What is pay for performance?

Pay for performance is a compensation strategy that leverages employee merit cycle and performance ratings to determine salary increases or raises, bonuses, or employee equity grants. In a pay-for-performance model, high performers are rewarded with higher compensation than lower performers. This strategy is in contrast with the “peanut butter approach” that spreads the budget for salary increases equally across employees, regardless of their performance rating.

What is pay equity?

Pay equity is the principle that employees should receive equal pay for work of equal value, regardless of gender, race, or other protected characteristics. The pay equity theory posits that fair compensation should be based on job responsibilities, skills required, and the value brought to the organization.

Exploring Insights from Merit Cycle Data

We recently took a look at merit cycle data from H1 merit cycles conducted in Pave’s compensation planning tool to understand how companies’ merit cycle matrices are playing out in practice. In other words, are companies leaning harder into pay for performance, or opting to maintain tighter pay equity within job levels?

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We grouped employees into four categories:

• Promoted Employees
• High Performers: all non-promoted employees receiving a rating better than “meets expectations”
• Meets Expectations: all non-promoted employees receiving a rating equivalent to “meets expectations”
• Below Expectations: all non-promoted employees receiving a rating worse than “meets expectations”

Then, we looked at the salary raise benchmarks for each of the four groups.

Key Findings: Surprising Trends in Salary Raises

The Narrow Gap Between Top and Average Performers

The “Above expectations” and “Meets expectations” salary raise benchmarks are remarkably similar–5.3% vs. 4.0% median raises respectively. 

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I would expect more differentiation for top performers given how commonly I hear the term “pay for performance” thrown around these days.

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Top performers surely drive more than a +1.3% impact on your company’s growth, right?

Unexpected Raises for Below-Expectations Employees

“Below expectations” salary raise benchmarks are distinctly non-zero; the median employee receiving a “below expectation” rating received a 2.0% raise.

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Perhaps the budget going to the “below expectations” bucket might be more strategically leveraged if spent on the “above expectations” bucket?

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Or, maybe it is still vital to distribute market-based adjustments to your lower performers despite the potential competing interests to lean into pay for performance?

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There is no right or wrong answer; just pros and cons to each approach.

Pay for performance vs pay equity: which is better?

Is it better to reward your top performers generously? Or better to ensure tighter pay equity within each job level?

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A strong pay-for-performance compensation philosophy will inevitably yield wide distributions of compa ratios within each job level which can seemingly feel counter to pay-equity interests.

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There is no free lunch in life–just tradeoffs. Pick your compensation strategy wisely and acknowledge the pros and cons of each decision you make. 

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