Performance & compensation management | Should salaries be tied to reviews?

Why do performance reviews make many professionals feel nervous and uncomfortable? Ideally, they should be productive conversations about well-being, progress, development, and future goals.

Leading people experts believe that performance evaluations continue to be a sensitive topic because of the relationship between performance and compensation management. Indeed, people’s career paths and financial futures traditionally depended heavily on the outcome of reviews, which would make anyone anxious.

‍With the current economic climate, financial health is top of mind for many professionals.*

Some people leaders believe that organizations should center appraisals around employee development and have separate conversations about raises and promotions. However, there’s no single best approach to compensation management, and different strategies may suit different organizations depending on their needs and goals.

This article will explore the purposes of performance reviews and compensation plans, as well as the advantages and disadvantages of linking them. We’ll also discuss four strategies for connecting performance and compensation management.

‍‍*SHRM, 2024

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The purpose of performance reviews

Effective performance reviews foster employee self-reflection, increase engagement, help identify strengths and areas of growth, and improve communication between managers and reports.‍

Reviews also allow leaders to ensure workers feel supported and challenged while giving them guidance on the skills they need to improve. Finally, keeping track of team performance lets employers and management teams identify knowledge gaps, consider hiring needs, and assign training budgets.

However, since performance evaluations are often part of the criteria for compensation and promotion assessments, they sometimes have a finger-pointing nature. That’s why we advocate for companies to embrace continuous performance management and make reviews all about development and growth.

Then, the performance evaluation process empowers managers to connect with their team members, discuss and align expectations, and collaborate with reports on their learning and development initiatives.

📈 According to a piece published in the Harvard Business Review, “regular conversations about performance and development change the focus to building the workforce your organization needs to be competitive both today and years from now.”

💡 Need some actionable insights into conducting development-focused reviews? Check out our list of performance review tips for managers.

The purpose of compensation plans

Talking about the purpose of pay may seem odd — but is it, really? Searching for the “why” behind seemingly obvious concepts can help uncover concerns that might go unnoticed. For example, discussing money at the workplace can make your company culture more transparent by identifying and addressing issues like unconscious biases, unfair promotion practices, and wage gaps.

‍Paying someone for their time, meeting legal requirements, and attracting and retaining talent are some of the most obvious purposes of compensation.

However, we’ve chatted with HR consultant Marie Richter, who brought attention to other objectives: “eliminating financial worry [or] threat for employees, showing appreciation of their work, and differentiating between responsibilities.”

On top of what we usually think of as compensation — like salary, bonuses, and stock options — you may also offer employees indirect compensation. Some examples:

• Pensions plans
• Insurances
• A development budget
• Wellness benefits
• Childcare stipends or facilities

It’s essential to understand your organization’s compensation strategy, views on when compensation should be used and what for, and remuneration objectives so you can help align them with your company culture. It’s also vital that team members and leaders recognize how financial compensation is linked to employee performance internally.
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Pros of linking compensation to performance reviews

For many organizations, decoupling employee evaluation and compensation isn’t realistic. That’s because appraisals measure employee performance and skills, inevitably influencing a manager’s decision to promote people and/or increase compensation. 

‍The key to benefiting from the pairing of performance and compensation is focusing your reviews on development. Some of these benefits include:

• Better employee recognition 
• More pay transparency 
• Lower employee stress levels
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Better employee recognition

Financial rewards for high performance are just one way you can make employees feel valued and recognized. They tell your people their efforts also impact their personal lives, and they’re doing more than just making more profit for the company. It gives the message that you’re growing together. 

Companies are competing for top talent now more than ever, and financial compensation for a job well done can improve retention.
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More pay transparency

If tied to performance reviews, salary bumps, performance bonuses, and other financial compensation will seem less arbitrary. Doing so will also give employees a better picture of what they need to do to earn more. However, this strategy requires a lot of open communication — along with well-defined competency frameworks, career paths, and policies.

Employees need to know that managers are honest with them and feel empowered to offer feedback and have ongoing conversations about compensation and performance. That way, the pairing can be a powerful tool for motivating your people.
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☝️ Regardless of financial rewards for high performers, keep investing in employee development.

Otherwise, you might end up primarily rewarding your most privileged team members (for instance, those who can pay for top professional courses) and missing out on other staff members’ potential! 

All in all, employee development helps your company and is a great tool for equity. Valuable employees come from different backgrounds, and unless you invest in training for everyone, they won’t have access to the same development opportunities.

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Lower employee stress levels 

Knowing exactly when they’ll have a dedicated opportunity to discuss compensation can help employees feel secure. Without a timeline, workers tend to feel anxious and stressed out, not knowing when and if to bring up the subject of a salary increase. Defining a time for this conversation helps manage employee expectations and increase trust in company practices. You’ll also spare them from the challenging, nerve-wracking task of asking for a raise.

Having to raise the subject of pay revision is another reason why employees who are more reserved — or come from underserved backgrounds — sometimes become disengaged. Many people fear losing their jobs and may accept less money than more privileged counterparts with equal skills.

If your company decides not to tie performance and compensation management together, communicate your remuneration model to employees. That way, they’ll know what to expect and won’t feel left in the dark. Details about your organization’s approach to compensation should be front and center during the hiring process so candidates have all the information they need to make an informed decision about their next career move.
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Pitfalls of linking compensation to performance reviews

While connecting performance management and compensation can be a powerful way to recognize, motivate, and engage your people, there are a few pitfalls to watch out for.  

These drawbacks include:

• Binding compensation to objectives and key results (OKRs) can be problematic 
• Self-assessments can become disingenuous 
• Reviews can be biased
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Binding compensation to OKRs can be problematic

Binding wages to objectives and key results (OKRs) isn’t a recommended practice because OKRs are meant to help organizations align with the same vision. They should be inspiring but ambitious, so employees shouldn’t necessarily aim for 100% fulfillment — and managers shouldn’t base compensation decisions on their completion.

As we’ve explained in our guide to setting the right OKRs: “If you’ve set the right OKRs (in a sweet spot between challenging the status quo and a ‘pie in the sky’), hitting 80% of your target should already validate your efforts and courage.”

Additionally, goal-setting can be highly subjective, and certain factors — like a company changing course or shifts in team dynamics — can cause staff members to not meet their goals. In this case, it’s wrong to base their compensation on factors that are out of their control.

Finally, linking compensation to OKRs might make your employees feel like tasks that aren’t tied to OKRs don’t matter, limiting their vision and negatively impacting their motivation. This might also increase frustration and competitiveness, making company decisions seem unfair, especially as team members often work together toward the same OKRs.
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Self-assessments can become disingenuous

Would people give their genuine opinion if they knew how they rate themselves could negatively impact their livelihood?

Self-assessments should drive development, not fear. And even the most ethical people might see a blurred image in the mirror if their livelihood is at stake. Would they honestly reflect on their shortcomings and ask their manager for direction? Would they ever suggest the need for a performance improvement plan? Or would they — even unconsciously — fail to see they’ve underperformed in a particular area?

‍Assure your employees that the purpose of self-assessments is to foster personal reflection and encourage development-focused conversations.‍

For example, an employee might rate themselves as “extremely proficient” in communication skills. Their manager, however, could mark that skill as “an area of growth.” This mismatch is a great opportunity for the worker to share their perspective with their manager. It could be that the person is simply unaware of the criteria that influence the rating or has a different understanding of what great communication skills look like.
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Reviews can be biased

Biases are still a reality, and to some extent, they may always be. Yet, progressive HR and people ops professionals should work to purge biases from their organizations — and that includes biases in performance reviews.

As an example, employees may not give their peers honest ratings in a 360° review if they know their department’s salary raise and promotion budget is limited. The opposite could also happen — peers may want their colleagues to receive wage bumps and promotions, giving them exaggerated positive reviews despite potential poor performance.

In a more subtle context, would reports be sincere when reviewing their managers? Or would they omit constructive feedback, hoping not to be punished when it’s time for their own performance appraisal?

Finally, race bias, gender bias, ageism, affinity bias, and other forms of unconscious bias are still blatant. How they often come into play in compensation-oriented performance reviews might widen systemic wage gap issues — such as women earning less than men and BIPOC women being paid even less.

It’s not easy to admit that this might happen within the company cultures we’re trying to build. Still, not acknowledging the intricacies of interpersonal relationships and systemic issues isn’t going to make our cultures flourish.
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4 strategies to connect performance & compensation management

Tying compensation and performance management isn’t always a matter of choice — some organizations need to comply with board and union regulations that mandate a pay vs. performance connection. Some companies also prefer to work with incentive plans for top performers.

That’s why we’ve made a list of four strategies you can employ to connect performance management and your organization’s compensation strategy effectively.
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1. Make development the focal point of performance management

Tracking an employee’s performance is crucial, but if it becomes the focal point of compensation management, it gives appraisals an accusatory quality, creates stress for employees, and opens the door for disingenuous self-assessments. 

However, if you make employee development the focus of performance reviews, you can show your people you’re invested in their professional growth and value their advancement.

Additionally, instead of pointing out poor performance, the review conversation becomes about identifying:

• Strengths 
• Areas for development
• Training gaps 
• Performance objectives
• Opportunities for adjusting responsibilities 
• Possibilities for reducing work-related stress

This all paves the way for creating a healthier work environment.
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“After a performance review, there could be a salary increase (quite often there should be), but it shouldn’t be the main result of the review, much less the only one…

If you can get reviews to be rhythmic consolidating points for a continuous, frequent conversation between your organization and the people in it, you could get better performance boosts than just relying on compensation.” 

— Aldo Bressan, Regional Continuous Improvement Manager at Infracommerce Latam

2. Schedule performance appraisal & compensation management talks separately

Talking about compensation during a performance appraisal makes it difficult for the employee to focus on their manager’s feedback and valuable takeaways. To reduce that anxiety, schedule a separate 1:1 meeting with the intention to only discuss compensation-related matters.“Compensation and performance reviews [can be] tied together but reviewed separately — i.e., once performance reviews are complete, performance ratings can then be used to calculate compensation changes,” recommends Dannie Lynn Fountain, Disability Accommodations Program Manager at Google.
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3. Run consistent initiatives to break down biases in the workplace 

Reviews inherently require that people judge someone else — and all judgments have the potential to be biased. And “when compensation is tied to inaccurate or biased performance reviews,” says Fountain, “the outcome is actually more harmful than a successful execution of this pairing might be.”

So, it’s crucial to run frequent reviews within your performance management cycle to help uncover and break down biases, along with engaging in bias reduction exercises to ensure fair evaluations.

💡 Curious to know how you can avoid unconscious bias in performance reviews? Check out our comprehensive playbook!

Another way to reduce the impact of unconscious bias is to enable managers and HR professionals to make joint decisions and share control over performance reviews with relevant stakeholders.

As noted by Fountain: “There should be two or more additional parties that check the review and the ‘performance rating,’ assuring that the performance justification matches the rating and that the manager is not exerting unnecessary pressure or bias on the employee.”
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4. Create transparent & streamlined processes

HR professionals and leaders need to define clear performance review criteria along with promotion and compensation processes.

‍It’s harder for team members to develop their skills if they don’t know what they’re being evaluated on or have competency frameworks that tell them how to move to the next level. A lack of transparency and consistent processes can also create unhealthy competition and resentment between teammates. 

Your approach to your organization’s pay strategy and performance evaluation is critical to your ability to retain and attract great talent. You can’t operate without great people!

‍Your compensation practices should reflect your company culture. Whether or not you choose to associate salary talks with performance appraisals, employee development should be at the heart of the review process.

Even if performance directly affects pay in your company, these should be separate conversations. That way, the employee will be more open to feedback and have time to absorb it before talking about money.

In addition, be as transparent as possible about your compensation strategy from the get-go to avoid dissatisfaction. Consider that a growing number of workers would like their employers’ salary ranges to be public. This strategy may or may not be your cup of tea, but reflecting on it is a worthy exercise to understand the culture you’d like to build.
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“One of the main reasons why companies link performance reviews to compensation is to establish a common understanding of the employee’s performance level through a review to then be able to compensate them fairly, according to the current market rate, but also their level of expertise and performance. (…)

Expecting a complete decoupling of performance reviews and compensation to achieve full transparency and honesty between people giving each other feedback might be idealistic. Power dynamics won’t go away purely based on that.”

— Marie Richter, HR consultant

Create fair & scalable compensation processes with Leapsome

While we’d recommend decoupling conversations about performance and compensation management as much as possible, we realize that different approaches suit different organizations. However, regardless of your company’s compensation strategy, you need a modern performance management system that can help you develop thorough, data-driven people processes.

Leapsome Compensation can create an ideal compensation experience for both team members and leaders. It empowers people teams to set up automated compensation processes and make fairer, more transparent pay and promotion decisions. In addition, Leapsome Reviews enables managers to run many different kinds of meaningful evaluations and link them to skills and core competencies to create a detailed roadmap for professional growth.

Leapsome can help you build effective, efficient processes for performance and compensation, no matter where you’re at.

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Frequently asked questions about performance and compensation management

What’s the importance of compensation for performance?

Compensation is a key element of great employee performance because people do their best work when they feel they’re being paid what they deserve. Fair, competitive compensation shows professionals not only that they have a valuable skill set, but also that their employer appreciates their contributions and is invested in their personal and professional success. 

Competitive compensation also nurtures great performance throughout the employee lifecycle and has a positive impact on recruitment, onboarding, and retention efforts.