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What is Performance-Based Compensation?

By G. Wiesen
Updated May 16, 2024
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Performance-based compensation is a type of compensation or payment made to employees within a company based on their performance and the achievement of specific goals. This type of compensation can be utilized for employees at any level, from newly hired staff to established management, and can be more reliable than other systems of compensation for inspiring hard work in employees. By rewarding results and efforts, rather than simply assigning payment based on seniority or time, employees are encouraged to produce results and benefit a company. Performance-based compensation can be used at just about any type of business, from retail stores to law firms, and has proven successful in numerous environments.

The basic idea behind performance-based compensation is that employees working for a company receive rewards based on their actual performance and the achievement of goals. Some businesses use a model that rewards employees merely for loyalty to the company, providing compensation in the form of annual salary raises. While this can certainly help ensure employee loyalty, it can also deter an employee from going beyond the call of duty, since doing so nets no real reward. This type of compensation can also create a work environment where someone who has worked at a company for a relatively long time is making far more than someone else doing the same job who has simply not worked at a company as long.

A new employee who can do the same job as someone who has been doing it for 10 years can therefore become more valuable to the company. A performance-based compensation strategy, on the other hand, gives financial rewards to those who meet sales goals or otherwise accomplish real goals for a business. The value of employees in this type of business is established through work and accomplishment, rather than merely through seniority. By using performance-based compensation, employees are encouraged to try hard and meet goals in order to receive not only praise but real compensation.

Another benefit of a performance-based compensation strategy in the workplace is that it can be applied to just about any type of business. At a law firm, for example, bonuses may be paid to employees or partners who get new clients and who can show that their total billing hours were higher than other partners. In a retail store, similar bonuses or pay raises might be awarded to salespeople who regularly hit sales goals and demonstrate real improvements in performance. This type of system can be quite simple to implement, and by establishing specific goals, performance-based compensation can disregard concerns about subjective managerial opinions or potential employee conflicts.

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Discussion Comments

By fBoyle — On Mar 12, 2014

@ddljohn-- I can't really think of disadvantages. I suppose performance based compensation increases competition at the workplace. I don't think that this is a bad thing though, because it will make employees strive to do better. But it could increase employee tension and stress.

If performance based compensation is given as a bonus compensation, I think the tension between employees can be reduced. What I mean by this is that each employee receives a baseline paycheck for their work. Employees that excel in their position and perform even better will be given the bonus compensation.

This way, other employees won't feel like they are punished and they won't stress out too much. At the same time, there will be an incentive for employees to do even better.

By ddljohn — On Mar 11, 2014

@fBoyle-- Aren't there any disadvantages to performance based compensation? If it was so great, then it would be utilized more frequently.

By fBoyle — On Mar 11, 2014

I agree that performance based compensation is the fairest compensation system. It can also be used as a performance management tool, because it's an incentive pay and rewards performance. Incentives are more important than we realize, it can motivate employees much better than other techniques. I think more workplaces and organizations need to adapt this system. It's not being utilized as much as it should be.

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