During the Q1, companies usually analyze the performance ratings of their employees and make decisions based on that information such as salary increases or variable remuneration bonus distribution. Some weeks ago, I had an interesting conversation with my colleagues regarding whether is a good idea to tie performance management to compensation and what are the implications of that decision so I would like to share some thoughts we had with you.

First, we must consider the purpose of the performance management model which is the vehicle used by companies to assess the contribution made by employees to the achievement of corporate objectives. In the different companies in which I have worked, performance management has had several components:

• A component to assess the financial performance of the company in which, according to the results of economic indicators for the year, a percentage of variable remuneration over the annual fixed salary is paid, and it varies depending on the organizational level of the person: the c-suite has a greater proportion of their bonus tied to the financial performance of the company than middle managers and theirs is in turn, greater than that of individual contributors.

• An individual performance component usually considers one or both of the following elements: the fulfillment of individual objectives or KPIs that show the contribution to the achievement company´s objectives, and a qualification on the competencies or soft skills needed to perform the job, granted by the leader to the employee. In other words: the WHAT and the HOW.

• Additionally, some companies tie the result of performance management to the employee´s annual salary increase.

There is common to find companies that reward the WHAT but When is important to reward also the HOW?

The answer will depend on the culture of the company. In my experience, in companies whose culture is highly result-oriented and competitive, performance management only measures the achievement of results and does not assign weight to the way of achieving them. In these companies, HOW is assessed and worked through other tools such as 360° reviews but there is no impact of these variables on compensation. On the other hand, in these companies the achievement of Individual objectives, or WHAT, completely impacts the settlement of variable remuneration and salary increase, which sends an organizational message about the importance of meeting individual goals, which in turn, undoubtedly generates high organizational performance but sometimes negatively impacts the work environment, collaboration, and long-term organizational commitment.

“We must consider the purpose of the performance management model which is the vehicle used by companies to assess the contribution made by employees to the achievement of corporate objectives.”

In contrast, in companies that give importance not only to the achievement of objectives but also to the way to achieve them, competencies are part of the performance management rating, which sends an organizational message about the behaviors expected of employees to ensure an adequate contribution to the achievement of company objectives. In these companies, the results of performance management are used to develop talent through leadership programs, coaching, mentoring, horizontal movements, or promotions to positions where a greater contribution can be made.

Once the performance management components have been defined, the question arises as to whether we should tie these results to the variable remuneration bonus and salary increase. For this, the level of maturity in the company's talent management practices is important because the impacts of this decision must be evaluated.

On one hand, tying performance management to compensation generates transparency in these decisions for employees and clarity regarding what they must do to achieve higher compensation. In addition, it eliminates biases on the part of leaders when assigning these increases as they are supported by compliance with KPIs or by evidence of behaviors to assess competencies. On the other hand, it can limit the ambition of employees when defining their objectives so they will prefer to play safe instead of choosing a more aspirational and challenging goal that could risk their bonuses. In addition, it can create a challenge for leaders knowing that their decisions when assessing competencies and assigning a final performance rating to their people will have a direct impact on their compensation. This is particularly important in companies where there is not a culture of continuous feedback and difficult conversations, and leaders have not received training on how to avoid unconscious biases in their leadership practice. Additionally, high inflation environments such as the ones we are experiencing now can lead leaders to soften their ratings to avoid further impacting their people from an economic point of view. As a result, leaders will not yield reliable data on employee performance, which impacts the quality of organizational decisions that must be made based on these results. Finally, these individual adjustments can have a significant impact on internal equity and external competitiveness by generating differences in wages for people with similar responsibilities that widen over time.

In short, each the C-Suite must identify the drivers to which it wants to give greater importance in accordance with its strategy and particular business model to design a performance management process that rewards these drivers and send the appropriate organizational message to employees: only the results matter, or there are equally important both the results and the way to reach them. In addition, it must be identified whether the leaders are at a sufficient level of maturity to define ambitious goals and maintain objectivity in their performance ratings even when these may impact the compensation of their team. This analysis will lead to the design of a performance management model that really fulfills its function of leveraging the achievement of organizational objectives.