Performance-related pay

PRP is a way of managing pay. It does this by linking salary progression to an assessment of individual performance. Individual performance. Individual performance is usually measured against pre-agreed objectives. It's also known as individual PRP or merit pay. PRP increases are normally consolidated into basic pay, although sometimes these increases may involve the payment of non-consolidated cash lump sums - see more in our pay progression factsheet.

PRP objectives may be grouped under three main headings.

1. Encouraging higher performance by linking performance to pay

Here the idea is to motivate staff by linking their salary to their work performance. If pay incentivises them to hit their targets, then the organisation's overall performance should improve. While the CIPD report Incentives and Recognition: An evidence review finds financial incentives have a positive effect on employee motivation and consequently performance, the research often does not compare PRP with non-consolidated financial rewards, such as incentives. So, we can’t say if the PRP approach is better than using bonuses. The appropriateness of using PRP or paying bonuses or possibly both, will depend on the organisational context.

2. Embedding an entrepreneurial or high-performance culture across an organisation

PRP can send a message to workers about what achievements the organisation requires and will reward for, although there are other (non-monetary) ways of doing this. 

3. The notion of equity or fairness

Staff like the idea of having  their efforts rewarded and recognised. They also like the idea that higher performing employees get a bigger pay rise than lower performing colleagues. CIPD members can see our Employee outlook Winter 2016-17: focus on employee pay and pensions survey, which found that private sector workers are more likely to want their pay to reflect their performance. 

When it comes to financial recognition, our report Incentives and Recognition: An evidence review finds strong evidence that fairness is an important factor in the success of using financial incentives. This is the case for distributive justice: if employees feel this allocation is fair, then the incentive does more to motivate them. It is also the case for procedural justice: incentives are more effective if the procedures and how managers apply them are seen as fair. Of course, this then raises the question of what’s meant by fair, something touched on in our report Incentives and recognition: an evidence review. Practice summary and recommendations.

PRP often uses a system based on consolidated pay progression within pay brackets attached to each grade, level, band or zone.

However, to reward performance requires an effective means of measuring that performance. Historically, this has been via performance appraisal. Currently, some employers are starting to use less formal approaches to appraise success.

Linking pay with performance

In traditional performance reviews, each employee’s performance is typically ranked on a scale. For example, ranging from ‘unsatisfactory’ to ‘superior’ (sometimes using ‘forced’ distributions). Some systems allow for managers' discretion in translating these scores into levels of pay rise.

Others determine increases through a formula or a matrix system linking each grade, level, or zone to each of the performance categories. This method may involve the use of a comparison ratio, or ‘compa ratio’. This is the term given to the relationship between each employee’s current salary and the mid-point of their grade. So, for a worker at the mid-point of their pay range, the compa ratio is 100%.

Given the presumed existence of a learning curve for new entrants to a grade, it’s often felt appropriate for pay rises associated with each performance category to be higher for employees at lower points within the pay brackets. However, more senior employees who’re performing highly may resent the award of comparatively low percentage pay rises.

Incentives and recognition: an evidence review shows that where ratings are used to gauge performance and allocate incentives, the rating method used makes a difference. If an employer uses a greater number of categories to rate contribution, then employees are more likely to feel that it’s fair. 

When it comes to using objective and subjective measures of employee performance the picture is more nuanced. Although subjective measures are generally seen as potentially prone to bias because they involve an element of judgement, research suggests that not including them may be detrimental and cause employees to perceive the rating process as unfair. However, performance evaluation that puts a lot of weight on subjective measures is also considered unfair by staff. This suggests a balance between objective and subjective assessments will be more effective than an overreliance on one or the other.

Who gets performance-related pay?

While various estimates of the coverage of PRP exist, partly because of differing definitions of PRP, we’ve identified the following broad themes and trends:

• In the private sector, individual PRP is widespread. In some parts of the private sector, it is ‘the norm’, such as financial services.

• In the public sector, most employers give a basic percentage increase. Only a small proportion include a performance-related element, typically for senior staff.

• PRP usually covers managerial and other white-collar staff. Few employers extend coverage to manual or lower-grade workers.

• PRP varies internationally. For example, employers in France make greater use of merit pay than occurs in Great Britain. 

Measuring trends in merit awards

Under PRP arrangements, the pay review process may provide for either:

• pay progression based entirely on individual performance ratings (known as ‘all-merit’ awards), or
• a general pay rise plus an increase linked to individual performance (‘basic-plus-merit’ awards).

Trends in PRP are commonly measured via the pay review budget (or pay bill budget) allocated for the merit element of awards. However, the scope for any merit element of pay tends to be smaller during times of low pay award levels. For example, instead of attempting a distribution based on merit, some employers decided it would be simpler to award a modest across-the-board increase during the first year of the COVID-19 pandemic.

For PRP to succeed, effective arrangements must be in place to define, measure, appraise and manage performance. The focus should be on encouraging high performance first, underpinned by effective performance management systems.

Only then should the focus be on pay as a reward to help achieve that goal. To create a sustainable high-performing workplace, the whole range of financial and non-financial rewards must be carefully designed to ensure that they support and are supported by PRP.

The key issues for employers implementing PRP include:

Line managers' objectivity and consistency

Line managers are key to effective implementation of PRP. They should be involved at an early stage in designing systems to ensure consistency and transparency when assessing achievement. Some schemes use ‘forced distribution’ arrangements. These aim to remove marking differences between ‘hard’ and ‘soft’ managers. Such approaches require that all managers band a certain proportion of staff in each performance pay grouping (for example, 10% ‘poor’ and 10% ‘superior’).

Research evidence reported in Incentives and recognition: an evidence review suggests there is no difference between:

• competitive schemes, in which only the highest performers are rewarded, and
• non-competitive schemes, where all employees whose performance increased receive an incentive.

However, given the importance of perceived fairness, highly competitive schemes that are seen as ‘winner takes all’ may well demotivate people. In a similar way, our performance management evidence review found that the use of competitive ‘forced ranking’ in staff appraisal tends to backfire, due to perceived unfairness. On balance, it seems forced distribution can be used to an extent, but there may be little point in condensing rewards in highly competitive systems, as this approach is no more effective than more equitable rewards and risks backlash.

Ensuring objectivity is also important to avoid rewarding favourites. The potential for unlawful discrimination is particularly serious. It’s important that line management training highlights the impact that unconscious bias can have on pay decisions. Employers should also review merit pay award decisions by gender, ethnicity, age and so on.

See more in our line managers' role factsheet. 

Distributing pay awards

Pay isn’t the only motivating factor, and sometimes might not even be the most important one. And the performance element of pay is often relatively small, particularly for those relatively middling performers forming the bulk of the workforce. The problem is accentuated in times of low inflation when the pay bill increase is usually limited to relatively small percentage figures. Even where PRP may have a motivational impact for high achievers, the corollary can be the demotivation of the lower or middle level performers. So, it’s important to consider the issue of pay award distribution carefully.

Identifying development needs

A major concern is that linking pay awards to the performance review process might inhibit an open and honest discussion of an individual’s developmental needs in case this influences the size of their pay rise. One option is to split the pay review aspect of performance assessment from the broader performance/development review, for instance by holding separate meetings months apart.

Communication can also suffer as employees may feel constrained about having open conversations with their line managers in case this influences the size of their pay rise.

Time-consuming nature

The processes associated with PRP, such as performance reviews, can be time-consuming. In general, it's important to allow enough time away from day-to-day duties for managers and staff to be able to engage fully in the PRP process.

Undesired impacts on employee behaviour

While financial incentives can increase worker performance, behavioural science indicates that if they are leveraged too strongly, incentives may create excessive risk. As a result, they may either:

• distort people’s motivations by incentivising unintended or excessive behaviour, or
• weaken the motivating effect if people feel averse to the added risk.

Rather, the size of incentives should be commensurate with what employees can do to increase their performance. Research (Incentives and recognition: an evidence review) indicates that linking pay to both individual and team achievements may be better than focusing on one or the other. See our report Show me the money! for more on what behavioural science says about how employees might respond to financial rewards and incentives.

Books and reports

Cotton, C., Gifford, J. and Young, J. (2022) Incentives and recognition: an evidence review. Practice summary and recommendations. London: Chartered Institute of Personnel and Development.

Armstrong, M. (2023) Armstrong's handbook of performance management: an evidence-based guide to delivering high performance. 7th ed. London: Kogan Page.

High Pay Centre. (2015) No routine riches: reforms to performance-related pay. London: HPC.

Marsden, D. (2009) The paradox of performance related pay systems: why do we keep adopting them in the face of evidence that they fail to motivate? CEP Discussion Paper, 946. London: London School of Economics, Centre for Economic Performance.

Perkins, S.J. and White, G. (2020) Reward management: alternatives, consequences and contexts. 4th ed. London: Chartered Institute of Personnel and Development.

Visit the CIPD and Kogan Page Bookshop to see all our priced publications currently in print.

Journal articles

Bryson, A., Forth, J. and Stokes, L. (2017) How much performance pay is there in the public sector and what are its effects? Human Resource Management Journal. Vol 27, No 4, November. pp581-597.

Cotton, C. (2018) Is time up for performance-related pay? CIPD Voice. Issue 13, 26 February.

Hunt, B.G. (2018) Pay for performance: six takeaways to shape a better outcome. Workspan. Vol 61, No 6, June/July. pp52-55.

Shaw, J.D. and Gupta, N. (2015) Let the evidence speak again! Financial incentives are more effective than we thought. Human Resource Management Journal. Vol 25, No 3, July. pp281-293

CIPD members can use our online journals to find articles from over 300 journal titles relevant to HR.

Members and People Management subscribers can see articles on the People Management website.