Third Edition Performance Management Herman Aguinis Kelley School of Business Indiana University Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo Editorial Director: Sally Yagan Acquisitions Editor: Brian Mickelson Director of Editorial Services: Ashley Santora Director of Marketing: Maggie Moylan Senior Marketing Manager: Nikki Ayana Jones Marketing Assistant: Ian Gold Editorial Project Manager: Sarah Holle Production Project Manager: Clara Bartunek Creative Director: Jayne Conte Cover Designer: Suzanne Behnke Cover Art: Fotolia: Teamwork © Les Cunliffe Full-Service Project Management: Kiruthiga Anand, Integra Software Services Pvt. Ltd. Printer/Binder: Courier Companies, Inc. Cover Printer: Lehigh /Phoenix - Hagerstown Text Font: 10/12 Palatino Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on the appropriate page within text. Copyright © 2013, 2009, 2007 by Pearson Education, Inc., publishing as Prentice Hall. All rights reserved. Manufactured in the United States of America. This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise. To obtain permission(s) to use material from this work, please submit a written request to Pearson Education, Inc., Permissions Department, One Lake Street, Upper Saddle River, New Jersey 07458, or you may fax your request to 201-236-3290. Many of the designations by manufacturers and sellers to distinguish their products are claimed as trademarks. Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps. Library of Congress Cataloging-in-Publication Data Aguinis, Herman Performance management / Herman Aguinis. — 3rd ed. p. cm. ISBN-13: 978-0-13-255638-5 (alk. paper) ISBN-10: 0-13-255638-3 (alk. paper) 1. Employees—Rating of. 2. Performance—Management. I. Title. HF5549.5.R3A38 2013 658.3'125—dc23 2011037274 10 9 8 7 6 5 4 3 2 1 ISBN 10: 0-13-255638-3 ISBN 13: 978-0-13-255638-5 CONTENTS Preface viii Acknowledgments xiii Dedication xiv About the Author xiv PART I Strategic and General Considerations 1 Chapter 1 Performance Management and Reward Systems in Context 1.1 1.2 1.3 1.4 1 Definition of Performance Management (PM) 2 The Performance Management Contribution 4 Disadvantages/Dangers of Poorly Implemented PM Systems 8 Definition of Reward Systems 10 1.4.1 1.4.2 1.4.3 1.4.4 1.4.5 1.4.6 1.4.7 1.4.8 Base Pay 10 Cost-of-Living Adjustments and Contingent Pay 11 Short-Term Incentives 11 Long-Term Incentives 11 Income Protection 12 Work/Life Focus 13 Allowances 13 Relational Returns 13 1.5 Aims and Role of PM Systems 14 1.5.1 1.5.2 1.5.3 1.5.4 1.5.5 1.5.6 Strategic Purpose 15 Administrative Purpose 16 Informational Purpose 16 Developmental Purpose 16 Organizational Maintenance Purpose 16 Documentational Purpose 17 1.6 Characteristics of an Ideal PM System 18 1.7 Integration with Other Human Resources and Development Activities 23 1.8 Performance Management Around the World 24 왘 CASE STUDY 1-1: Reality Check: Ideal Versus Actual Performance Management System 28 왘 CASE STUDY 1-2: Performance Management at Network Solutions, Inc. 31 왘 CASE STUDY 1-3: Distinguishing Performance Management Systems from Performance Appraisal Systems 32 Chapter 2 Performance Management Process 37 2.1 Prerequisites 38 2.2 Performance Planning 46 2.2.1 Results 46 2.2.2 Behaviors 46 2.2.3 Development Plan 47 iii iv Contents 2.3 2.4 2.5 2.6 Performance Execution 48 Performance Assessment 49 Performance Review 50 Performance Renewal and Recontracting 52 왘 CASE STUDY 2-1: Job Analysis Exercise 55 왘 CASE STUDY 2-2: Disrupted Links in the Performance Management Process at “Omega, Inc.” 55 왘 CASE STUDY 2-3: Performance Management at the University of Ghana 56 Chapter 3 Performance Management and Strategic Planning 59 3.1 Definition and Purposes of Strategic Planning 60 3.2 Process of Linking Performance Management to the Strategic Plan 61 3.2.1 3.2.2 3.2.3 3.2.4 Strategic Planning 65 Developing Strategic Plans at the Unit Level 74 Job Descriptions 76 Individual and Team Performance 77 3.3 Building Support 79 왘 CASE STUDY 3-1: Evaluating Vision and Mission Statements at Pepsico 82 왘 CASE STUDY 3-2: Dilbert’s Mission Statement Generator 83 왘 CASE STUDY 3-3: Linking Individual with Unit and Organizational Priorities 84 왘 CASE STUDY 3-4: Linking Performance Management to Strategy at Procter & Gamble 84 PART II System Implementation 87 Chapter 4 Defining Performance and Choosing a Measurement Approach 87 4.1 Defining Performance 88 4.2 Determinants of Performance 89 4.2.1 Implications for Addressing Performance Problems 90 4.2.2 Factors Influencing Determinants of Performance 91 4.3 Performance Dimensions 91 4.4 Approaches to Measuring Performance 95 4.4.1 Behavior Approach 95 4.4.2 Results Approach 96 4.4.3 Trait Approach 99 왘 CASE STUDY 4-1: Diagnosing the Causes of Poor Performance 101 왘 CASE STUDY 4-2: Differentiating Task from Contextual Performance 102 왘 CASE STUDY 4-3: Choosing a Performance Measurement Approach at Paychex, Inc. 102 왘 CASE STUDY 4-4: Deliberate Practice Makes Perfect 103 Chapter 5 Measuring Results and Behaviors 106 5.1 Measuring Results 107 5.1.1 Determining Accountabilities 107 Contents 5.1.2 Determining Objectives 109 5.1.3 Determining Performance Standards 111 5.2 Measuring Behaviors 112 5.2.1 Comparative Systems 115 5.2.2 Absolute Systems 118 왘 CASE STUDY 5-1: Accountabilities, Objectives, and Standards 126 왘 CASE STUDY 5-2: Evaluating Objectives and Standards 126 왘 CASE STUDY 5-3: Measuring Competencies at the Department of Transportation 127 왘 CASE STUDY 5-4: Creating BARS-Based Graphic Rating Scales for Evaluating Business Student Performance in Team Projects 128 Chapter 6 Gathering Performance Information 6.1 6.2 6.3 6.4 6.5 130 Appraisal Forms 131 Characteristics of Appraisal Forms 137 Determining Overall Rating 140 Appraisal Period and Number of Meetings 143 Who Should Provide Performance Information? 146 6.5.1 6.5.2 6.5.3 6.5.4 6.5.5 6.5.6 Supervisors 146 Peers 146 Subordinates 147 Self 148 Customers 149 Disagreement Across Sources: Is This a Problem? 149 6.6 A Model of Rater Motivation 150 6.7 Preventing Rating Distortion Through Rater Training Programs 153 왘 CASE STUDY 6-1: Evaluating an Appraisal Form Used in Higher Education 157 왘 CASE STUDY 6-2: Judgmental and Mechanical Methods of Assigning Overall Performance Score at The Daily Planet 162 왘 CASE STUDY 6-3: Minimizing Intentional and Unintentional Rating Errors 164 왘 CASE STUDY 6-4: Minimizing Biases in Performance Evaluation at Expert Engineering, Inc. 165 Chapter 7 Implementing a Performance Management System 168 7.1 Preparation: Communication, Appeals Process, Training Programs, and Pilot Testing 169 7.2 Communication Plan 170 7.3 Appeals Process 174 7.4 Training Programs for the Acquisition of Required Skills 176 7.4.1 7.4.2 7.4.3 7.4.4 Rater Error Training 177 Frame of Reference Training 180 Behavioral Observation Training 181 Self-Leadership Training 182 7.5 Pilot Testing 184 7.6 Ongoing Monitoring and Evaluation 185 v vi Contents 7.7 Online Implementation 188 왘 CASE STUDY 7-1: Implementing a Performance Management Communication Plan at Accounting, Inc. 192 왘 CASE STUDY 7-2: Implementing an Appeals Process at Accounting, Inc. 192 왘 CASE STUDY 7-3: Evaluation of Performance Management System at Accounting, Inc. 192 왘 CASE STUDY 7-4: Training the Raters at Big Quality Care 193 PART III Employee Development 195 Chapter 8 Performance Management and Employee Development 195 8.1 Personal Developmental Plans 196 8.1.1 Developmental Plan Objectives 197 8.1.2 Content of Developmental Plan 199 8.1.3 Developmental Activities 200 8.2 Direct Supervisor’s Role 203 8.3 360-Degree Feedback Systems 206 8.3.1 Advantages of 360-Degree Feedback Systems 213 8.3.2 Risks of Implementing 360-Degree Feedback Systems 215 8.3.3 Characteristics of a Good System 215 왘 CASE STUDY 8-1: Developmental Plan Form at Old Dominion University 220 왘 CASE STUDY 8-2: Evaluation of a 360-Degree Feedback System Demo 220 왘 CASE STUDY 8-3: Implementation of 360-Degree Feedback System at Ridge Intellectual 221 왘 CASE STUDY 8-4: Personal Developmental Plan at Brainstorm, Inc.—Part I 221 왘 CASE STUDY 8-5: Personal Developmental Plan at Brainstorm, Inc.— Part II 222 Chapter 9 Performance Management Skills 226 9.1 Coaching 227 9.2 Coaching Styles 233 9.3 Coaching Process 233 9.3.1 Observation and Documentation of Developmental Behavior and Outcomes 235 9.3.2 Giving Feedback 239 9.3.3 Disciplinary Process and Termination 245 9.4 Performance Review Meetings 248 왘 왘 왘 왘 CASE STUDY 9-1: Was Robert Eaton a Good Coach? 256 CASE STUDY 9-2: What Is Your Coaching Style? 257 CASE STUDY 9-3: Preventing Defensiveness 259 CASE STUDY 9-4: Recommendations for Documentation 260 PART IV Reward Systems, Legal Issues, and Team Performance Management 263 Chapter 10 Reward Systems and Legal Issues 263 10.1 Traditional and Contingent Pay Plans 264 10.2 Reasons for Introducing Contingent Pay Plans 265 Contents 10.3 10.4 10.5 10.6 Possible Problems Associated with Contingent Pay Plans 268 Selecting a Contingent Pay Plan 270 Putting Pay in Context 272 Pay Structures 276 10.6.1 Job Evaluation 277 10.6.2 Broad Banding 279 10.7 Performance Management and the Law 280 10.8 Some Legal Principles Affecting Performance Management 281 10.9 Laws Affecting Performance Management 284 왘 왘 왘 왘 CASE STUDY 10-1: Making the Case for a CP Plan at Architects, Inc. 289 CASE STUDY 10-2: Selecting a CP Plan at Dow AgroSciences 289 CASE STUDY 10-3: Contingency Pay Plan at Altenergy LLC 290 CASE STUDY 10-4: Possible Illegal Discrimination at Tractors, Inc. 291 Chapter 11 Managing Team Performance 294 11.1 Definition and Importance of Teams 295 11.2 Types of Teams and Implications for Performance Management 296 11.3 Purposes and Challenges of Team Performance Management 298 11.4 Including Team Performance in the Performance Management System 299 11.4.1 11.4.2 11.4.3 11.4.4 11.4.5 11.4.6 Prerequisites 300 Performance Planning 302 Performance Execution 303 Performance Assessment 304 Performance Review 305 Performance Renewal and Recontracting 306 11.5 Rewarding Team Performance 307 왘 CASE STUDY 11-1: Not All Teams Are Created Equal 309 왘 CASE STUDY 11-2: Team Performance Management at Duke University Health Systems 310 왘 CASE STUDY 11-3: Team-Based Rewards for the State of Georgia 312 왘 CASE STUDY 11-4: Team Performance Management at Bose 313 Index 315 vii PREFACE AND INTRODUCTION In today’s globalized world, it is relatively easy to gain access to the competition’s technology and products. Thanks to the Internet and the accompanying high speed of communications, technological and product differentiation is no longer a key competitive advantage in most industries. For example, most banks offer the same types of products (e.g., various types of savings accounts and investment opportunities). If a particular bank decides to offer a new product or service (e.g., online banking), it will not be long until the competitors offer precisely the same product. As noted by James Kelley, performance management project leader at Idaho Power, “technology is a facilitator, but not a guarantor, of effectiveness or efficiency of a company’s workforce.”1 So, what makes some businesses more successful than others? What is today’s key competitive advantage? The answer is people. Organizations with motivated and talented employees offering outstanding service to customers are likely to pull ahead of the competition, even if the products offered are similar to those offered by the competitors. This is a key organizational resource that many label “human capital” and gives organizations an advantage over the competition. Customers want to get the right answer at the right time, and they want to receive their products or services promptly and accurately. Only having the right human capital can make these things happen. Only human capital can produce a sustainable competitive advantage. And, performance management systems are the key tools that can be used to transform people’s talent and motivation into a strategic business advantage. Unfortunately, although 96% of human resources (HR) professionals report that performance management is their number 1 concern, fewer than 12% of HR executives and technology managers believe that their organizations have aligned strategic organizational priorities with employee performance.2 This edition includes the following six important changes. More detailed information on each of these issues is provided in the section titled “Changes in This Edition.” • There is an emphasis on the role of the context within which performance management takes place. • This edition emphasizes that knowledge generated regarding performance management is essentially multidisciplinary. • This edition emphasizes the important interplay between science and practice. • This edition describes the technical aspects of implementing a performance management system in detail and, in addition, it emphasizes the key role that interpersonal dynamics play in the process. • This new edition includes new cases in almost every chapter. Taken together, this new edition includes a total of 43 case studies. • Each of the chapters includes new sections. SOME UNIQUE FEATURES OF THIS BOOK Performance management is a continuous process of identifying, measuring, and developing the performance of individuals and teams and aligning their performance with the strategic goals of the organization. Performance management is critical to small and large, for-profit and not-for-profit, 1 Generating buzz: Idaho Power takes on performance management to prepare for workforce aging. (2006, June). Power Engineering. Retrieved November 26, 2010 from http://www.powergenworldwide.com/index/ display/articledisplay/258477/articles/power-engineering/volume-110/issue-6/features/generating-buzzidaho-power-takes-on-performance-management-to-prepare-for-workforce-aging.html 2 Workforce performance is top HR priority. (2005). T+D, 59(7), 16. viii Preface and Introduction domestic and global organizations, and to all industries. In fact, the performance management model and processes described in this book have been used to create systems to manage the performance of college students.3 After all, the performance of an organization depends on the performance of its people, regardless of the organization’s size, purpose, and other characteristics. As noted by Siemens CEO Heinrich von Pierer, “whether a company measures its workforce in hundreds or hundreds of thousands, its success relies solely on individual performance.” As an example in the not-for-profit sector, the government in England has implemented what is probably the world’s biggest performance management system, and, by statutory force, the performance of teachers and “headteachers” (i.e., school principals) is now evaluated systematically. This particular system includes a massive national effort of approximately 18,000 primary schools, 3,500 secondary schools, 1,100 special schools, 500 nursery schools, 23,000 headteachers, 400,000 teachers, and an unspecified number of support staff.4 Unfortunately, few organizations use their existing performance management systems in productive ways. Performance management is usually vilified as an “HR department requirement.” In many organizations, performance management means that managers must comply with their HR department’s request and fill out tedious, and often useless, evaluation forms. These evaluation forms are often completed only because it is required by the “HR cops.” Unfortunately, the only tangible consequence of the evaluation process is that the manager has to spend time away from his or her “real” job duties. This book is about the design and implementation of successful performance management systems. In other words, it focuses on research-based findings and up-to-date applications that help increase an organization’s human capital. Performance management is ongoing and cyclical; however, for pedagogical reasons, the book needs to follow a linear structure. Because performance observation, evaluation, and improvement are ongoing processes, some concepts and practices may be introduced early in a cursory manner but receive more detailed treatment in later sections. Also, this book focuses on best practices and describes the necessary steps to create a top-notch performance management system. As a result of practical constraints and lack of knowledge about system implementation, many organizations cut corners and do not implement systems that follow best practices because of environmental and political issues (e.g., goals of raters may not be aligned with goals of the organization). Because the way in which systems are implemented in practice is often not close to the ideal system, the book includes numerous examples from actual organizations to illustrate how systems are implemented given actual situational constraints. CHANGES IN THIS EDITION This edition includes important updates and additional information. In preparation for revising and updating this book, I gathered more than 300 potentially relevant articles and books. About 150 of those were most relevant, and about 50 of those new sources are now included in this edition. These sources have been published since the second edition of the book went into production. This vast literature demonstrates an increased interest in performance management on the part of both academics and practitioners. This edition includes five important changes throughout the book. First, there is an emphasis on the role of the context within which performance management takes place. Performance management does not operate in a vacuum. Rather, it takes place within a particular organizational context, and organizations have a particular history, unwritten norms about what is valued and what is not, 3 Gillespie, T. L., & Parry, R. O. (2009). Students as employees: Applying performance management principles in the management classroom. Journal of Management Education, 33, 553–576. 4 Brown, A. (2005). Implementing performance management in England’s primary schools. International Journal of Productivity and Performance Management, 54, 468–481. ix x Preface and Introduction and unwritten norms about communication, trust, interpersonal relations, and many other factors that influence daily activities. Thus, for example, implementing a 360-degree feedback system may be effective in some organizations but not in others (Chapter 8). As a second illustration, some organizations may have a culture that emphasizes results more than behaviors which, in turn, would dictate that the performance management system also emphasize results; instead, other organizations may place an emphasis on long-term goals, which would dictate that performance be measured by emphasizing employee behaviors rather than results (Chapter 4). Also, we need to understand the contextual reasons why performance ratings may not be accurate—particularly if there is no accountability for raters to provide valid assessments (Chapter 6). As yet another example, cultural factors affect what sources are used for performance information: In a country like Jordan, whose culture determines more hierarchical organizational structures, the almost exclusive source of performance information is supervisors, whereas employees and their peers almost have no input; this situation is different in countries with less hierarchical cultures in which not only performance information is collected from peers, but also supervisors are rated by their subordinates (Chapter 6). To emphasize the role of culture, this edition describes examples and research conducted in organizations in Jordan (Chapter 6); Japan, China, Turkey, Germany, France, South Korea, Mexico, Australia, and the United Kingdom (Chapter 1); Brazil (Chapter 3); Hong Kong and the Pearl River Delta (Chapter 11); Ghana (Chapter 1); South Africa (Chapter 1); Bulgaria and Romania (Chapter 1); and India (Chapters 1 and 3). Second, this edition emphasizes that knowledge generated regarding performance management is essentially multidisciplinary. Accordingly, the sources used to support best-practice recommendations offered in this book come from a very diverse set of fields of study ranging from micro-level fields focusing on the study of individual and teams (e.g., organizational behavior, human resource management) to macro-level fields focusing on the study of organizations as a whole (e.g., strategic management). This is consistent with a general movement toward multidisciplinary and integrative research in the field of management.5 For example, best-practice recommendations regarding the measurement of performance originate primarily from industrial and organizational psychology (Chapter 5). On the other hand, best-practice recommendations regarding the relationship between performance management and strategic planning were derived primarily from theories and research from strategic management (Chapter 3). In addition, much of the best-practice recommendations regarding team performance management originated from the field of organizational behavior (Chapter 11). Third, this edition emphasizes the important interplay between science and practice. Unfortunately, there is a great divide in management and related fields between scholars and practitioners. From the perspective of scholars, much of the work conducted by practitioners is seen as relevant but not rigorous. Conversely, from the perspective of practitioners, the work done by scholars is seen as rigorous but mostly not relevant. This “science-practice divide” has been documented by a content analysis of highly prestigious scholarly journals, which regularly publish work that does not seem to be directly relevant to the needs of managers and organizations.6 This edition attempts to bridge this divide by discussing best-practice recommendations based on sound theory and research and, at the same time, by discussing the realities of organizations and how some of these practices have been implemented in actual organizations. Fourth, this edition, as its predecessor, describes the technical aspects of implementing a performance management system in detail. In addition, this edition emphasizes the key role that interpersonal dynamics play in the process.7 Traditionally, much of the performance appraisal literature has focused almost exclusively on the measurement of performance—for example, 5 Aguinis, H., Boyd, B. K., Pierce, C. A., & Short, J. C. (2011). Walking new avenues in management research methods and theories: Bridging micro and macro domains. Journal of Management, 37, 395–403. 6 Cascio, W. F., & Aguinis, H. (2008). Research in industrial and organizational psychology from 1963 to 2007: Changes, choices, and trends. Journal of Applied Psychology, 93, 1062–1081. Preface and Introduction whether it is better to use 5-point versus 7-point scales. However, more recent research suggests that, related to the issue of context mentioned earlier, issues such as trust, politics, leadership, negotiation, mentorship, communication, and other related topics related to interpersonal dynamics are just as important in determining the success of a performance management system. Accordingly, this edition discusses the need to establish a helping and trusting relationship between supervisors and employees (Chapter 9), the role of an organization’s top management in determining the success of a system (Chapter 3), and the motivation of supervisors to provide accurate performance ratings (Chapter 6), among many other related issues throughout the book. Fifth, this new edition includes new cases in almost every chapter. Taken together, this new edition includes a total of 43 case studies. In addition, the instructor’s manual includes approximately 4 more cases per chapter, for a total of about 40 additional cases. Thus, depending on an instructor’s preference, a course based on this new edition could be taught entirely following a case format or using a lecture and case combination format. In addition to the aforementioned changes that permeate the entire book, each chapter includes new sections. As illustrations, consider the following chapter-by-chapter nonexhaustive additions: • Performance management around the world (Chapter 1). This material will be useful in terms of understanding that although performance management systems may have similar goals, their implementation and deployment will be affected by cultural and contextual factors depending on where the organization is located. • Biases in the job analysis process and their effects in the resulting job analysis ratings (Chapter 2). This material will be useful in terms of providing guidelines on how to gather valid job analysis information. • Relationship between strategies, goals, and firm performance (Chapter 3). This new material will be useful in providing guidelines on the most effective sequence of implementation of the various strategic planning steps as it cascades down and across the various organizational units. • Voice behavior: Raising constructive challenges with the goal to improve rather than merely criticize, challenge the status quo in a positive way, and make innovative suggestions for change when others, including an employee’s supervisor, disagree (Chapter 4). This material will be useful in terms of understanding the multidimensional nature of performance and how different performance dimensions may be valued differently in different organizations. • Relative percentile method for measuring performance (Chapter 5). This material will be useful regarding the development of measures to assess performance more accurately. • Open-ended sections included in most appraisal forms (Chapter 6). This material will be useful in terms of learning how to make the most of this information, which is typically underutilized in most performance management systems. • Calculation of return on investment of portions of a performance management system (Chapter 7). This material will be useful in terms of learning how to document the relative effectiveness, in tangible and financial terms, of a performance management system. • The feedforward interview (FFI) (Chapter 8). This new material will be useful in terms of understanding how the FFI is a process that leads to uncovering the contextual and personal conditions that lead to success regarding both achievement and job satisfaction. • Disciplinary process that may lead to termination (Chapter 9). This material will be useful in terms of providing information on what to do when performance problems are identified but employees are unable or unwilling to address them effectively. • Relationship between new legal regulations and the implementation of performance management systems in China (Chapter 10). This new information will be useful in terms 7 Aguinis, H., & Pierce, C. A. (2008). Enhancing the relevance of organizational behavior by embracing performance management research. Journal of Organizational Behavior, 29, 139–145. xi xii Preface and Introduction of understanding how the legal environment has a direct impact on performance management practices worldwide. • Types of learning that can take place as part of the team development plan in the performance planning stage (Chapter 11). This material will be useful in terms of providing a deeper understanding of specific interventions aimed at improving team learning and performance. Further, the following is a nonexhaustive list of specific topics that have been updated and expanded in each chapter: • The discussion of voice behavior (i.e., constructive criticisms that challenge the status quo and promote innovative improvements) as an important contribution of performance management systems, performance management’s contribution to minimizing employee misconduct, an expanded discussion of allowances, an expanded discussion of the four different dimensions of fairness (i.e., procedural, distributive, interpersonal, and informational justice), the additional strategic purpose of performance management systems as a catalyst for onboarding (i.e., processes helping new employees to transition from organizational outsiders to organizational insiders), and the importance of implementing a system that is congruent with the cultural norms of the organization as well as the culture of the region and country where the organization is located (Chapter 1). • An expanded discussion of how rater accountability leads to improved accuracy in performance ratings (Chapter 6). • An expanded discussion of how to evaluate whether the performance management system is working as intended, and a new section on the implementation of online performance management systems (Chapter 7). • A description of the performance review meetings as work meetings—each one with specific purposes, the need to separate the performance review meetings to minimize negative surprises, an expanded discussion of how to deal with employee defensiveness during the performance review meeting, and the need to consider an employee’s personality (e.g., core self-evaluations) in the process of giving feedback (Chapter 9). • An expanded discussion of nonfinancial rewards (Chapter 10). • New material regarding challenges faced in implementing performance management with expatriate teams (Chapter 11). PLAN FOR THE BOOK Part I, which includes Chapters 1 through 3, addresses general as well as strategic considerations regarding performance management. Chapter 1 discusses the advantages of implementing a successful performance management system as well as the negative outcomes associated with deficient systems, including lowered employee motivation and perceptions of unfairness. This chapter also includes what can be described as the features of an ideal system. Chapter 2 describes the performance management process starting with what should be done before a system is implemented and ending with the performance renewal and recontracting phases. Chapter 3 links performance management systems with reward systems and an organization’s strategic plan. This chapter makes it clear that a good performance management system is a critical component of the successful implementation of an organization’s strategy. Part II, including Chapters 4 through 7, addresses the details of system implementation. This discussion is sufficiently general yet detailed enough so that all managers, not just HR managers, will benefit from this material. Chapters 4 and 5 describe some of the technical aspects associated with the assessment of performance and how to identify and measure both behaviors and results. Chapter 6 discusses appraisal forms and various types of rating schemes, and it discusses the Preface and Introduction advantages and disadvantages of using various sources of performance information (e.g., supervisor, peers, and customers). Finally, Chapter 7 describes the steps involved in implementing a performance management system, including a communication plan and pilot testing of the system before it is implemented. Part III, including Chapters 8 and 9, addresses employee development issues. Chapter 8 includes a description of employee developmental plans and the advantages of using 360-degree systems for developmental purposes. Chapter 9 addresses the skills needed by supervisors to observe and assess performance as well as those needed to provide constructive feedback. Part IV, including Chapters 10 and 11, concerns the relationship among performance management, rewards, the law, and teams. Chapter 10 includes a discussion of traditional and contingent pay plans, pay structures, and their links to performance management. In addition, this chapter provides a discussion of legal issues to consider when implementing a performance management system. Finally, Chapter 11 addresses the timely topic of how to design and implement performance management systems dealing with team performance. FACULTY RESOURCES Each of the chapters includes a list of its learning objectives as well as summary points and cases for discussion. I hope this additional material will allow students to have an enjoyable and productive learning experience that will enhance your own individual human capital. Also, there are several resources available for instructors including PowerPoint slides, exam questions and answers (multiple choice and essay-type), role plays, and approximately 40 additional cases (about 4 per chapter) that can be used for in-class discussions, examination materials, or take-home homework or examinations. These materials will allow instructors to prepare for teaching this course more quickly and help make teaching this course a more enjoyable and interactive experience. These faculty resources can be downloaded by visiting www.pearsonhighered.com/aguinis and clicking on Instructor Resources. ACKNOWLEDGMENTS I would like to thank several individuals who were extremely instrumental in allowing me to write the first edition, second, and current third edition of this book. I am indebted to Graeme Martin for encouraging me to start this project. Wendy O’Connell and Jon Dale helped me gather the numerous examples and illustrations that I have used throughout. Barbara Stephens helped me update many of these examples in the second edition. Christine Henle allowed me to use her extremely useful lecture notes. Barbara Stephens, Bonnie Davis, Debra Lammers, and Ray Zammuto gave me excellent and detailed comments that allowed me to improve each of the chapters. Harry Joo, Ryan K. Gottfredson, and Sofia J. Vaschetto assisted me in writing the Instructor’s Manual for this edition. Teaching and giving lectures and workshops on performance management at the Instituto de Empresa (Madrid, Spain), Université Jean Moulin Lyon 3 (Lyon, France), University of Johannesburg (South Africa), University of Salamanca (Spain), and University of Melbourne (Australia) allowed me to test and improve various sections of the book. Finally, this edition benefited from the feedback provided by Lynn K. Bartels, Robyn A. Berkley, Perry A. Barton, Alan Cabelly, and Clifford E. Thermer, who have used the second edition to teach courses at universities throughout the United States and were kind enough to offer their suggestions for improvements and additions. I thank each of you for your time and intellectual investment in this project. Your coaching and feedback certainly helped me improve my performance! Herman Aguinis Bloomington, Indiana xiii DEDICATION To my dear friend Ariel Aisiks, true visionary and global leader who has been teaching me how to be a top performer for more than 30 years. ABOUT THE AUTHOR Dr. Herman Aguinis is the Dean’s Research Professor, Professor of Organizational Behavior and Human Resources, and the Founding Director of the Institute for Global Organizational Effectiveness at Indiana University’s Kelley School of Business. He has been a visiting scholar at universities in the People’s Republic of China (Beijing and Hong Kong), Malaysia, Singapore, Australia, Argentina, France, Puerto Rico, South Africa, and Spain. His teaching, research, and consulting activities are in the areas of human capital acquisition, development, and deployment. Dr. Aguinis wrote Applied Psychology in Human Resource Management (with Wayne F. Cascio, 7th ed., 2011, Prentice Hall) and Regression Analysis for Categorical Moderators (2004, Guilford) and edited Test-Score Banding in Human Resource Selection (2004, Praeger) and Opening the Black Box of Editorship (with Y. Baruch, A. M. Konrad, & W. H. Starbuck, 2008, Palgrave-Macmillan). In addition, he has written more than 90 refereed journal articles in Academy of Management Journal, Academy of Management Review, Journal of Applied Psychology, Personnel Psychology, Organizational Behavior and Human Decision Processes, and elsewhere. Dr. Aguinis is a Fellow of the American Psychological Association, the Society for Industrial and Organizational Psychology, and the Association for Psychological Science, and has been inducted into the Society of Organizational Behavior. He has served as Division Chair for the Research Methods Division of the Academy of Management, Program Chair for the Iberoamerican Academy of Management, and editor-in-chief for the journal Organizational Research Methods. He has delivered more than 180 presentations at professional conferences and more than 90 invited presentations at universities in more than 20 countries around the world, and consulted with numerous organizations in the United States, Europe, and Latin America using his English, Spanish, French, Italian, and German language skills. For more information, please visit http://mypage.iu.edu/~haguinis/ xiv PART I: STRATEGIC AND GENERAL CONSIDERATIONS Chapter 1 Performance Management and Reward Systems in Context A manager is responsible for the application and performance of knowledge. —PETER F. DRUCKER LEARNING OBJECTIVES By the end of this chapter, you will be able to do the following:         Explain the concept of performance management (PM). Distinguish performance management from performance appraisal. Explain the many advantages and make a business case for implementing a well-designed performance management system. Recognize the multiple negative consequences that can arise from the poor design and implementation of a performance management system. These negative consequences affect all the parties involved: employees, supervisors, and the organization as a whole. Understand the concept of a reward system and its relationship to a performance management system. Distinguish among the various types of employee rewards, including compensation, benefits, and relational returns. Describe the multiple purposes of a performance management system including strategic, administrative, informational, developmental, organizational maintenance, and documentational purposes. Describe and explain the key features of an ideal performance management system. 1 2 Part I • Strategic and General Considerations    Create a presentation providing persuasive arguments in support of the reasons that an organization should implement a performance management system, including the purposes that performance management systems serve and the dangers of a poorly implemented system. Note the relationships and links between a performance management system and other human resources functions, including recruitment and selection, training and development, workforce planning, and compensation. Describe and explain contextual and cultural factors that affect the implementation of performance management systems around the world. 1.1 DEFINITION OF PERFORMANCE MANAGEMENT Consider the following scenario: Sally is a sales manager at a large pharmaceutical company. The fiscal year will end in one week. She is overwhelmed with end-of-the-year tasks, including reviewing the budget she is likely to be allocated for the following year, responding to customers’ phone calls, and supervising a group of 10 salespeople. It’s a very hectic time, probably the most hectic time of the year. She receives a phone call from the human resources (HR) department: “Sally, we have not received your performance reviews for your 10 employees; they are due by the end of the fiscal year.” Sally thinks, “Oh, those performance reviews. . . .What a waste of my time!” From Sally’s point of view, there is no value in filling out those seemingly meaningless forms. She does not see her subordinates in action because they are in the field visiting customers most of the time. All that she knows about their performance is based on sales figures, which depend more on the products offered and geographic territory covered than the individual effort and motivation of each salesperson. And, nothing happens in terms of rewards, regardless of her ratings. These are lean times in her organization, and salary adjustments are based on seniority rather than on merit. She has less than three days to turn in her forms. What will she do? She decides to follow the path of least resistance: to please her employees and give everyone the maximum possible rating. In this way, Sally believes the employees will be happy with their ratings and she will not have to deal with complaints or follow-up meetings. Sally fills out the forms in less than 20 minutes and gets back to her “real job.” There is something very wrong with this picture, which unfortunately happens all too frequently in many organizations. Although Sally’s HR department calls this process “performance management,” it is not. Performance management is a continuous process of identifying, measuring, and developing the performance of individuals and teams and aligning performance with the strategic goals of the organization. Let’s consider each of the definition’s two main components: 1. Continuous process. Performance management is ongoing. It involves a neverending process of setting goals and objectives, observing performance, and giving and receiving ongoing coaching and feedback.1 Chapter 1 • Performance Management and Reward Systems in Context 2. Alignment with strategic goals. Performance management requires that managers ensure that employees’ activities and outputs are congruent with the organization’s goals and, consequently, help the organization gain a competitive advantage. Performance management therefore creates a direct link between employee performance and organizational goals and makes the employees’ contribution to the organization explicit. Note that many organizations have what is labeled a “performance management” system. However, we must distinguish between performance management and performance appraisal. A system that involves employee evaluations once a year without an ongoing effort to provide feedback and coaching so that performance can be improved is not a true performance management system. Instead, this is only a performance appraisal system. Performance appraisal is the systematic description of an employee’s strengths and weaknesses. Thus, performance appraisal is an important component of performance management, but it is just a part of a bigger whole because performance management is much more than just performance measurement.2 As an illustration, consider how Merrill Lynch has transitioned from a performance appraisal system to a performance management system. Merrill Lynch is one of the world’s leading financial management and advisory companies, with offices in 37 countries and private client assets of approximately US$ 1.6 trillion (http://ml.com/). As an investment bank, it is a leading global underwriter of debt and equity securities and strategic adviser to corporations, governments, institutions, and individuals worldwide. Recently, Merrill Lynch started the transition from giving employees one performance appraisal per year to focusing on one of the important principles of performance management: the conversation between managers and employees in which feedback is exchanged and coaching is given if needed. In January, employees and managers set employee objectives. Mid-year reviews assess what progress has been made toward the goals and how personal development plans are faring. Finally, the end-of-the-year review incorporates feedback from several sources, evaluates progress toward objectives, and identifies areas that need improvement. Managers also get extensive training on how to set objectives and conduct reviews. In addition, there is a Web site that managers can access with information on all aspects of the performance management system. In sharp contrast to its old performance appraisal system, Merrill Lynch’s goal for its newly implemented performance management program is worded as follows: “This is what is expected of you, this is how we’re going to help you in your development, and this is how you’ll be judged relative to compensation.”3 As a second example, consider the performance management system for managers at Germany-based Siemens, which provides mobile phones, computer networks, and wireless technology and employs 475,000 people in 190 countries (www.siemens.com). At Siemens, the performance management system is based on three pillars: setting clear and measurable goals, implementing concrete actions, and imposing rigorous consequences. The performance management at Siemens has helped change people’s mind-set, and the organization is now truly performance oriented. Every manager understands that performance is a critical aspect of working at Siemens, and this guiding philosophy is communicated in many ways throughout the organization.4 Performance management systems that do not make explicit the employee contribution to the organizational goals are not true performance management systems. Making an explicit link between an employee’s performance objectives and the 3 4 Part I • Strategic and General Considerations organizational goals also serves the purpose of establishing a shared understanding about what is to be achieved and how it is to be achieved. This is painfully clear in Sally’s case described earlier: from her point of view, the performance review forms did not provide any useful information regarding the contribution of each of her subordinates to the organization. Sally’s case is unfortunately more common than we would like. A survey conducted by the consulting firm Watson Wyatt showed that only 3 in 10 employees believe their companies’ performance review systems actually helped them improve their performance.5 In subsequent chapters, we describe best practices on how to design and implement performance management systems. For now, however, let’s say that well-designed and implemented performance management systems make substantial contributions to the organization. This is why a recent survey of almost 1,000 HR management professionals in Australia revealed that 96% of Australian companies currently implement some type of performance management system.6 Similarly, results of a survey of 278 organizations, about two-thirds of which are multinational corporations, from 15 different countries, indicated that about 91% of organizations implement a formal performance management system.7 Moreover, organizations with formal and systematic performance management systems are 51% more likely to perform better than the other organizations in the sample regarding financial outcomes, and 41% more likely to perform better than the other organizations in the sample regarding other outcomes including customer satisfaction, employee retention, and other important metrics. Based on these results, it is not surprising that senior executives of companies listed in the Sunday Times list of best employers in the United Kingdom believe that performance management is one of the top two most important HR management priorities in their organizations.8 Let’s describe these performance management contributions in detail. 1.2 THE PERFORMANCE MANAGEMENT CONTRIBUTION There are many advantages associated with the implementation of a performance management system.9 A performance management system can make the following important contributions:10 1. Motivation to perform is increased. Receiving feedback about one’s performance increases the motivation for future performance. Knowledge about how one is doing and recognition about one’s past successes provide the fuel for future accomplishments. 2. Self-esteem is increased. Receiving feedback about one’s performance fulfills a basic human need to be recognized and valued at work. This, in turn, is likely to increase employees’ self-esteem. 3. Managers gain insight about subordinates. Direct supervisors and other managers in charge of the appraisal gain new insights into the person being appraised. The importance of knowing your employees is highlighted by the fact that the Management Standards Centre, the government-recognized organization in the United Kingdom for setting standards for the management and leadership areas, has recognized that developing productive relationships with colleagues is a key competency for managers (http://www.management-standards.org, Unit D2). Gaining new insights into a person’s performance and personality will help Chapter 1 • Performance Management and Reward Systems in Context 4. 5. 6. 7. 8. 9. 10. the manager build a better relationship with that person. Also, supervisors gain a better understanding of each individual’s contribution to the organization. This can be useful for direct supervisors as well as for supervisors once removed. The definitions of job and criteria are clarified. The job of the person being appraised may be clarified and defined more clearly. In other words, employees gain a better understanding of the behaviors and results required of their specific position. Employees also gain a better understanding of what it takes to be a successful performer (i.e., what are the specific criteria that define job success). Self-insight and development are enhanced. The participants in the system are likely to develop a better understanding of themselves and of the kind of development activities that are of value to them as they progress through the organization. Participants in the system also gain a better understanding of their particular strengths and weaknesses that can help them better define future career paths. Administrative actions are more fair and appropriate. Performance management systems provide valid information about performance that can be used for administrative actions such as merit increases, promotions, and transfers as well as terminations. In general, a performance management system helps ensure that rewards are distributed on a fair and credible basis. In turn, such decisions based on a sound performance management system lead to improved interpersonal relationships and enhanced supervisor–subordinate trust.11 For example, a good performance management system can help mitigate explicit or implicit emphasis on age as a basis for decisions. This is particularly important given the aging working population in the United States, Europe, and many other countries around the world.12 Organizational goals are made clear. The goals of the unit and the organization are made clear, and the employee understands the link between what she does and organizational success. This is a contribution to the communication of what the unit and the organization are all about and how organizational goals cascade down to the unit and the individual employee. Performance management systems can help improve employee acceptance of these wider goals (i.e., organizational and unit levels). Employees become more competent. An obvious contribution is that employee performance is improved. In addition, there is a solid foundation for helping employees become more successful by establishing developmental plans. Employee misconduct is minimized.13 Employee misconduct is an increasingly pervasive phenomenon that has received widespread media coverage. Such misconduct includes accounting irregularities, churning customer accounts, abusing overtime policies, giving inappropriate gifts to clients and potential clients hoping to secure their business, and using company resources for personal use. Although some individuals are more likely to engage in misconduct compared to others based on individual differences in personality and other attributes, having a good performance management in place provides the appropriate context so that misconduct is clearly defined and labeled as such and identified early on before it leads to sometimes irreversible negative consequences. There is better protection from lawsuits. Data collected through performance management systems can help document compliance with regulations (e.g., equal treatment of all employees regardless of sex or ethnic background). When performance management systems are not in place, arbitrary performance 5 6 Part I • Strategic and General Considerations 11. 12. 13. 14. evaluations are more likely, resulting in an increased exposure to litigation for the organization. There is better and more timely differentiation between good and poor performers. Performance management systems allow for a quicker identification of good and poor performers. Also, they force supervisors to face up to and address performance problems on a timely basis (i.e., before the problem becomes so entrenched that it cannot be easily remedied). Supervisors’ views of performance are communicated more clearly. Performance management systems allow managers to communicate to their subordinates their judgments regarding performance. Thus, there is greater accountability in how managers discuss performance expectations and provide feedback. Both assessing and monitoring the performance of others are listed as key competencies for managers by the Management Standards Centre (www.management-standards.org, Units B3, B4, and B7). When managers possess these competencies, subordinates receive useful information about how their performance is seen by their supervisor. Organizational change is facilitated. Performance management systems can be a useful tool to drive organizational change. For example, assume an organization decides to change its culture to give top priority to product quality and customer service. Once this new organizational direction is established, performance management is used to align the organizational culture with the goals and objectives of the organization to make change possible. Employees are provided training in the necessary skills and are rewarded for improved performance so that they have both the knowledge and motivation to improve product quality and customer service. This is precisely what IBM did in the 1980s when it wanted to switch focus to customer satisfaction: the performance evaluation of every member in the organization was based, to some extent, on customer satisfaction ratings regardless of function (i.e., accounting, programming, manufacturing, etc.).14 For IBM as well as numerous other organizations, performance management provides tools and motivation for individuals to change, which, in turn, helps drive organizational change. In short, performance management systems are likely to produce changes in the culture of the organization and, therefore, the consequences of such cultural changes should be considered carefully before implementing the system.15 As noted by Randy Pennington, president of Pennington Performance Group, “The truth is that the culture change is driven by a change in performance. An organization’s culture cannot be installed. It can be guided and influenced by policies, practices, skills, and procedures that are implemented and reinforced. The only way to change the culture is to change the way individuals perform on a daily basis.”16 Motivation, commitment, and intentions to stay in the organization are enhanced. When employees are satisfied with their organization’s performance management system, they are more likely to be motivated to perform well, to be committed to their organization, and not try to leave the organization.17 For example, satisfaction with the performance management system is likely to make employees feel that the organization has a great deal of personal meaning for them. In terms of turnover intentions, satisfaction with the performance management system leads employees to report that they will probably not look for a new job in the next year and that they don’t often think about quitting Chapter 1 • Performance Management and Reward Systems in Context their present job. As an illustration of this point, results of a study including 93 professors at a university in South Africa suggested that the implementation of a good performance management system would be useful in preventing them from leaving their university jobs.18 15. Voice behavior is encouraged. A well-implemented performance management system allows employees to engage in voice behavior that can lead to improved organizational processes. Voice behavior involves making suggestions for changes and improvements that are innovative, challenge the status quo, are intended to be constructive, and are offered even when others disagree.19 For example, the performance review meeting can lead to a conversation during which the employee provides suggestions on how to reduce cost or speed up specific process. 16. Employee engagement is enhanced. A good performance management system leads to enhanced employee engagement. Employees who are engaged feel involved, committed, passionate, and empowered. Moreover, these attitudes and feelings result in behaviors that are innovative and, overall, demonstrate good organizational citizenship and take action in support of the organization. Employee engagement is an important predictor of organizational performance and success and, consequently, engagement is an important contribution of good performance management systems.20 Table 1.1 lists the 16 contributions made by performance management systems. Recall Sally’s situation earlier in the chapter. Which of the contributions included in Table 1.1 result from the system implemented at Sally’s organization? For example, are Sally’s employees more motivated to perform as a consequence of implementing their “performance management” system? Is their self-esteem increased? What about Sally’s TABLE 1.1 Contributions of Performance Management Systems Motivation to perform is increased. Self-esteem is increased. Managers gain insight about subordinates. The definitions of job and criteria are clarified. Self-insight and development are enhanced. Administrative actions are more fair and appropriate. Organizational goals are made clear. Employees become more competent. Employee misconduct is minimized. There is better protection from lawsuits. There is better and more timely differentiation between good and poor performers. Supervisors’ views of performance are communicated more clearly. Organizational change is facilitated. Motivation, commitment, and intentions to stay in the organization are enhanced. Voice behavior is encouraged. Employee engagement is enhanced. 7 8 Part I • Strategic and General Considerations BOX 1.1 What CEOs Say About the Contribution of Performance Management Systems A study conducted by Development Dimensions International (DDI), a global human resources consulting firm specializing in leadership and selection, found that performance management systems are a key tool that organizations use to translate business strategy into business results. Specifically, performance management systems influence “financial performance, productivity, product or service quality, customer satisfaction, and employee job satisfaction.” In addition, 79% of the CEOs surveyed say that the performance management system implemented in their organizations drives the “cultural strategies that maximize human assets.”21 insight and understanding of her employees’ contributions to the organization? Is Sally’s organization now better protected in the face of potential litigation? Unfortunately, the system implemented at Sally’s organization is not a true performance management system but simply an administrative nuisance. Consequently, many, if not most, of the potential contributions of the performance management system are not realized. In fact, poorly implemented systems, as in the case of Sally’s organization, not only do not make positive contributions but also can be very dangerous and lead to several negative outcomes. 1.3 DISADVANTAGES/DANGERS OF POORLY IMPLEMENTED PM SYSTEMS What happens when performance management systems do not work as intended, as in the case of Sally’s organization? What are some of the negative consequences associated with low-quality and poorly implemented systems? Consider the following list: 1. Increased turnover. If the process is not seen as fair, employees may become upset and leave the organization. They can leave physically (i.e., quit) or withdraw psychologically (i.e., minimize their effort until they are able to find a job elsewhere). 2. Use of misleading information. If a standardized system is not in place, there are multiple opportunities for fabricating information about an employee’s performance. 3. Lowered self-esteem. Self-esteem may be lowered if feedback is provided in an inappropriate and inaccurate way. This, in turn, can create employee resentment. 4. Wasted time and money. Performance management systems cost money and quite a bit of time. These resources are wasted when systems are poorly designed and implemented. 5. Damaged relationships. As a consequence of a deficient system, the relationship among the individuals involved may be damaged, often permanently. 6. Decreased motivation to perform. Motivation may be lowered for many reasons, including the feeling that superior performance is not translated into meaningful tangible (e.g., pay increase) or intangible (e.g., personal recognition) rewards. Chapter 1 • Performance Management and Reward Systems in Context 7. Employee burnout and job dissatisfaction. When the performance assessment instrument is not seen as valid and the system is not perceived as fair, employees are likely to feel increased levels of job burnout and job dissatisfaction. As a consequence, employees are likely to become increasingly irritated.22 8. Increased risk of litigation. Expensive lawsuits may be filed by individuals who feel they have been appraised unfairly. 9. Unjustified demands on managers’ and employees’ resources. Poorly implemented systems do not provide the benefits provided by well-implemented systems, yet they take up managers’ and employees’ time. Such systems will be resisted because of competing obligations and allocation of resources (e.g., time). What is sometimes worse, managers may simply choose to avoid the system altogether, and employees may feel increased levels of overload.23 10. Varying and unfair standards and ratings. Both standards and individual ratings may vary across and within units and be unfair. 11. Emerging biases. Personal values, biases, and relationships are likely to replace organizational standards. 12. Unclear ratings system. Because of poor communication, employees may not know how their ratings are generated and how the ratings are translated into rewards. Table 1.2 summarizes the list of disadvantages and negative consequences resulting from the careless design and implementation of a performance management system. Once again, consider Sally’s organization. What are some of the consequences of the system implemented by her company? Let’s consider each of the consequences listed in Table 1.2. For example, is it likely that the performance information used is false and misleading? How about the risk of litigation? How about the time and money invested in collecting, compiling, and reporting the data? Unfortunately, an analysis of Sally’s situation, taken with the positive and negative consequences listed in Tables 1.1 and 1.2, leads to the conclusion that this particular system is more likely to do harm than good. Now think about TABLE 1.2 Disadvantages/Dangers of Poorly Implemented Performance Management Systems Increased turnover Use of false or misleading information Lowered self-esteem Wasted time and money Damaged relationships Decreased motivation to perform Employee job burnout and job dissatisfaction Increased risk of litigation Unjustified demands on managers’ and employees’ resources Varying and unfair standards and ratings Emerging biases Unclear ratings system 9 10 Part I • Strategic and General Considerations BOX 1.2 What Happens When Performance Management Is Implemented Poorly? One example of a poorly implemented performance management system resulted in a $1.2 million lawsuit. A female employee was promoted several times and succeeded in the construction industry until she started working under the supervision of a new manager. She stated in her lawsuit that once she was promoted and reported to the new manager, the boss ignored her and did not give her the same support or opportunities for training that her male colleagues received. After eight months of receiving no feedback from her manager, she was called into his office, where the manager told her that she was failing, resulting in a demotion and a $20,000 reduction in her annual salary. When she won her sex-discrimination lawsuit, a jury awarded her $1.2 million in emotional distress and economic damages.24 the system implemented at your current organization or at the organization you have worked for most recently. Take a look at Tables 1.1 and 1.2. Where does the system fit best? Is the system more closely aligned with some of the positive consequences listed in Table 1.1 or more closely aligned with some of the negative consequences listed in Table 1.2? One of the purposes of a performance management system is to make decisions about employees’ compensation (e.g., pay raises). For many employees, this is perhaps one of the most meaningful consequences of a performance management system. Chapter 10 provides a detailed discussion of how a performance management system is used to allocate rewards. However, here we will discuss some basic features of reward systems and the extent to which the allocation of various types of rewards is dependent on the performance management system. 1.4 DEFINITION OF REWARD SYSTEMS An employee’s compensation, usually referred to as tangible returns, includes cash compensation (i.e., base pay, cost-of-living and merit pay, short-term incentives, and long-term incentives) and benefits (i.e., income protection, work/life focus, tuition reimbursement, and allowances). However, employees also receive intangible returns, also referred to as relational returns, which include recognition and status, employment security, challenging work, and learning opportunities. A reward system is the set of mechanisms for distributing both tangible and intangible returns as part of an employment relationship. It should be noted that not all types of returns are directly related to performance management systems. This is the case because not all types of returns are allocated based on performance. For example, some allocations are based on seniority as opposed to performance. The various types of returns are defined next.25 1.4.1 Base Pay Base pay is given to employees in exchange for work performed. The base pay, which usually includes a range of values, focuses on the position and duties performed rather than an individual’s contribution. Thus, the base pay is usually the same for all employees performing similar duties and ignores differences across employees. However, Chapter 1 • Performance Management and Reward Systems in Context differences within the base pay range may exist based on such variables as experience and differential performance. In some countries (e.g., United States), there is a difference between wage and salary. Salary is base cash compensation received by employees who are exempt from regulations of the Fair Labor Standards Act and, in most cases, cannot receive overtime pay. Employees in most professional and managerial jobs (also called salaried employees) are exempt employees. On the other hand, nonexempt employees receive their pay calculated on an hourly wage. 1.4.2 Cost-of-Living Adjustments and Contingent Pay Cost-of-living adjustments (COLA) imply the same percentage increase for all employees regardless of their individual performance. Cost-of-living adjustments are given to combat the effects of inflation in an attempt to preserve the employees’ buying power. For example, in 2003 in the United States, organizations that implemented a COLA used a 2.1% pay increase. In 2001, this same percentage was only 1.4%. Year-by-year COLA percentages can be obtained from such agencies as the Social Security Administration in the United States (http://www.ssa.gov/OACT/COLA/colaseries.html). Contingent pay, sometimes referred to as merit pay, is given as an addition to the base pay based on past performance. Chapter 10 describes the topic of contingent pay in detail. In a nutshell, contingent pay means that the amount of additional compensation depends on an employee’s level of performance. So, for example, the top 20% of employees in the performance score distribution may receive a 10% annual increase, whereas employees in the middle 70% of the distribution may receive a 4% increase, and employees in the bottom 10% may receive no increase at all. 1.4.3 Short-Term Incentives Similar to contingent pay, short-term incentives are allocated based on past performance. However, incentives are not added to the base pay and are only temporary pay adjustments based on the review period (e.g., quarterly or annual). Incentives are one-time payments and are sometimes referred to as variable pay. A second difference between incentives and contingent pay is that incentives are known in advance. For example, a salesperson in a pharmaceutical company knows that if she meets her sales quota, she will receive a $3,000 bonus at the end of the quarter. She also knows that if she exceeds her sales quota by 10%, her bonus will be $6,000. By contrast, in the case of contingent pay, in most cases, the specific value of the reward is not known in advance. 1.4.4 Long-Term Incentives Whereas short-term incentives usually involve an attempt to motivate performance in the short term (i.e., quarter, year) and involve cash bonuses or specific prizes (e.g., two extra days off), long-term incentives attempt to influence future performance over a longer period of time. Typically, they involve stock ownership or options to buy stocks at a preestablished and profitable price. The rationale for long-term incentives is that employees will be personally invested in the organization’s success, and this investment is expected to translate into a sustained high level of performance. Both short-term and long-term incentives are quite popular. Take, for example, the public sector in the United States. A survey administered in late 1998 to 25 state and 400 11 12 Part I • Strategic and General Considerations BOX 1.3 Short-Term Incentives for Physicians Short-term incentives are being used in a test pilot program in Colorado Springs, Colorado. Eight health-care providers and three insurance companies have teamed up with the nonprofit Colorado Business Group on Health to pay physicians up to $100 in cash per patient for providing diabetes care that results in positive outcomes for patients. Doctors in the program receive the additional pay as an incentive without an increase to base salary. The program requires doctors to work closely with patients and focus on preventative medicine, including education, goal-setting, and follow-up meetings. Physical indicators, such as blood pressure, blood sugar, and cholesterol, are measured against goals to determine whether successful outcomes are being achieved. The goals of the program are to provide better disease control for the patient and to cut down on expensive future treatments, such as emergency room visits and inpatient stays in the hospital. Additional savings are expected through reduced medical claims and health insurance premiums paid by employers. In summary, the health providers and insurers are utilizing short-term incentives as part of the performance management systems with the goal of motivating physicians to focus on treatments that will enhance the overall health and well-being of the patient in an ongoing manner.27 local governments employing more than six people showed that all but one of the state governments and 242 (i.e., 85%) of the local governments used some type of incentive.26 Some organizations are taking this idea to what may be called “big pay for big performance.” Contingent pay plans will be discussed in detail in Chapter 10. In the meantime, consider the case of a Denver, Colorado, energy company, Delta Petroleum, which gave four top executives 1.5 million shares the day the stock closed at $21.76, for a total value of $32.6 million.28 However, there is a catch: Delta stock will have to reach $40 per share for the executives to be able to sell theirs. If this value is not reached, the executives’ shares cannot be cashed in. Moreover, the executives will be able to sell only one-sixth of their shares when the price reaches $40. They will be able to sell another one-sixth if and when the stock price reaches $50, and another sixth if and when it reaches $60. And there is yet another restriction: time. The first batch of stock that vests at $40 must reach that value within 13 months of the time the executives received the options. If the value of $40 is not reached within this time frame, the second and third batches of stock cannot be cashed in and they simply disappear. 1.4.5 Income Protection Income protection programs serve as a backup to employees’ salaries in the event that an employee is sick, disabled, or no longer able to work. Some countries mandate income protection programs by law. For example, Canadian organizations pay into a fund that provides income protection in the case of a disability. Take, for instance, the University of Alberta, which offers a monthly income of 70% of salary to employees who become severely disabled. In the United States, employers pay 50% of an employee’s total contribution to Social Security so that income is protected for family members in case of an employee’s death or a disability that prevents the employee from doing substantial work for one year and for an employee when he or she reaches retirement age. For example, a 40-year-old employee earning an annual salary of Chapter 1 • Performance Management and Reward Systems in Context $90,000 and expected to continue to earn that salary until retirement age would receive about $1,400 a month if he retired at age 62, about $2,000 a month if he retired at age 67, and about $2,500 if he retired at age 70. Other types of benefits under the income protection rubric include medical insurance, pension plans, and savings plans. These are optional benefits provided by organizations, but they are becoming increasingly important and often guide an applicant’s decision to accept a job offer. In fact, a recent survey including both employees in general and HR professionals in particular showed that health care/medical insurance is the most important benefit, followed by paid time off and retirement benefits.29 1.4.6 Work/Life Focus Benefits related to work/life focus include programs that help employees achieve a better balance between work and nonwork activities. These include time away from work (e.g., vacation time), services to meet specific needs (e.g., counseling, financial planning, on-site fitness program), and flexible work schedules (e.g., telecommuting, nonpaid time off). For example, Sun Microsystems actively promotes an equal balance between work and home life and closes its Broomfield, Colorado, campus from late December through early January every year. This benefit (i.e., vacation time for all employees in addition to individual yearly vacation time) is part of Sun’s culture. Sun believes in a work hard–play hard attitude, as is evidenced by CEO Scott McNealy’s motto: “Kick butt and have fun.”30 1.4.7 Allowances Benefits in some countries and organizations include allowances covering housing and transportation. These kinds of allowances are typical for expatriate personnel and are popular for high-level managers throughout the world. In South Africa, for example, it is common for a transportation allowance to include one of the following choices:31 • The employer provides a car and the employee has the right to use it both privately and for business. • The employer provides a car allowance, more correctly referred to as a travel allowance, which means reimbursing the employee for the business use of the employee’s personal car. Other allowances can include smart phones and their monthly charges, club and gym fees, discount loans, and mortgage subsidies.32 Although these allowances are clearly a benefit for employees, some of them directly or indirectly also produce a benefit for the employer. For example, smart phones means that employees are reachable via phone, text, and e-mail 24/7. Similarly, if employees take advantage of a gym fee allowance, they are likely to stay healthier which in turn may lead to less health-related expenses for the organization. 1.4.8 Relational Returns Relational returns are intangible in nature. They include recognition and status, employment security, challenging work, opportunities to learn, and opportunities to form personal relationships at work (including friendships and romances).33 For example, Sun Microsystems allows employees to enroll in SunU, which is Sun’s own online education tool. SunU encapsulates a mix of traditional 13 14 Part I • Strategic and General Considerations TABLE 1.3 Returns and Their Degree of Dependency on the Performance Management System Return Degree of Dependency Cost-of-living adjustment Low Income protection Low Work/life focus Moderate Allowances Moderate Relational returns Moderate Base pay Moderate Contingent pay High Short-term incentives High Long-term incentives High classroom courses with online classes that can be accessed anywhere in the world at any time.34 Sun offers its employees enormous scope for development and career progression, and there is a commitment to ensuring that all employees are given the opportunity to develop professionally. The new knowledge and skills acquired by employees can help them not only to further their careers within Sun but also to take this knowledge with them if they seek employment elsewhere. Thus, some types of relational returns can be long-lasting. Table 1.3 includes a list of the various returns, together with their degree of dependency on the performance management system. As an example of the low end of the dependency continuum, cost-of-living adjustment has a low degree of dependency on the performance management system, meaning that the system has no impact on this type of return. In other words, all employees receive this type of return regardless of past performance. On the other end, short-term incentives have a high degree of dependency, meaning that the performance management system dictates who receives these incentives and who does not. Long-term incentives (e.g., profit sharing and stock options, which are discussed in more detail in Chapter 10) also have a high degree of dependency; although this type of incentive is not specifically tied to individual performance, it does depend on performance measured at the team, unit, or even organizational levels. Between the high and low end, we find some returns with a moderate degree of dependency on the performance management system such as base pay, a type of return that may or may not be influenced by the system. Think about the performance management system of your current employer, the system used by your most recent employer, or the system in place at an organization where someone you know is employed at present. Based on Table 1.3, try to think about the various types of tangible and intangible returns allocated in this organization. To what extent is each of these returns dependent on the organization’s performance management system? 1.5 AIMS AND ROLE OF PM SYSTEMS The information collected by a performance management system is most frequently used for salary administration, performance feedback, and the identification of employee strengths and weaknesses. In general, however, performance management systems can Chapter 1 • Performance Management and Reward Systems in Context serve the following six purposes: strategic, administrative, informational, developmental, organizational maintenance, and documentational purposes.35 Let’s consider each of these purposes in turn. 1.5.1 Strategic Purpose The first purpose of performance management systems is to help top management achieve strategic business objectives. By linking the organization’s goals with individual goals, the performance management system reinforces behaviors consistent with the attainment of organizational goals. Moreover, even if for some reason individual goals are not achieved, linking individual goals with organizational goals serves as a way to communicate what are the most crucial business strategic initiatives. A second strategic purpose of performance management systems is that they play an important role in the onboarding process.36 Onboarding refers to the processes that lead new employees to transition from being organizational outsiders to organizational insiders. Performance management serves as a catalyst for onboarding because it allows new BOX 1.4 How Sears Uses Performance Management to Focus on Strategic Business Priorities New leadership at Sears is utilizing performance management practices and principles to align human resources with business strategy. Headquartered in Hoffman Estates, Illinois, Sears Holdings Corporation is the third largest broad-line retailer in the United States, with approximately $55 billion in annual revenues and with approximately 3,900 retail stores in the United States and Canada. Sears Holdings is the leading home appliance retailer as well as a leader in tools, lawn and garden products, home electronics, and automotive repair and maintenance. The company is the nation’s largest provider of home services, with more than 13 million service calls made annually. Following the merger with Kmart Corp. and Sears, Roebuck & Co., Aylwin B. Lewis was promoted to chief executive and tasked with a strategic culture change initiative in hopes of reinvigorating the struggling retail company. A strategic objective is to move from an inward focus to a customer service approach. A second key objective is to bring about an entrepreneurial spirit where store managers strive for financial literacy and are challenged to identify opportunities for greater profits. Several aspects of the performance management system are being utilized to achieve these strategic objectives. For example, employee duties and objectives are being revised so that employees will spend less time in back rooms and more time interacting with customers to facilitate purchases and understand customer needs. In addition, leadership communication with employees and face-to-face interaction are being encouraged. Lewis spends three days per week in stores with employees and frequently quizzes managers on their knowledge, such as asking about profit margins for a given department. The greatest compliment employees receive is to be referred to as “commercial” or someone who can identify opportunities for profits. All Sears headquarters employees are also required to spend a day working in a store, which many had never done before. Executive management has identified 500 employees who are considered potential leaders and given training and development opportunities specifically aimed at cultural and strategic changes. In sum, the performance management system at Sears is used as a strategic tool to change Sears’ culture because senior management views encouraging key desired behaviors as critical to the company’s success in the marketplace.37 15 16 Part I • Strategic and General Considerations employees to understand the types of behaviors and results that are valued and rewarded, which, in turn, lead to an understanding of the organization’s culture and its values. 1.5.2 Administrative Purpose A second function of performance management systems is to furnish valid and useful information for making administrative decisions about employees. Such administrative decisions include salary adjustments, promotions, employee retention or termination, recognition of superior individual performance, identification of poor performers, layoffs, and merit increases. Therefore, the implementation of reward systems based on information provided by the performance management system falls within the administrative purpose. For example, the government in Turkey mandates performance management systems in all public organizations in that country with the aim to prevent favoritism, corruption, and bribery and to emphasize the importance of impartiality and merit in administrative decisions.38 1.5.3 Informational Purpose Performance management systems serve as an important communication device. First, they inform employees about how they are doing and provide them with information on specific areas that may need improvement. Second, related to the strategic purpose, they provide information regarding the organization’s and the supervisor’s expectations and what aspects of work the supervisor believes are most important. 1.5.4 Developmental Purpose As noted earlier, feedback is an important component of a well-implemented performance management system. This feedback can be used in a developmental manner. Managers can use feedback to coach employees and improve performance on an ongoing basis. This feedback allows for the identification of strengths and weaknesses as well as the causes for performance deficiencies (which could be due to individual, group, or contextual factors). Of course, feedback is useful only to the extent that remedial action is taken and concrete steps are implemented to remedy any deficiencies. Feedback is useful only when employees are willing to receive it. Organizations should strive to create a “feedback culture” that reflects support for feedback, including feedback that is nonthreatening and is focused on behaviors and coaching to help interpret the feedback provided.39 Another aspect of the developmental purpose is that employees receive information about themselves that can help them individualize their career paths. Thus, the developmental purpose refers to both short-term and long-term aspects of development. 1.5.5 Organizational Maintenance Purpose A fifth purpose of performance management systems is to provide information to be used in workforce planning. Workforce planning comprises a set of systems that allows organizations to anticipate and respond to needs emerging within and outside the organization, to determine priorities, and to allocate human resources where they can do the most good.40 An important component of any workforce planning effort is Chapter 1 • Performance Management and Reward Systems in Context the talent inventory, which is information on current resources (e.g., skills, abilities, promotional potential, and assignment histories of current employees). Performance management systems are the primary means through which accurate talent inventories can be assembled. Other organizational maintenance purposes served by performance management systems include assessing future training needs, evaluating performance achievements at the organizational level, and evaluating the effectiveness of HR interventions (e.g., whether employees perform at higher levels after participating in a training program). These activities cannot be conducted effectively in the absence of a good performance management system. 1.5.6 Documentational Purpose Finally, performance management systems allow organizations to collect useful information that can be used for several documentation purposes. First, performance data can be used to validate newly proposed selection instruments. For example, a newly developed test of computer literacy can be administered to all administrative personnel. Scores on the test can then be paired with scores collected through the performance management system. If scores on the test and on the performance measure are correlated, then the test can be used with future applicants for the administrative positions. Second, performance management systems allow for the documentation of important administrative decisions. This information can be especially useful in the case of litigation. Several companies implement performance management systems that allow them to accomplish the multiple objectives described earlier. For an example of one such company, consider the case of SELCO Credit Union (http://selco.org/selco/ about.asp) in Eugene, Oregon, a not-for-profit consumer cooperative that was established in 1936. 41 SELCO’s eight branches serve nearly 80,000 members. SELCO offers many of the same services offered by other banks, including personal checking and savings accounts, loans, and credit cards. Being members of the credit union, however, allows individual members a say in how the credit union is run, something a traditional bank does not permit. Recently, SELCO scrapped an old performance appraisal system and replaced it with a new multipurpose and more effective performance management system. First, the timing of the new system is now aligned with the business cycle instead of the employee’s date of hire to ensure that business needs are aligned with individual goals. This alignment serves both strategic and informational purposes. Second, managers are given a pool of money that they can work with to award bonuses and raises as needed, which is more effective than the complex set of matrices that had been in place to calculate bonuses. This improved the way in which the system is used for allocating rewards and therefore serves an administrative purpose. Third, managers are required to sit down and have regular conversations with their employees about their performance and make note of any problems that arise. This gives the employees a clear sense of areas in which they need improvement and provides documentation if disciplinary action is needed. This component serves both informational and documentational purposes. Finally, the time that was previously spent filling out complicated 17 18 Part I • Strategic and General Considerations TABLE 1.4 Purposes Served by a Performance Management System Strategic: To help top management achieve strategic business objectives Administrative: To furnish valid and useful information for making administrative decisions about employees Informational: To inform employees about how they are doing and about the organization’s and the supervisor’s expectations Developmental: To allow managers to provide coaching to their employees Organizational maintenance: To provide information to be used in workplace planning and allocation of human resources Documentational: To collect useful information that can be used for various purposes (e.g., test development, administrative decisions) matrices and forms is now spent talking with the employees about how they can improve their performance, allowing for progress on an ongoing basis. This serves a developmental purpose. Although multiple purposes are possible, a survey of industrial and organizational psychologists working in HR departments in more than 100 different organizations reported that the two most frequent purposes are administrative (i.e., salary decisions) and developmental (i.e., to identify employees’ weaknesses and strengths). Overall, in the organizations that participated in this study, performance management served at least two of the purposes mentioned earlier.42 As will be discussed in Chapter 9, these purposes place conflicting demands on the raters because they must be both judges (i.e., make salary decisions) and coaches (i.e., provide useful feedback for performance improvement) at the same time. Now, think about the performance management system implemented in your organization or the last organization for which you worked. Table 1.4 summarizes the various purposes served by a performance management system. Which of these purposes are being served by the system you are considering? 1.6 CHARACTERISTICS OF AN IDEAL PM SYSTEM So far, we have defined performance management, described the advantages of implementing good performance management systems, discussed some of the dangers of not doing a good job with the design and implementation of the system, and described the various purposes achieved by a good system. But what does a good system look like? The following characteristics are likely to allow a performance management system to be successful. Practical constraints may not allow for the implementation of all these features. The reality is that performance management systems are seldom implemented in an ideal way.43 For example, there may not be sufficient funds to deliver training to all people involved, supervisors may have biases in how they provide performance ratings, or people may be just too busy to pay attention to a new organizational initiative that requires their time and attention. Also, there may be organizational or even country-level constraints that prevent the implementation of a good performance management system. For example, consider the case of Ghana, which is a country that espouses collectivist values over individual performance, and it is a society that is male-dominated and dominated by Chapter 1 • Performance Management and Reward Systems in Context political and administrative leaders, where these socio-cultural norms have a clear influence on organizational decision making and practices.44 These institutional constraints that are so pervasive in Ghana and so many other emerging market countries must be taken into consideration in terms of what type of performance management system will be possible to implement as well as the effectiveness of such a system. However, regardless of the societal, institutional, and practical constraints, we should strive to place a check mark next to each of these characteristics: the more features that are checked, the more likely it will be that the system will live up to its promise. • Strategic congruence. The system should be congruent with the unit and organization’s strategy. In other words, individual goals must be aligned with unit and organizational goals. • Context congruence. The system should be congruent with the organization’s culture as well as the broader cultural context of the region or country. The importance of context in implementing highly effective performance management systems is emphasized throughout the book. However, for now, consider the example of an organization that has a culture in which communication is not fluid and hierarchies are rigid. In such organizations, a 360-degree feedback system in which individuals receive comments on their performance from their subordinates, peers, and superiors would be resisted and likely not very effective. Regarding broader cultural issues, consider that performance management research published in scholarly journals has been conducted in about 40 countries around the world.45 Taken together, this body of work suggests that culture plays an important role in the effectiveness of a performance management system. For example, in countries such as Japan, there is an emphasis on the measurement of both behaviors (i.e., how people do the work) and results (i.e., the results of people’s work), whereas in the United States results are typically preferred over behaviors. Thus, implementing a results-only system in Japan is not likely to be effective. As a second illustration, a study including 97 multinational corporations suggested that they have adapted their performance management systems in their subsidiaries in Bulgaria and Romania.46 Specifically, although performance is measured similarly around the world (see standardization criterion below), the interpersonal aspects of the system are adapted and customized to the local culture. For example, performance management systems in the subsidiaries are more likely to differ from those in the headquarters as differences in power distance (i.e., degree to which a society accepts unequal distribution of power) increase between countries. • Thoroughness. The system should be thorough regarding four dimensions. First, all employees should be evaluated (including managers). Second, all major job responsibilities should be evaluated (including behaviors and results; a detailed discussion of this topic is presented in Chapter 5). Third, the evaluation should include performance spanning the entire review period, not just the few weeks or months before the review. Finally, feedback should be given on positive performance aspects as well as those that are in need of improvement. • Practicality. Systems that are too expensive, time consuming, and convoluted will obviously not be effective. Good, easy-to-use systems (e.g., performance data are entered via user-friendly software) are available for managers to help 19 20 Part I • Strategic and General Considerations them make decisions. Finally, the benefits of using the system (e.g., increased performance and job satisfaction) must be seen as outweighing the costs (e.g., time, effort, expense). • Meaningfulness. The system must be meaningful in several ways. First, the standards and evaluations conducted for each job function must be considered important and relevant. Second, performance assessment must emphasize only those functions that are under the control of the employee. For example, there is no point in letting an employee know she needs to increase the speed of service delivery when the supplier does not get the product to her on time. Third, evaluations must take place at regular intervals and at appropriate moments. Because one formal evaluation per year is usually not sufficient, informal quarterly reviews are recommended. Fourth, the system should provide for the continuing skill development of evaluators. Finally, the results should be used for important administrative decisions. People will not pay attention to a system that has no consequences in terms of outcomes that they value. For example, a recent study compared performance management systems in the former East versus former West Germany. Results showed that in former West German companies, there was a stronger link between the performance management system and administrative decisions such as promotions. This relationship was weaker in former East German companies, and this difference is probably due to the socialist political system in the former German Democratic Republic, which has had a long-lasting effect that is still observed today.47 • Specificity. A good system should be specific: it should provide detailed and concrete...
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