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

The performance review cycle may be evolving to a more development-focused approach, but many professionals still feel uneasy when it’s time for assessments. Why is that the case, given that reviews should be productive conversations about learning, goals, and well-being?

The answer may lie in the long-established practice of linking performance to compensation. That’s why many people leaders advocate for prioritizing employee development over conversations about raises and promotions in appraisals. But that still doesn’t negate the fact that performance and compensation are intrinsically linked for most companies. Or that connecting the two can be used in a people-first way, like when Salesforce successfully tied diversity, equity, and inclusion (DEI) goals with executive compensation to hit higher diversity targets.*

It’s possible to make the connection between compensation and performance management more transparent while still following a fair “pay for performance” model that enables professionals to grow at their own pace. That’s what this article will explore, digging into 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.

* Fast Company, 2023

👀 Explore how Leapsome streamlines compensation management
Leapsome Compensation empowers organizations to build trust and increase retention with transparent, data-driven compensation decisions.
‍
👉 Take a five-minute product tour ‍‍

The purpose of performance reviews

The primary goal of performance reviews is to inspire employees to develop — and to drive this improvement, reviews must be transparent and fair. However, only 2% of CHROs believe their performance management systems achieve this, and just one in five employees report experiencing fairness during their assessments.

There’s also so much at stake for team members during performance reviews; as evaluations are often part of the criteria for compensation and promotion assessments, they tend to put people on edge. Those fears are exacerbated by the current business climate and news about companies laying off hundreds of workers following performance reviews.  

Given these challenges, it’s clear that traditional performance reviews may contribute to anxiety rather than foster growth. That’s why we advocate for continuous performance management, shifting the focus of reviews to development and growth.

An ideal performance review fosters employee self-reflection and empowers managers to connect with their reports. It also gives them a shared space to align expectations and collaborate on learning and development initiatives. 

Reviews also enable leaders to support employees while guiding them toward improving their skills; monitoring performance helps organizations identify knowledge gaps, assess hiring needs, and allocate training budgets.

“Consider traditional annual performance reviews, which are typically designed to strike fear into low performers rather than help high performers excel (which comes instead from continuous developmental coaching). Rigid goal setting and approval, mandatory training programs, detailed procedural guidelines — none of these processes accelerate your most valuable colleagues. 

(...)

Organizations need to build cultures that are obsessed with high performers, focusing the culture on keeping them and making new ones.”

‍— Lindsay McGregor and Neel Doshi for the Harvard Business Review on how culture influences performance

‍

💡 Looking for insights into conducting development-focused reviews? Check out our performance review tips for managers

The purpose of compensation plans

The purpose of pay may seem obvious, but examining its underlying goals can reveal overlooked concerns. For example, informal discussions among coworkers sometimes expose unconscious biases, unfair promotion practices, and wage gaps — all of which can contribute to a toxic workplace culture. 

Indeed, compensation serves clear purposes: paying people for their time so they can afford to live, meeting legal requirements, and attracting and retaining talent. But transparency is another culturally relevant goal of pay, with eight US states making it a legal requirement to share salary ranges for jobs, and 15 more states hoping to do the same.

HR consultant Marie Richter highlights additional compensation objectives: “eliminating financial worry for employees, showing appreciation for 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
• Insurance
• Development budgets
• Wellness benefits
• Childcare stipends or facilities

Understanding your organization’s compensation strategy and objectives is crucial to aligning them with culture. Equally important is that employees and leaders know how compensation is tied to performance at each company.
‍

Comparison of different top compensation strategies

When it comes to compensation management, there are three major strategies to consider — all of which are susceptible to economic and market disruptions:

• Leading compensation strategy — Also called a “lead-the-market” strategy, this approach involves paying employees above the accepted market rate. Companies that adopt this strategy often do so to boost recruitment, improve retention, and differentiate themselves from competitors. 

• Lagging compensation strategy — A lagging strategy means paying employees below the market rate, typically due to budget constraints. Organizations that follow this approach may offset lower pay with benefits and non-monetary rewards like extra time off or flexible working hours.
  ‍
• ‍Meeting the market — This is the most common compensation strategy, where companies pay employees at or around the market rate. It does, however, mean you’ll always be paying less than competitors that offer leading compensation, so you may have to be creative with other rewards.
  ‍

Linking compensation to performance: a case study

Let’s take a look at Salesforce, which started linking DEI (diversity, equity, and inclusion) targets to executive compensation in 2022 — just like McDonald’s, Starbucks, and Microsoft.

In this pay-for-performance model, a portion of Salesforce’s variable pay for executives at the VP level and above is determined by four ESG (environmental, social, and governance) measures — with goals like increasing the percentage of underrepresented employees. According to Mercer, 38% of companies use at least one ESG metric in their executive incentive plans; DEI is the most prevalent, included by 27% of companies.

While this is a forward-thinking compensation scheme that more companies should adopt, HR teams should also be aware of potential risks. One concern is whether organizations are setting sufficiently challenging DEI goals.

There’s also the broader issue of compensation disparity, as the CEO-to-worker pay ratio stands at over 344:1 in the United States.
‍

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 managers’ decisions to promote people and increase compensation. 

The key to making the most of performance-based compensation is to focus your reviews on development. Some benefits of this approach include:

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

Better employee recognition

Financial rewards for high performance are more than just incentives — they show your employees that their contributions impact their personal success, not just company profits. This creates a sense of shared growth and lets your people know their efforts are appreciated.
‍

More pay transparency

When salary increases, performance bonuses, and other forms of pay are tied to performance reviews, compensation becomes less arbitrary. This clarity helps employees understand what they need to do to earn more. However, achieving true pay transparency requires clear communication, well-defined competency frameworks, career paths, and policies.

Managers must foster an open environment where employees feel empowered to discuss compensation and performance, making these conversations an ongoing process. In this way, compensation and feedback become powerful tools for motivating and retaining talent.

☝️ But remember: financial rewards shouldn’t be the only focus

Investing in employee development is critical for equity and long-term success. Without equal access to development opportunities, you risk rewarding only those with more privilege, like those who can afford top professional courses. 

Investing in everyone’s development ensures all employees have a chance to reach their potential.

Salary benchmarking 🤝 fair pay decisions
‍
Leapsome’s partnership with Mercer offers access to the latest compensation data, ensuring our customers can make informed, equitable pay decisions.
‍
👉 Leverage Leapsome’s integrated benchmarking data

Lower employee stress levels 

Knowing exactly when they’ll have a chance to discuss compensation can give employees a sense of security. Without a set timeline, workers might feel anxious, not knowing when or how to bring up the subject of a raise. Defining a time for these discussions helps manage expectations and build trust in company practices — plus, it spares employees the nerve-wracking task of asking for a raise.

The stress of negotiating pay can disproportionately affect more reserved employees or those from underserved backgrounds, who might be less likely to advocate for themselves, leading to disengagement. Many people fear losing their jobs and may settle for less than equally qualified peers.

If your company decides not to tie performance and compensation management together, be clear about your remuneration model. That way, employees will know what to expect and won’t feel left in the dark. Transparency around your company’s compensation approach should be front and center during the hiring process so candidates have all the information they need to make an informed decision.
‍

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 include:

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

Binding compensation to OKRs can be problematic

Linking wages to objectives and key results (OKRs) isn’t recommended because OKRs are meant to guide organizations toward a shared vision. OKRs must be inspiring yet ambitious, so employees shouldn’t necessarily aim for 100% completion — and managers shouldn’t base compensation decisions on meeting those targets.

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 — might prevent employees from reaching their goals. Basing their compensation on factors outside of their control is unfair.

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 influencing their motivation. This might also fuel frustration and competitiveness, making company decisions unjust, especially when teams work toward the same OKRs.
‍

Self-assessments can become disingenuous

Would employees write honest self-assessments if they knew their ratings could negatively impact their income?

Even the most ethical person might find it hard to offer a candid reflection if their livelihood is at risk. Would they admit to their shortcomings or ask for guidance? Or would they, even subconsciously, overlook their areas for development?

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

For instance, an employee might rate themselves as “extremely proficient” in communication skills, while their manager might identify this as “an area for growth.” This difference in perspective provides an opportunity for dialogue. The employee may not be aware of the criteria influencing the manager’s rating or may have a different understanding of what excellent communication entails.
‍

Reviews can be biased

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

For example, employees may hesitate to give honest feedback in a 360° review if they know that salary raises and promotions are limited within their department. Alternatively, they may give an overly positive review to boost a colleague’s chances of receiving a raise or promotion, even when performance hasn’t warranted it.

Similarly, would employees provide genuine feedback for their managers, or would they avoid constructive criticism to protect themselves from potential consequences during their own performance appraisals?

More insidiously, race, gender, age, affinity biases, and other unconscious biases continue to influence performance reviews. These biases can exacerbate systemic wage gaps — for example, women often earn less than men, and BIPOC women are paid even less.

It’s uncomfortable to acknowledge these dynamics within our organizations, but ignoring them won’t help our cultures thrive. Addressing these interpersonal and systemic issues is essential for building fairer workplaces.
‍

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 compiled four strategies to effectively connect performance management with your organization’s compensation strategy.
‍

1. Make development the focal point of performance management

Tracking an employee’s performance is crucial, but if it becomes the central focus of compensation management, appraisals may become accusatory and encourage disingenuous self-assessments.

However, if you shift the focus of performance reviews to employee development, you demonstrate that your organization is invested in their growth. This helps make reviews about:

• Strengths 
• Areas for development
• Training gaps 
• Performance objectives
• Adjusting responsibilities 
• Reducing work-related stress

This all paves the way for creating a healthier work environment.

"After a performance review, there could be a salary increase (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

Discussing compensation during a performance appraisal can distract the employee from the actual development feedback. To reduce anxiety, hold a separate 1:1 meeting dedicated solely to compensation.

“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.
‍

3. Run consistent initiatives to break down biases in the workplace 

Reviews inherently involve judgment, which means they can be prone to bias. 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.”

That’s why it’s crucial to regularly assess your performance management cycle to help uncover and break down biases and engage in bias reduction exercises to ensure fair evaluations.

Another way to reduce bias is to involve more stakeholders in the review process. “There should be two or more additional parties that check the review and the ‘performance rating,’ ensuring that the justification matches the rating and that the manager isn’t exerting unnecessary pressure or bias on the employee,” Fountain suggests.

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

4. Create transparent & streamlined processes

HR professionals and leaders must define clear performance review criteria along with promotion and compensation processes. Thankfully, compensation software can automate these workflows, making them more data-informed.

‍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 attract and keep great talent.

‍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 influences pay in your organization, these conversations should be separate. This allows employees to process feedback before discussing compensation.

In addition, be as transparent as possible about your compensation strategy from the get-go to avoid dissatisfaction. A growing number of workers want salary ranges to be public, and while this approach may not suit every organization, reflecting on it can help you align your pay practices with your desired company culture.
‍

“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 recommend separating conversations about performance and compensation management as much as possible, we understand that different approaches work for different organizations. Regardless of your compensation strategy, you need a modern performance management system that supports thorough, data-driven people processes.

Leapsome Compensation helps create a seamless compensation experience for team members and leaders. It empowers HR teams to automate compensation processes and make fairer, more transparent pay and promotion decisions. In addition, Leapsome Reviews enables managers to run meaningful evaluations tied to skills and core competencies, creating a clear roadmap for professional growth.

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

🚀 Let Leapsome transform your compensation and performance management   

Our holistic platform lets companies customize, automate, and scale their processes with ease.

👉 Book a demo

Frequently asked questions about performance and compensation management

What’s the importance of compensation for performance?

Compensation plays a key role in employee performance because people perform best when they feel they’re being fairly paid. Competitive compensation validates their skills and contributions and shows that their employer values their personal and professional success.

Fair compensation also nurtures performance throughout the employee lifecycle and positively impacts recruitment, onboarding, and retention efforts.