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Chapter 4: Human Resource Management
Link Employee Performance and Compensation to Agency Performance
Summary
Many private companies as well as state and federal agencies have adopted pay-for-performance (PFP) compensation systems. PFP systems are designed to increase productivity by recognizing the best performers and compensating them accordingly. PFP furthers performance-based management by linking the goals of the organization to those of the individual, whose role is to contribute to the defined performance objectives. Through PFP planning, individuals participate cooperatively with the organization to design performance objectives and define mutually beneficial outcomes.
Background
The term “pay for performance” (PFP) is closely associated with theories designed to make organizations more competitive by linking pay directly to output. Analysts use the term to designate systems that make a large portion of a worker’s annual compensation partly or entirely contingent on the firm’s overall economic performance.[1] In a broader sense, PFP systems provide incentives to employees for performance that furthers the organization’s success.
Under performance-based pay plans, employees and their supervisors are required to mutually define and agree on measurable job performance objectives tied to advancing the organization’s broader goals and mission. Employees are evaluated on how effectively they accomplish these predetermined objectives. Higher performance serves as the basis for higher compensation.
More than 70 percent of America’s private companies have implemented practices for monetarily rewarding employees based on performance. Among those companies, 89 percent with strongly defined PFP plans and effectively communicated performance goals have reported boosts in performance results.[2] Among Fortune 1000 companies using at least one PFP practice, 60 percent report that the practices increased productivity, and 70 percent report improvements in service quality.[3]
The 1999 Texas Performance Review report Challenging the Status Quo recommended linking state employee pay to job performance. The report recommended that the state provide merit increases solely to employees who meet specific performance standards. State law limits agency pay raises for merit and promotions to no more than 1.7 percent of each agency’s prior-year salary expenditures.[4]
The Legislature did not address performance pay in the 1999 session. State agencies continue to wrestle with at least two pressing concerns related to employee compensation—the loss of competent, seasoned employees to higher-paying private jobs, and the widening gap between public and private pay in a booming Texas economy.
State Pay Issues
Texas government salaries are not keeping pace with those offered by private companies. In 1999, state workers in Central Texas averaged $616 per week as opposed to private sector workers, who averaged $792 per week.[5] To maintain the level of service the public expects, the state needs to attract, develop and retain quality employees. Moreover, as of August 2000, the unemployment rate in the Austin-San Marcos Metropolitan Statistical Area (MSA) was 2.1 percent, making competition for all workers extremely competitive in the capital city.[6]
It is difficult to quantify exactly how many state employees are lured from government by the attraction of more money and greater opportunity in the private sector, but turnover trends (that is, the percentage of employees leaving their jobs each year) provide some indication. In fiscal 1999, at a time when the median national turnover rate was 14.9 percent annually, Texas state employee turnover was 17.6 percent. In that year, turnover among state employees cost the state between $127 and $254 million, according to a “conservative” SAO estimate.[7] Such turnover costs include but are not limited to, recruiting, training and costs associated with lost productivity. Turnover rates in fiscal 1999 at 15 state agencies exceeded 30 percent among agencies with 20 or more employees. Generally, the lower state employees’ salaries are, the more likely they are to leave state government.[8]
The US Department of Labor estimates that replacing an employee costs the equivalent of one-third of a new hire’s salary. Hay Management consultants puts the figure at 50 percent, and Hewitt Associates estimates the cost at 150 percent of an employee’s annual salary.[9]
State law divides classified state employment into three categories: “Salary Schedule A” primarily involves administrative positions; “Salary Schedule B” includes professional and paraprofessional occupations; and “Salary Schedule C” primarily involves occupations in the state law enforcement and corrections system. Another SAO report offers significant findings indicating that agencies have not taken full advantage of the salary ranges with Salary Schedules A and B:
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Texas is second in population behind California, but its state workers’ pay ranks last among the ten most populous states, or $7,656 lower than the average salary of $37,485 in the nine other most populous states.[10]
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Of 139,525 Schedule A and B employees, 69 percent are being paid below the midpoint in their salary ranges.
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Of 57,915 employees under Salary Schedule B, 74 percent are paid below the midpoint of their salary grades, with 55 percent of them falling at or below the first quartile.
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36 percent of employees under Salary Schedule A are at the bottom step of their salary range, possibly accounting for the higher levels of turnover for the lower pay grades.
Since fiscal 1992, Texas state agencies have been able to hire employees at salaries above the first step. The Legislature has added further compensation flexibility for agencies. Agencies now may award merit raises up to the maximum level within the appropriate salary range, and may grant increases every six months.[11]
Despite these new increases in compensation flexibility, the majority of employees receive salaries lower than half of the maximum allotted by the Legislature, and less than their counterparts in the other most populous states. The issue of pay equity surfaced yet again in recent reports issued by the State Auditor’s Office.[12] During the 1990s, average salaries increased by 115 percent overall in Travis County, the region containing the greatest number of state workers. Per capita income across Texas increased by 58 percent. But during this same period, state workers saw their pay increase by only 28 percent. Texas state government salaries would need to rise by 26 percent to reach the average in the other nine most populous states.[13]
PFP Benefits
In the private sector, organizations using PFP systems may enjoy several distinct advantages over competitors, including higher revenues, cost containment, and a marked improvement in professional and individual competencies.
PFP systems provide organizations and their employees:
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Strong emphasis on priorities,
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Greater awareness of performance difficulties before they reach crisis proportions,
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Opportunities to correct performance problems before they hurt financial performance, and
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Rewards for high performing executives and managers.
PFP systems in the private sector often include features such as:
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Annual incentive plans that reward participants in direct relation to their contributions to the organization and their individual performance,
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Incentive pay scaled according to impact on successes at the corporate, unit, and individual level, and
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Opportunities for managers to measure their own performance.[14]
Performance Appraisals
Most performance appraisals occur after the fact, either at the end of the year or on an employment anniversary date. Managers generally sit down with their employees in an effort to reconstruct the events of the past year, note what each accomplished, and decide whether or not to give each employee a pay increase.[15] Research conducted among private firms indicates that the average manager spends between four and six hours per employee on annual appraisals.[16]
The performance review process can be unpleasant for managers and employees alike; workers often take issue with their appraisals, sometimes in a vocal way. A PFP plan worked out in advance, in consultation with employees, can help prevent situations that impede productive working relationships.
Gainsharing
Another concept commonly used in conjunction with PFP systems is “gainsharing,” a system of rewarding employee groups from the savings that result from higher productivity. Gainsharing bonuses are tied to qualitative measures of performance and are paid only as earned; they do not become part of an employee’s base salary. Instead, they are used to reinforce productivity, and are shared by the teams who made them possible.
Gainsharing fosters enhanced group cooperation, more innovation and more effort, improved labor-management relations, higher acceptance of newer technologies, worker demands for better, more efficient management, and higher overall productivity. Ultimately, gainsharing programs help companies by communicating a shared vision of performance among management and labor.[17]
Performance-Based Management in the Federal Government
Early development of federal performance management systems began with three separate pilot programs. In 1980, the US Navy created the “China Lake” project, a pilot program under the direction of the Office of Personnel Management. It was made permanent in 1994 and covered 5,000 employees involved in two research fields. In 1988, the National Institutes of Standards and Technology established another program covering 3,000 employees at facilities in Colorado and Maryland. A third study, conducted from 1988 to 1993, focused on the Pacer Share program of the Sacramento Air Logistics Center and McClellan Air Force Base in California. This program took a more radical approach, eliminating individual performance evaluations and replacing them with a focus on organizational performance.
All three pilots adopted “broadbanding,” collapsing the federal pay grade system from 18 levels to five. The federal government allocated funding to allow high performers to receive raises of up to 10 percent.
The pilots identified a number of common critical factors to PFP:
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Significant rewards should be given and tied to performance.
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Employees should understand how and why rewards are given.
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Supervisors must be willing to explain and support the reward system in discussions with employees.
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Rewards can vary widely, contingent upon performance.
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Performance must be measured objectively and inclusively.
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Supervisory training in PFP systems is essential.
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Cost control factors should be built into the design of merit pay systems.[18]
Congress began efforts to institute performance-based management throughout the federal government with the Government Performance and Results Act of 1993 (GPRA), which gives federal agencies the flexibility to waive limitations on compensation or award raises in return for individual or organizational accountability for the achievement of concrete performance goals.[19]
The US General Accounting Office (GAO) has stated that “human capital” represents one of the most critical factors in ensuring effective performance. Under this philosophy, people are viewed as assets whose value to an organization can be enhanced through investment. As such, the organization’s goal is to invest in its people to increase performance, thereby benefiting customers and stakeholders, as well as managing costs and risks. GPRA requires that federal agencies incorporate human capital management into their annual strategic plans.[20]
To better implement GPRA, Congressional committees held hearings to identify how performance-based management works in the private sector. GAO reviewed nine private organizations recognized for innovation and efficacy in strategic management, including Federal Express, IBM, Marriott International, Merck and Company, Inc., Motorola, Sears Roebuck, Southwest Airlines, Weyerhaeuser Company, and Xerox’s Document Solutions Group.
The GAO study encouraged managers to:
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Recognize the integral value of employees and their contributions to strategic management,
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Obtain outside expert help when needed,
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Hire, develop, and sustain leaders according to leadership characteristics that mirror the organization’s goals,
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Let employees know that their collective contributions to the organization’s goals are valued,
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Hire, develop, and retain employees with the right skills and pay them fairly, based upon their performance for individual initiatives as well as teamwork.
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Listen to employees and use their ideas, and
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Measure the effectiveness of human capital policies and practices.[21]
At present, however, the federal government appears to be a long way from perfecting its PFP systems. In early 2000, US Comptroller General David Walker told a Senate Governmental Affairs subcommittee that the federal government’s present human capital plan is ineffectual, and possibly one of the worst managerial problems facing the federal government.[22] Among federal employees surveyed in 1999, only 31 percent agreed that recognition and rewards are based on merit, and only 26 percent said their agencies clearly define what is expected under the term “good performance.”[23]
PFP in Colorado
Colorado initially adopted a PFP plan entitled “Colorado Peak Performance” (CPP) in 1996. CPP was intended to be phased in over three years. By summer 1999, however, legislative concerns about cost and perceptions of unfairness had derailed the project. Consequently, in 2000, the legislature repealed the statutory language that created the program and required the state’s Department of Personnel to develop a new PFP plan by September 1, 2000, stipulating that the new plan must be simple, understandable, and cost-neutral. The department was to develop the new plan with input from employees, managers, and other stakeholders, and provide uniform guidelines for all state agencies emphasizing the need for effective planning, management, and evaluation.[24]
The new legislation restored statutory language that had existed prior to 1996 authorizing the state director of Personnel to establish a system to provide for periodic salary increases based on performance quality, withhold raises for unsatisfactory performance, and give incentive awards for “above standard or outstanding” performance.
In designing the new plan, the Department of Personnel solicited input through employee and stakeholder surveys. The agency placed the proposed plan on the Internet and received comments from 160 stakeholders. The final plan was posted on the Internet as well. The department also held seminars and town meetings to familiarize people with the plan.
Some noteworthy features of the new Colorado plan include its limit on evaluation categories to four, one being the lowest and four representing excellence. If employees receive the lowest rating, the program calls for remedial action. The plan has several official oversight mechanisms to ensure quality and equity in its administration, as well as training and communication components designed to address employee concerns that their managers lack skills in planning, coaching, and evaluation. The plan also provides dispute resolution tools, and ended all connection between salaries and longevity after June 2000. The program is scheduled for a five-year implementation period.
Pay for Performance in Texas
In considering PFP, it is important to note that Texas state government has no civil service program and, unlike many other governments, does not offer seniority-based or cost-of-living pay raises. Many states have strong collective bargaining issues related to compensation and human resources, but Texas has more flexibility to adopt innovative human resources policies.
Texas is also unusual in that it has no single, central Office of Human Resources or State Personnel Office; instead, state executive agencies administer their own personnel offices. These separate personnel offices are able to operate with a fair degree of flexibility, within the framework of statutes addressing issues such as compensation and staffing. The 1991 Legislature passed a “Strategic Budgeting” law requiring statewide implementation of strategic planning, covering all state agencies over a five-year period. In 1993, the Legislature added requirements for the use of strategic planning requirements, including goals, objectives, and strategies for state budgeting, creating the performance budgeting system currently used in Texas. Performance reporting is included in these requirements, along with performance rewards and penalties to encourage the achievement and maintenance of performance goals.
In addition, Article IX of the General Appropriations Act sets performance targets for agencies based upon their previous performance history. When these goals are met, agencies can communicate the specifics of their achievement to the Senate Finance Committee, House Committee on Appropriations, Legislative Budget Board, and the Governor’s Office of Budget and Planning. Agencies attaining high performance measures then may award lump sums to employees who contributed to their success.[25]
The State Employee Incentive Program (SEIP), administered by Texas Incentive and Productivity Commission, is another program recognizing state employees for their organizational contributions. SEIP, designed to foster higher performance, greater creativity, and savings for the state, rewards employees for suggestions that save money, generate revenue, or enhance state programs.
PFP at the Comptroller’s Office
The Comptroller’s office has begun establishing its own PFP system. The Comptroller’s Revenue Processing Division’s Production Enhancement Program was the first example of such a system. It offers bonuses to remittance and data entry workers who exceed keystroke and accuracy targets. The program has increased productivity, lowered turnover, and improved job attendance.
To further the objectives of the state’s merit pay system, the Comptroller’s office also has drafted a new Employee Performance Plan containing a “Performance Standards Checklist” that must be completed by the employee’s immediate supervisor. The checklist incorporates output measures and key performance indicators, and allows supervisors to submit comments regarding the quality of the employee’s performance. The evaluation also offers employees the option of dispute resolution if needed. Finally, the review form includes definitions of the performance standards that must be met to achieve the agency’s responsibilities.
Recommendations
A. State law should be amended to require state agencies to adopt policies to ensure that individual performance expectations are linked to goals in agency strategic plans.
Clear connections between agency strategic plans and individual performance expectations will make it feasible to provide suitable rewards to employees based on performance. Allowing agencies to adopt customized performance pay policies suitable to their own organizational cultures and types of employees should engender the creativity and innovation that leads to improved agency performance.
B. A task force should be created to evaluate, compare, and contrast the benefits of the state’s current merit system with a pay-for-performance system of compensation.
The task force should include representatives of small, medium-sized, and large state agencies and should represent the Governor’s office, the State Auditor’s Office, the Comptroller’s office, and the Legislative Budget Board. The task force should:
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Evaluate the strengths and weaknesses of the current merit system.
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Identify statewide opportunities for funding pay-for-performance policies and practices to supplement current efforts at recruiting and retaining
employees.
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Provide recommendations to the Legislature prior to the 2003 legislative
session.
Fiscal Impact
These recommendations could be implemented without any direct impact on state finances.
Endnotes
[1] National Research Council, Pay for Performance: Evaluating Performance Appraisal and Merit Pay, edited by George T. Milkovich and Alexandra K. Wigdor (Washington, DC: National Academy Press, 1991), p. 8.
[2] Institute of Management and Administration, Pay For Performance Report, March 1999, citing Hewitt Associates (http://www.lexis.com/research/retrieve?_m+f54dc3100efda411f006c97eba39&docnum=88&). (Internet document.)
[3] Jeffrey Kling, “High Performance Work Systems and Firm Performance,” Monthly Labor Review (May 1995), p. 29.
[4] Texas H.B. 1, 75th Leg., Reg. Sess., p. IX-38 (1997).
[5] Bahadur, Gaiutra, “Region’s Public Sector Can’t Keep Up with Hi-Tech Pay of ‘New Economy,’ ”Austin American Statesman, June 24, 2000, pp. A-1, A12.
[6] Texas Workforce Commission, “Record-Low Unemployment Continues Despite Slight Rise,” September 14, 2000 (http://www.twc.state.tx.us/news/press/091400epress.html). (Internet document.)
[7] State Auditor’s Office, Report Number 00-707: An Annual Report on Full-Time Classified State Employee Turnover for Fiscal 1999 (Austin, Texas, March 2000), p. 1.
[8] State Auditor’s Office, Report Number 00-707: An Annual Report on Full-Time Classified State Employee Turnover for Fiscal 1999, (Austin, Texas, March 2000), pp. 9-10.
[9] State Auditor’s Office, Report Number 00-707: An Annual Report on Full-Time Classified State Employee Turnover for Fiscal 1999 (Austin, Texas, March 2000), p. 3.
[10] State Auditor’s Office, Report No. 01-701: A Biennial Report on Recommended Adjustments to the Classification Salary Schedules (Austin, Texas, October 2000), p. 10.
[11] State Auditor’s Office, Report No. 01-702: A Biennial Report on Recommended Changes to the Classification Salary Schedules (Austin, Texas, October 2000), pp. 4-5.
[12] State Auditor’s Office, Report No. 01-701: A Biennial Report on Recommended Adjustments to the Classification Salary Schedules, and Report No. 01-702: A Biennial Report on Recommended Changes to the Classification Salary Schedules (Austin, Texas, October 2000).
[13] State Auditor’s Office, Report No. 01-701: A Biennial Report on Recommended Adjustments to the Classification Salary Schedules (Austin, Texas, October 2000), p. 9.
[14] Bratton Consulting, Inc., “Enhancing Corporate Success by Linking Pay to Performance,” by David A. Bratton, Indianapolis, Indiana, April 1997 (http://www.bratton.on.ca/pay.html). (Internet document.)
[15] Bratton Consulting, Inc., “Enhancing Corporate Success by Linking Pay to Performance,” by David A. Bratton (Indianapolis, Indiana, April 1997) (http://www.bratton.on.ca/pay.html). (Internet document.)
[16] National Research Council, Pay for Performance: Evaluating Performance Appraisal and Merit Pay (Washington, D.C: National Academy Press, 1991), p. 105.
[17] National Research Council, Pay for Performance: Evaluating Performance Appraisal and Merit Pay, pp. 86-87.
[18] Risher, Fay, and Associates, New Strategies for Public Pay (Jossey-Bass Inc.: San Francisco, California, 1997), pp. 254-270.
[19] USC Title 31, Chapter 97, §9703.
[20] US General Accounting Office, Report to Congressional Requesters: Human Capital—Key Principles from Nine Private Sector Organizations (Washington, DC, January 2000), p. 4.
[21] US General Accounting Office, Report to Congressional Requesters: Human Capital—Key Principles from Nine Private Sector Organizations, pp. 2-4.
[22] Katy Saldarini, “Federal Agencies Neglect Workforce Planning, Officials Say,” Govexec.com (March 10, 2000) (http://www.govexec.com/dailyfed/0300/031000k1.htm). (Internet document.)
[23] Brian Friel, “Agencies Stop Tying Bonuses to Annual Appraisals,” May 12, 2000 (http://www.govexec.com/dailyfed/0500/051200b1.htm). (Internet document.)
[24] State of Colorado, “Senate Bill 00-211 Summary” (http://www.state.co.us/gov_dir/gss/hr/perfmgmt/sb211_summary.htm). (Internet document.)
[25] Texas Comptroller of Public Accounts, Challenging the Status Quo: Toward Smaller, Smarter Government (Austin, Texas, 1999), Volume II, p. 322.
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