Performance-Based Reward Systems are Unsuitable for the Public Sector - Essay Example

PERFORMANCE-BASED REWARD SYSTEMS ARE UNSUITABLE FOR THE PUBLIC SECTOR-AN EVALUATION Performance-Based Reward Systems are Unsuitable for the Public Sector-An Evaluation 1. Introduction Management of an organization expects particular contributions from its employees for the successful performance of a company including high productivity, high performance and maintaining core values (Tsui et al, 1997). Hence to ensure high performance from the employees, performance based reward system has been regarded as a motivating factor in different organizations. Though this has worked well in the private sector, its appropriateness in public sector is debatable. On the one hand, it is argued that performance based reward system is a motivating factor for the public sector employees to work harder and they are expected to perform their best due to this motivating factor (Maguire and Wood, 1992; Donell, 1998 etc).On the other hand it is argued that though the performance related pay system may work well in the private sector, this may not be appropriate for public sector. This is because there are lot of differences between the public and private services. The complexity of the public services make it difficult to measure performance and many differences exist between the optimal incentives for those in public and private sector according to the second view point(Buchanan,1990;Wright,1995;Burgess and Rato,2003 etc). The debate remains unsettled. In this context, this essay evaluates the appropriateness of performance based rewards system in the public sector based on theoretical and empirical evidence. It is argued in this essay that the impact of performance based reward system cannot be generalized to the public sector as a whole and differs between different sectors and between different levels of employees. Moreover this essay argues that there exist differences between the reward system for individual based performance and team performance. The importance of monitoring in team based work is clearly illustrated here. These arguments are brought out based on the theoretical and empirical evidence. This essay is organized as follows. The second section discusses the theoretical arguments on performance based rewards in the public sector. Section 3 discusses the empirical evidence in this regard. Section 4 concludes the essay. 2. Theoretical Arguments 2.1. Principal Agent Theory Based on the principal agent theory, the reward schemes are linear functions of performance. In the case of a perfectly observable output, the agent’s efforts can be perfectly shown by the value of the output. Hence pareto optimality in the effort level can be ensured by performance based pay in this case (Burgass and Rato, 2003).In the case of an output which is not perfectly observable, the agents’ efforts cannot be measured precisely by the principal. The noisier is the output, the risk aversion of agent increases and so is the marginal cost of effort. Thus based on this, it is argued that the performance measurement is very important in determining the incentive structures. If the performance is measured poorly, then it can lead to low powered incentive structures. In the case of public sector, the main problem is that the reward schemes are vulnerable to the manipulation of agents (Dixit, 2002).Even in the case of perfectly measurable output, the measurement of performance requires sophisticated management systems which is very expensive for a public sector organization(Burgass and Rato,2003). 2.2. Multiple Tasks, and Measurement Problems Agents have to perform multiple tasks in reality than doing only one task. In such cases, the optimal design of the incentive scheme is highly affected especially if the tasks are substitutes (Milgrom and Roberts, 1990). In case of substitutable tasks, higher incentives for one task can induce the agents to reduce their efforts on the other tasks which are substitutes. Moreover, if the tasks have multiple outcomes, the measurement of outcomes will be very subject to errors. It is more likely that higher incentive swill be given to more easily measurable outcome, which will be a poor indicator of the agents’ effort in this case (Marx and McDonald, 2001). In the case of most public sector organizations, the employees have to perform multiple tasks and hence are exposed to the problems mentioned above( Dixit,2002).In addition to these, among the higher and lower level public sector employees themselves, significant differences exist in the motivational patterns (Buelens and Van den Boeck, 2007; Festre and Garrouste, 2008). The higher level public sector employees are motivated mainly by higher commitment and higher satisfaction and are more or less similar to the private sector employees while this is not the case with the lower level employees. Hence the optimal design of reward system need not be the same for all levels of public sector employees. Another main measurement problem arises due to the fact that some types of occupations like police officers, tax inspectors, agency managers etc will be uniquely in the public sector .They will be decision makers and the organizations where they are working do not have a clearly defined single goal unlike their private sector counterparts (Prendergast, 2002). This makes the measurement of outcome difficult which affects the optimal design of the incentive scheme. 2.3. Multiple Principles In the case of most public sector employees they will have to work for multiple principals. In this case, the design of incentive structure will be very complex. This is because each principal will provide higher incentive for the dimensions of the output they are interested and lower incentives for those in which they are not interested. This can create negative externality to other principals who face lower efforts in those dimensions. Thus as the number of principals increase, the total marginal incentive coefficient for each outcome decreases (Holmstrom and Milgrom, 1988; Burgess and Rato, 2003). Moreover, in case of substitutable efforts for the agents for each principal, the agent will be willing to work for principal paying higher incentive which again increase the negative externality and reduce the aggregate marginal incentive (Burgess and Rato, 2003). 2.4. Multiple Agents An opposite situation of multiple principals is the multiple agents case where there will be one principal and many agents. In case of complementarities of production and the output is shared between team members, in this case, there can be problems of free riding. S the uncertainty in the output measurement increases and the size of the team becomes larger, the design of incentive structure becomes extremely difficult which demands the need for monitoring. Monitoring can increase the quantity of effort which becomes difficult in larger teams (Kandel and Lazear, 1992). 2.5. Lack of Competition In the private sector, to get powerful incentives, competition is a main incentive factor for each profit seeking firm. In the case of public sector services most are monopolies and hence there is lack of competition and hence weak incentive structure(Dixit,2002).Even in public sector services which have been privatized, or working under mixed arrangements, the evidence shows mixed results(Dixit,2002).Moreover the multiple principals working in public sector organizations may use political pressure to regulate the firms which in turn may increase costs , reducing competition and resulting in dropping out .Thus the activities which have been privatized look same as public services due to these pressures(Dixit,2002). The above theoretical arguments show that there are some special features that make public service different from the private sector firms .Hence, the performance measurement is difficult and subject to many errors in the public sector. Even among the public sector, there are differences among different levels of employees and different activities. Hence the performance based reward system can have different effects for each type of activities. The next section discusses the empirical evidence in this regard. 3. Empirical Evidence 3.1. Mixed Evidence In the study by Asch (1990), the impact of incentive scheme on US Navy recruiters .The results showed dramatic fall in the number and quality of recruits as the cut off date for the reward approached. This was mainly due to the reduction i8n the number and quality of recruits by the recruits to hit the target before cut off date. Donell(1998) examined the impact of the performance based pay in the Australian Public Service from 1992 to 1996.The results showed the performance based pay failing to adequately measure the performance of senior officers and the failure of the performance appraisals to enhance the feedback between supervisors and senior officers. Moreover, the study showed the performance based pay enhancing friction between those who received bonuses and other incentives and those who were excluded from the scheme. There was lot of subjectivity involved in the scheme and the collective values were undermined with greater focus on individual employment. Mann (2006) defined public service motivation as the aspiration to make changes, the capability to have an effect on the community, and the feeling of commitment and honor. As such Mann (2006) predicted that people with high public service motivation would not rely on salary, job security, or extrinsic rewards. However, they are more interested in intrinsic rewards like recognition and career advancement. Knez and Simester(2001) examined the effect of firm level incentive scheme in Continental Airlines in 1995.Since free riding was expected to be dominating in the reaction to the scheme, monitoring was introduced. This worked due to the relatively small team size and the sustainability of monitoring and enforcement of group norms. The study by Hamilton et al (2003) also showed the performance based pay system working well for teams rather than individuals. However, in the studies by Encinosa et al(1997) and Gaynor et al(2001) showed drop in productivity rates due to the performance based pay for team works. In both these studies, due to the large team size, monitoring didn’t work and hence free ridding dominated which adversely affected the overall productivity. These studies clearly showed the special features of public sector services making it inappropriate to give performance based pay. Moreover, the importance of team based rewards is shown for the public sector organizations rather than individual pay. In case of free riding, monitoring works well if the team size is small as shown by the studies above. Team size is an important factor determining the impact of performance based reward systems in these studies. On the other hand, Kahn et al (2001) examined how the performance based pay including the individual and team based financial incentives, has affected the Brazilian tax authority in 1989. The results showed 75 percent increase in the fine collection per inspection than in the original. After controlling for other macroeconomic factors also, the performance pay appeared to be significant inn affecting the results. However, the results varied significantly among different regions. 3.2. Sector wise Studies One sector which has been studied a lot regarding the impact of performance related pay in public sector is education. The impact of the performance related pay on the teachers in public sector is a much debatable topic. Ladd (1999) based on panel data examined the impact of performance based team reward system for school teachers in Dallas .The results appeared to be positive while varied significantly among different ethnic groups .Moreover, the positive effect was seen before the introduction of the reward scheme also. Hence the impact of the reward scheme was not clear in this study. Lavy(2002) examined the impact of performance based pay on Israel school teachers observed positive impact of the performance based pay on the performance without any negative spillovers. Beavis (2003) examined the impact of performance based reward system in the public schools in United States in different regions. The study obtained some evidence in favour of team based pay but no evidence in favour of individual pay. Most of the reward schemes were obtained to be implemented without careful design and planning which has affected the performance of the teachers. It is shown in this study that the merit based pay is short lived for the public school teachers without proper planning and design. The main reasons for these were shown as subjectivity in evaluation methods, reduced cooperation between teachers, poor relation between school management and staff and no place for market in education. Burgess and Metcalfe (1999) based on cross section data from private and public manufacturing services in the UK establishments obtained lesser impact of performance based reward system in the public service than in the private services. The study showed the issue of multiple tasks and multiple principles affecting the performance measurement in these sectors. 4. Conclusion In this essay, the appropriateness of performance based reward system in public sector organizations is critically evaluated. The theoretical arguments show the public sector having some special feature s that makes them different from private sector. Hence the performance measurement here will be more difficult than in private sector. Moreover, the performance evaluation is more subjective and is vulnerable to manipulation. There will be multiple principals for same agents and multiple agents for each principal which make the performance measurement complicated. This can also create negative externalities .The results however vary from sector to sector. Reward schemes for team based rather than individual performance appears to work well in public sector services. However, in this case, free riding may dominate the outcome. This demands the need for monitoring which wo9rks well without any negative externalities as shown by empirical studies. However, for large teams monitoring need not work well. Overall, it can be concluded that the performance based reward system needs to be designed with proper planning, careful design and implementation. The impact of the performance based reward system may differ among different sectors and also among different levels of public sector employees. Hence to get positive impact of the incentive scheme, these specificities need to be considered. References Asch, B(1990). “Do incentives matter? The case of Navy recruiters” Industrial and Labor Relations Review, 43, pp.89-107. Beavis OH(2003): “Performance-Based Rewards for Teachers: A Literature Review “,Paper prepared at the 3rd workshop of Participating Countries on OECD’s Activity Attracting, Developing and Retaining Effective Teachers ,4-5 June 2003, Athens, Greece. Buchanan, J. (1990), ‘Issues paper on the use of Performance-based pay in the Commonwealth public sector’, Job Evaluation & Performance Pay in the Public Sector. 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