The effectiveness of pay for performance plan - Essay Example

Not every employee is the same; therefore their preferences and motivating factors are as varied as their individual personalities. Utilizing, combining, and integrating the right compensation strategy in the corporate structure plays a critical role in maintaining employee motivation, retaining talent, and attracting high-performing candidates to the company. Although pay for performance compensation plans have always played an integral role in the compensation package of many companies there are a number of shortcomings related to the merit pay system.

Traditional compensation models ignore the key emotional influencers that reveal an individual’s key motivating factors. According to a recent paper called “The Psychological Costs of Pay-for-Performance”, by Ian Larkin, Lamar Pierce of Harvard and Francesca Gino of Washington University, this working paper identify the psychological costs of how social comparison, employee overconfidence, and loss aversion are prime determinants of the success and viability of individual performance-based compensation systems (Tighe, 2011).

“Social comparison is the tendency of individuals to compare their pay vs. effort ratio with their peers and their expectations of their compensation to be “fair” based on these preconceived notions. As a result of this comparisons pay plan effectiveness or perceived fairness is often compromised. Individuals commonly judge the extent of other people’s work contribution based on what they can see and not on actual results. Consequently coworkers are often unfairly judged since the value or true extent of their work is performed off premises or behind closed doors such as with salespeople or executives.

Although in the case of major CEO’s or star athletes for instance pay becomes a social measuring stick to which they compare against their peers, so pay becomes more closely tied to social factors and not necessarily economics. Employee overconfidence is where individuals have the tendency to overestimate their own abilities and skill set therefore they are prone to accepting tasks above their capabilities. According to Larkin; “Psychologists and decision research scholars have long noted that people tend to be overconfident about their own abilities and too optimistic about their future.

"; "Recent research has shown that overconfidence is not as much an individual personality trait as it is a bias that affects most people"(Tighe, 2011). The authors elaborate that in general people tend to be overconfident in their ability to complete tasks that they tend to perform frequently. On the other hand individuals tend to underestimate their ability to complete tasks which they are not familiar with or seem too complex. Since pay-for-performance systems are based on the ability of individuals to pick and choose positions that they feel best matches their skill set, the misalignment between the individual’s perception of themselves and their true skill set can cause them to undertake projects or tasks that are beyond their capabilities (Tighe, 2011).

Instead of pay-for-performance becoming a catalyst for increased organizational achievement and individual performance an employee’s overconfidence can cause them to underperform under pressure, increase general dissatisfaction, and can also bring about a