Performance management and how it impacts the way companies pay and develop executives and employees continues to be a topic that dominates the HR agenda. speaks to Dr Harriet Sebald and Joachim Kayser on current trends and the impact of linking performance and pay.
Ms. Sebald, Mr Kayser, it seems that there is probably no HR process that creates more dissatisfaction among managers and employees than performance management. Why is this? 
Joachim Kayser: Indeed, performance management is widely regarded as an expensive and time-consuming way of making people unhappy. What is more: the way we set goals, give feedback and measure individual performance may even reduce performance by reducing employees’ motivation. To some extend this view is supported by research, which tells us that existing performance management systems may inadvertently actually encourage a way of thinking that limits the ability to grow talent.
Harriet Sebald: As a result, the textbook approach to performance management, whereby employees and line managers define objectives and desired behavior, line managers assess the performance of their team members and agree their evaluation in panels and then feedback the outcome to their employees as a basis for decisions about compensation and development is under review.
Why is there a perception that existing approaches do not work and what can replace them? 
Joachim Kayser: The premise of many performance management systems (especially those that are purely or mostly formulaic) today is the same as for balanced score card, combined with management by objectives. In hierarchical organizations this means that goals are formulated on top and cascaded down. However, many successful companies today - especially in the technology sector - are moving towards a more collaborative style of management where employees and dynamic teams work in a less structured and more networked way. This – some believe – requires a fresh approach to performance management.
Harriet Sebald: Most companies believe that business success is not only driven by the achievement of targets, but also by the right leadership behaviours. As a result, they are reviewing their approach to performance management. The changes they are making or considering to make range from eliminating performance ratings altogether to de-linking bonus payments from performance management.
Does this mean that we do not need targets and competencies?
Harriet Sebald: Target-setting assumes that the value drivers can be clearly defined and broken down to an individual level. They assume that what counts is the what, not the how. This is the reason why a majority of companies typically use a combination of targets and competencies, which define expected behaviors, to assess individual performance.
Joachim Kayser: The importance of the use of financial and non-financial targets vis-à-vis competencies or a more discretionary approach varies widely between countries and industries. For example, in low-tech engineering or manufacturing companies an exclusive focus on targets which sometimes translate directly into compensation can be found. However, even in such industries the increased need for agility, cooperation and innovation may lead companies to also consider behavioral factors.
Do we need ratings?
Joachim Kayser: In practice, managers have a number of competing interests and constraints and therefore, most performance ratings are not accurate reflections of individual performance. As a result, a number of companies are reducing ratings. Other companies, e.g. a number of financial services organizations are making their systems more rather than less structured.
Does this mean that there is no clear trend? 
Harriet Sebald: Yes, or rather, different trends in different industries and for different companies. Most importantly, companies should define the purpose of their performance management, there is no “one size fits all”.
Joachim Kayser: In addition, there are cultural differences. The use of forced distributions as a basis for layoffs, for example, would be culturally and legally insensitive in many European countries. Many multinational companies also observe cultural differences in the willingness to give and receive negative feedback.
… especially if pay is strongly linked to performance management. Do we have to link performance and pay?
Harriet Sebald: It is intuitive that individual performance and pay should be correlated. However, the way in which this is being achieved varies widely. In some companies the performance rating immediately translates into an award under a short-term incentive. In other cases individual performance is reflected in merit increases.
Joachim Kayser: Other companies use a more discretionary approach, or a combination of formulaic and discretionary approaches and/or consciously separate decisions about performance from decisions about pay to avoid effects such as reverse-engineering and enable a focus on employee development instead of a sole focus on compensation. Some companies are even severing the link between evaluation and compensation altogether, at least for the majority of the workforce.
Harriet Sebald: Where compensation is at least in part the outcome of the performance management process the most common compensation vehicle is the STI. However, there are also companies that use other compensation elements, such as base salaries, instead.
So what should companies do? 
Joachim Kayser: While there are situations where overhauling the existing performance management system makes sense - for example, where companies wish to support a cultural shift - the large majority of companies continue to use targets, performance reviews, ratings and monetary rewards linked to individual performance. There are good reasons for this, including the need of managers and employees for a certain amount of structure, transparency and legitimacy and the fact that performance management provides the basis for allocating limited resources, such a bonuses, training and/or promotions.
Harriet Sebald: Therefore, instead of completely redesigning performance management, most companies are responding to the changed requirements by making changes to their existing system. This allows them to address some of the shortcomings of traditional performance management systems while retaining the benefits. The most common changes include shifting the balance between targets and competencies, replacing formulaic translations of performance ratings into reward decisions with an approach whereby management is able to exercise some discretion, facilitating continuous or at least more frequent feedback and focusing the performance management process more on developing employee potential.

Ms. Sebald, Mr Kayser, thank you very much!