understand how raters process information, and train raters how to avoid common errors in appraising performance. Strategy One: Improve Evaluation Formats An evaluation format is the method used to evaluate an employee’s performance, either ranking against other employees or rating on one or more performance criteria. The two general categories in evaluating performance are: (1) ranking procedures and (2) rating format. Ranking compares employees to other employees; Rating compares employees to absolute standards measured on a scale that identifies dimensions of performance. See Exhibit 10.5 on page 229 to review three ranking formats including the straight ranking method, the alternation ranking method and paired comparison performance ranking method. The alternation ranking method is a process that ranking the best employee, then the worst employee, then the next-best and next-worst and so on. Paired comparison performance ranking method is a ranking where each employee is ranked against all other employees, one pair at a time. Behaviourally anchored rating scales (BARS) is a performance rating scales using behavioural descriptions as anchors for different levels of performance on the scale. It is very demanding to generate these behavioural descriptions but once set up, BARS provides the most valid performance information once generated. The use of BARS is an attempt to reduce the subjectivity of a standard rating scale by anchoring the scales to concrete work behaviours. This gives raters a common definition for performance dimensions. See Exhibit 10.7 on page 231 to review a standard rating scale with behavioural scale anchors. A third rating technique, Management by Objectives (MBO) uses outcomes to appraise performance. MBO is a performance rating method based on meeting objectives set at the beginning of the performance review period. Here, performance objectives are set by the employee and supervisor at the beginning of the period, then reviewed to determine if they have been met at the end. Performance appraisal depends on the accomplishment of the objectives. See Exhibit 10.9 on page 232 to see an example of setting a MBO objective for a communications skill. See Exhibit 10.10 on page 233 to review the components of a successful MBO program. Evaluating Performance Evaluation Formats- evaluation formats are generally evaluated against five criteria: employee development potential, (amount of feedback about performance that the format offers); administrative ease, how easily the results can be used for administrative decisions; HR research potential, how well the method lends itself to validation and use in other personnel-related questions; cost, how cost effective the method is; and validity, how free from error and accurate the method is. Suggestions for Choosing Rating Formats: A contingency approach is suggested: the nature of the tasks is matched to the format best able to measure performance of those tasks. For instance, if tasks are not routine, then an MBO approach might be appropriate to measure whether or not a goal was achieved. See Exhibit 10.11 on page 234 to review an evaluation of performance evaluation formats. Strategy Two: Select the Right Raters A second way that firms have tried to improve the accuracy of performance ratings is to focus on who might conduct the ratings and which of these sources is more likely to be accurate. To lessen the impact of one reviewer, and to increase participation in the process, a method known as 360-degree feedback has grown more popular in recent years. It is a performance appraisal method that includes feedback from up to five sources: supervisor, peers, self, customers, and subordinates. Generally, this system is used in conjunction with supervisory reviews. Supervisors as Raters - is the most common choice since supervisors are the most knowledgeable with the work of the employee on a day-to-day basis and are also familiar with the requirements of the job. Supervisors are prone to halo and leniency errors. Peers as Raters - can be appropriate if work is done in group settings and peers have more interactions with the ratee than do supervisors. This can lead to group tensions or unrealistic evaluations if the raters are not trained or do not understand the purpose of the rating. Self as Rater - can be used since the ratee has complete knowledge about his/her own performance. Since the individual may be more lenient than the organization would like, self-ratings can be used for developmental purposes. Customer as Rater – customers’ opinions are often sought to support the notion of quality. More companies are recognizing the importance of the customer. Subordinate as Rater – subordinates are a good source for providing information into the performance process but typically on an anonymous basis. The notion of subordinates as raters is appealing since most employees want to be successful with the people who report to them. Strategy Three: How Raters Process Information Understanding how raters gather, store and use performance information can also help improve the accuracy of the process. This involves an examination of Models of the Appraisal Process, or how appraisers view information and make judgements: Errors in the Rating Proves to examine why raters commit the errors that they do; Errors in Observation (Attention); Errors in Storage and Recall; and Errors in Actual Evaluation. Models of the appraisal process show that the rater goes through several stages in the appraisal process. First, the ratee is observed. Next, their behaviour is encoded and stereotypes may be used. The information is put into memory, but some may be forgotten. Next, information is retrieved then reconsidered in light of other information, so that a final decision is made. Errors can occur at any stage of this processing model. See Exhibit 10.13 on page 236 to view the most common errors in the appraisal process. Errors in the rating process deals with how the rater includes behaviours (such as personality traits) that are not relevant to the performance in the assessment of the performance. Errors in observation (Attention) examines what raters pay attention to when they are evaluating performance. For instance, raters are influenced by appearance and race in their evaluations. Change in performance over time also influences raters. For instance, an employee whose performance improves over time is seen as motivated, but an employee whose performance is variable over time is not. Errors in storage and recall come about because raters store information in the form of traits and retrieve it in the form of trait categories. Errors also occur because of decay of memory, especially if there is a long period between the time of the performance and the time of the evaluation. Errors in actual evaluation occur when raters are unwilling to differentiate between workers or are uneasy giving feedback about the performance. Raters may try to avoid unpleasant situations by giving employees inaccurate ratings. STRATEGY 4: TRAINING RATERS TO RATE MORE ACCURATELY. Most research indicates that rater training is an effective method for reducing appraisal errors. Rater-training programs can be divided into three distinct categories: Rater-error training, in which the goal is to reduce psychometric errors (e.g. leniency, severity, central tendency, halo) by familiarizing raters with their existence; performance dimension training, which exposes supervisor to the performance dimensions to be used in rating; and performance-standard training, which provides raters with a standard of comparison or frame of reference for making appraisals. There are several factors that lead raters to give inaccurate appraisals: guilt embarrassment about giving praise taking things for granted not noticing halo effect dislike of confrontation spending too little time on preparation of the appraisal PUTTING IT ALL TOGETHER: THE PERFORMANCE EVALUATION PROCESS The actual appraisal process should provide the following: A clear sense of direction An opportunity for employees to participate in setting the goals and standards for performance Prompt, honest, and meaningful feedback Immediate and since reinforcement Coaching and suggestions for improving future performance Fair and respectful treatment An opportunity for employees to understand and influence decisions that affect them. DESIGNING A PAY-FOR-PERFORMANCE PLAN As the pay model suggests, the effectiveness of reward systems is dependent on three things: efficiency, equity and legislative compliance. Efficiency involves three general areas of concern: strategy, structure and standards. Strategy – the pay-for-performance strategy should be aligned with corporate objectives and HR strategy Structure – the organizational structure has many formats which can influence a pay-for-performance plan Standards – prior to creating a pay-for-performance plan, it is essential that performance standards be set Fairness objective is to ensure that the plan is fair to employees. Two types of fairness are concerns for employees: distributive justice and procedural justice. Legislative Compliance- pay-for-performance plan should comply with existing laws. We want a reward system that maintains and enhances the reputation of a firm. LINKING PAY WITH SUBJECTIVELY APPRAISED PERFORMANCE It is often difficult for employees to believe that their raise is a reward for performance. If organizations give across the board cost of living increases, employees will not see a connection to their performance. Organizations often use guidelines to give raises based on performance. Performance-and Position-Based Guidelines A performance-and position-based guideline for pay raises bases the increase on the performance appraisal score and the position in the pay range. This is done so that poorer performing employees will receive lower pay increases, and to control costs because as an employee moves up the pay range, pay increases at a decreasing percentage. Designing Merit Guidelines Four questions must be answered in order to design a merit guideline: (1) What increase should the poorest performers receive? (2) What increase should average performers receive? (3) What should top performers receive? (4) How much of a differential should there be in the percentage rewards between performance categories? PROMOTIONAL INCREASES AS A PAY-FOR-PERFORMANCE TOOL One of the most effective methods of rewarding good performance is a promotion accompanied by a salary increase. This method of linking pay to performance has at least two characteristics that distinguish it from traditional annual merit pay increases. First, the size of the increment and second, promotion increases represent a reward to employees for commitment and exemplary performance over a sustained period of time. Instructor Manual for Compensation George T. Milkovich, Jerry M. Newman, Barry Gerhart, Cole, Margaret Yap 9780071051569, 9781259086878, 9780078029493
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