Effective performance management helps organisations to build stronger, more productive workforces. When it’s done right, it involves managers and HR working collaboratively with employees to identify weaknesses and help them to overcome them.
The problem? Performance reviews and appraisals are often tied directly to salary decisions, which can put employees on the defensive and make them less receptive to feedback.
In this article, we’ll dive into the pros and cons of tying salary reviews to performance reviews, so you can decide what’s best for your organisation.
(Psst! Read to the end for our tips on how to do it right.)
The importance of performance reviews
Regular performance reviews allow you to identify your employee’s training gaps or weaknesses, and give them the resources they need to improve. They’re also an opportunity to give employees feedback on the things they’ve been doing well — which can help them to feel valued and seen.
The importance of salary reviews
A salary review is an opportunity to reassess your company’s compensation structure. Doing this regularly helps you to make sure your salaries are in line with the market, and to uncover any internal inequities.
Ultimately, this can help you to retain your people for longer. According to a recent survey of recruiters and HR decision-makers, pursuing more money is the top reason people gave for quitting their jobs in 2022.
The big question: Should pay reviews be linked to performance?
Not all companies take performance data into consideration when making decisions about pay. Instead, they might simply rely on things like external benchmarking, inflation, and seniority to determine which employees should get a raise.
We’ll go into some of the pros and cons of tying these two concepts together below. But the argument really comes down to one question: what are performance reviews for?
The traditional view is that a performance review is to create accountability for employees. The idea is to assess each worker and determine how well they’ve performed over the past year compared to their colleagues. In this context, it makes sense to reward top performers with a raise or bonus.
But these days, many organisations take a different approach to performance reviews. Instead of being about accountability, they’re all about helping employees to develop. Ultimately, their aim is to improve performance across the organisation as a whole by empowering each employee to grow and overcome their weaknesses.
Let’s dive a bit deeper into some of the advantages and disadvantages of tying salary reviews directly to performance.
Pros of tying salary reviews to performance
Here are some of the reasons why linking salary reviews and performance might be a good idea.
1. Promotes transparency around salary decisions
When employees don’t understand the reasoning behind your salary decisions, they might think they’ve been made unfairly. But these decisions will seem much less arbitrary if they’re clearly linked to performance reviews.
2. Provides employee recognition and rewards
The whole point of tying salary reviews to performance is to encourage employees to do their best work. And rewarding top performers with a financial incentive is a great way to show employees that they’re valued and appreciated.
3. Can lower employee stress levels
Having a clear and structured process for assessing salaries tells your employees that you care about paying them fairly and helps them to feel secure. When this is linked to performance, employees also have a clear idea of what they need to do to move up within their salary band.
Cons of tying salary reviews to performance
Here are some of the downsides of letting performance reviews influence your salary decisions.
1. Possibility for bias
Unconscious bias of all kinds is present in many workplaces — if not all of them. For example, we reported earlier this year that tech companies in Europe have an average unadjusted gender pay gap of 19% in 2023.
Even when your intentions are good, performance reviews are often subjective and leave room for bias. And when these are directly linked to your salary review process, it can widen systemic issues like pay gaps between different genders, ethnicities, ages and abilities.
2. Makes self-assessment and peer reviews less reliable
These days, performance reviews often take into account feedback from multiple sources, including the employee themself and their colleagues. But when employees know their feedback could have an impact on your salary decisions, this can muddy the waters.
First, employees are less likely to be honest about their own struggles and weaknesses if they think it might jeopardise their chances of getting a raise.
And when it comes to peer reviews, some employees might downplay their colleagues’ achievements because they know you have a limited salary budget and want to maximise their own chances of getting a raise. Others might exaggerate their reviews to help their friends get wage bumps and bonuses.
3. Goal-setting can be subjective and goals can change over time
In a typical performance review, employees are assessed against a series of predetermined criteria, which you might have defined at your last review. But there are all sorts of reasons why an employee might not meet certain goals — and many of them aren’t the employee’s fault.
Particularly in young or fast-growing companies, course-changes are frequent. That means that tying an employee’s ability to get a raise to criteria you set a year ago might not be realistic.
How to fairly incorporate performance into your salary reviews
For most organisations, completely separating compensation from performance isn’t realistic. Managers, HR and company leaders need to make fair, data-driven decisions about things like promotions and pay rises. And performance reviews can provide the information they need.
However, there are certain things you can do to make sure your compensation reviews are fair, and your performance reviews help employees to improve.
Here are our tips for doing it right.
Keep the focus on employee development
While performance reviews can provide the data you need to make informed decisions about salary, the focus should always be on helping your employees grow. Otherwise, these reviews can become less objective (and less useful), for the reasons we’ve talked about. They can also become extremely stressful for employees.
When it’s done right, a performance review should be a productive process that involves working with the employee to identify training gaps and areas for development — as well as pointing out strengths and things they’ve done well. This becomes much more difficult if the only thing the employee can think about is whether or not they’re getting a raise.
Have the two conversations separately
Even if your compensation reviews are tied to performance, you should always keep these two discussions separate.
That means you should complete the performance review and meet with employees for appraisals that have nothing to do with pay. Then, use the data you’ve gathered to complete your compensation review and schedule a separate meeting to discuss your decisions with your employees.
This way, employees will be able to focus on their manager’s feedback and suggestions during their appraisal. But they’ll also be reassured that they’ll get an opportunity to discuss compensation later on.
Develop clear processes for performance and pay reviews
It’s important to have a clearly defined, structured process for both your performance reviews and your pay reviews.
When it comes to performance, employees should understand exactly what criteria they’re being measured against and what they can do to move to the next level.
We’re also big believers in being transparent about your compensation structure. Employees should understand what factors go into your decision to give someone a pay rise (or not). That way, even if they don’t get what they want, they’ll understand the reasoning behind your decision.
Opt for continuous performance analysis
Traditionally, a performance review was an annual conversation between an employee and their manager. But these days, many organisations are taking a different approach: frequent, informal check-ins throughout the year.
According to a Harvard Business Review article from 2016, this strategy can save companies vast amounts of time and money, promote better collaboration and even drive innovation. It also makes it easier for employees to continuously improve their performance, because they don’t have to wait until the end of the year to realise they have a problem.
Of course, that doesn’t mean you need to ditch the annual review altogether. But combining it with less formal, more regular communications can help you to improve performance across your organisation — without questions about pay hanging over the conversation.
The missing piece: salary benchmarking
While it’s perfectly reasonable to incorporate performance data into your pay decisions, it shouldn’t be the only factor you consider. You should also be conducting regular salary benchmarking to ensure you’re paying every employee what they deserve.
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Our compensation planning tool helps you to run smooth, effective compensation reviews, taking into account inflation, market adjustment, and employee performance.
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