Pay-for-Performance and Performance Management

Earlier in the month, embattled insurance giant AIG announced plans to change how they pay for performance  (Wall Street Journal: “AIG Plans Revamp on Pay,” February 10, 2010).  This move was in response to their wildly reported bonus payment controversy.

On my earlier post (“Talent Management: Watching Your Investments”), I mentioned some of the difficulties that managers have when it comes to executing on the performance management process.  Regardless of the type of model in place, when not properly managed, not only is compensation skewed but also the process may miss its purpose of accurately assessing performance.

In theory, performance management is used to assess the performance of an employee against pre-established goals and organizational norms. It should involve timely coaching from the manager towards improved performance, and may involve disciplinary action in the case of serious problem behavior or transgressions. As it is difficult to achieve goals without having multiple touch points within the team and throughout the organization, performance management also gauges the level of competency in place for critical skills such as communication, teamwork, cooperation, etc., as well as other organizationally supported competencies.

Most organizations adhere to either a four or five-point system where managers assign the performance ratings they deem as accurate, or, a four or five-point system with a forced distribution among the points. I will lay out some of the benefits and challenges for HR leaders with either model.

To curve or not to curve?

Forced Distribution (also known as a Bell Curve) – In a forced distribution system, each of the performance categories is assigned a percentage to be distributed throughout the organization. For instance, in a four-point system, such as the one that AIG is suggesting, the expectation is that the highest performance ratings, in this case 1 and 2, will be limited to 20% of the employee population. From there, 70% will receive the next rating of 3, and 10% will receive the lowest rating of 4. This system is typically used as a means to distribute the compensation budget pool.


  • Gives the organization a roadmap to follow in order to pre-plan its compensation budget
  • Makes it easier to “assume” an expected level of performance
  • Forces differentiation among performance
  • Calibration sessions are conducted with senior managers and HR where managers discuss their team’s performance


  • Forcing people to fit in the set rating categories may not paint a full picture of where performance actually lies (a case of the distribution determining performance rather than the other way around)
  • Takes some of the developmental “powers” away from the manager – a great manager will work towards recruiting, developing, and retaining the best talent for each of the roles within their team, a practice all managers should follow. If along the way, they have built a solid team of “A players,” forcing them to categorize their folks among all ratings, can upset that balance.
  • Creates tendency to foster competition rather than collaboration among teams and colleagues
  • May demoralize the employee base
  • Creates a perverse incentive for managers to keep low performers around to be used against the “quota”

Common challenges:

-        Is the distribution used across the board overall, within each department, or level by level?:

  • Overall – Risks having higher (more senior) levels receiving best ratings
  • Within each department – Same risk as Overall
  • Level by level – In theory, this is probably the fairest way of applying this model since the rest of the organization is being forced to differentiate performance.  But, challenges here point towards the possibility of frustrating talent that has grown to the highest levels, and it would indicate that higher-ranking officers have “average” and “below average” performers among them. As a substantial investment has surely been made to maintain people at the senior level who are supposed to be high performing almost by definition, applying a force distribution to them would not be realistic. Not applying it to the senior levels on the other hand does not solve the conundrum that there may be equally high performing employees who are getting forced into lower ratings.

No Forced Distribution – This system does not have an expected percentage tied to each of the performance categories and ratings. The compensation budget uses the performance management results as a guide, but it is not ruled by it.


  • Paints accurate picture of actual performance
  • Perceived as more fair by employees
  • Managers have more leeway to manage their employees’ performance without an organizational dictum, including managing out poor performers in time.


  • If badly managed, performance differentiation is not achieved
  • May lead to conformity
  • Temptation to divide “pool” equally
  • Tendency to avoid lower ratings
  • It is logistically more difficult to plan and distribute the compensation budget
  • May not involve calibration sessions, leaving performance to be managed in silos

Common challenges:

  • It requires high touch from HR and the leadership to ensure consistent application of performance standards
  • The onus for performance is on the manager, and awareness, a watchful eye, and a high dose of courage are all needed to effectively manage this process

What are we solving for?

The use of either one depends quite a bit on the organizational culture, how the methodology is communicated, and more importantly, how it is fairly and consistently applied.

One question to ask is, what is the organization trying to achieve? I would venture to say that above a way to assess performance, above a way to distribute compensation budgets, and with all the investment made in recruitment and training, what the organization is seeking is high performance throughout. It must then be careful how it gauges that performance. Does it do it through arbitrarily forced metrics or does it ensure high quality managers understand and apply performance ratings accurately?

Managerial subjectivity is a problem with both models, but on the forced distribution, even the manager may have limited option to exercise their own judgment and the rating may no be reflective of the actual work performed.

The forced distribution system follows the statistical concept that 20% of the people do 80% of the work. However, it must have flexibility to gauge where the 20% is located and when the 20% may fluctuate.

For AIG, attempting to placate the outrage over their bonus pay by instituting a forced distribution system may miss the mark. The public will not be placated if AIG has only 20% of its “top performers” receive the majority of the available pool when the company is tanking overall. Certainly, not having the discipline to use their previously established process appropriately was a huge management and HR mistake. However, the public’s outcry was directed at the overall amount of bonuses handed out for a failing organization, not at their performance management process.

When it comes to performance management, the issue here is how to compensate the best performers. The truth is that in a team, three people may have strived for the top rating, and if you lose one because of a less-than-expected rating, what would be the difference of having given all three the same rating and having one get upset because they did not receive a higher bonus amount? Both models can have the same devastating effect.

Another caution is to realize that sometimes, instead of performance, what is being rewarded is potential. Many organizations fall in the trap of wanting a cookie-cutter approach to apply at the end of the year. As mentioned in earlier posts, people strategies take a back seat to the other business activities. If both were on equal footing, a thoughtful approach would be applied where true performance is assessed and rewarded based on business success. Wouldn’t the employee population appreciate knowing that extensive thought went into the performance management process rather than knowing that at times, and no matter how great their performance was, prescribed “rules” played against them?

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This entry was posted on Sunday, February 28th, 2010 at 10:47 am and is filed under Performance Management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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