In this millennium, more than ever, businesses have a critical mission to distinguish top performers and retain key talent through incentive rewards. Forced-ranking systems have been in existence for decades, typically aligning people in preset “buckets” of performance that is constrained by a percentage, forcing managers to rank employees from best to worst; but do these systems work?
The Equity Theory offers insights on impacts of these systems and perceptions of social justice or the fairness of the resulting social exchange and impact to individual performance. According to J. Stacy Adams (1965), how hard a person is willing to work, is partially determined by their perception of how fair or just his/her comparison to others is (as cited by PSU, n.d., screen 6).
Case of Overpayment/Underpayment as a result of a “Forced Ranking” performance system.
This case offers insights of Overpayment and Underpayment inequities experienced by employees of one of the largest Insurance companies in the world, who after falling into hard financial times, had to implement a “Pay for Performance” program aimed at increasing competition amongst employees for top compensation thus increasing work output through higher performance.
Changes to the company’s compensation program included:
- Freeze to base compensation (unless dictated by regulatory company in country)
- Introduction of target incentive compensation based on the employee’s grade level that could be improved or reduced based on performance of the individual and the company:
- 1 - Outstanding performance = 130% of Target
- 2 - Excellent performance = 110% of Target
- 3 - Meets expectations = 100% of target
- 4 - Below expectations = 80% of target or less
- 5 - Unacceptable performance = No incentive compensation
- Limitations on how many employees can be included in each category were:
- Performance of 1 – 10% of the population
- Performance of 2 - 20% of the population
- Performance of 3 – 50% of the population
- Performance of 4 – 5 – 20% of the population
- Manager and subordinate agree on 3 – 5 goals at the beginning of the year
- Manager and employee meet midyear to review progress against goals , re-align goals if appropriate
- Year End preliminary review by the manager and assignment of performance rating based on goal outcomes
- Final rating assigned through verbal roundtables force ranking lobbyist (typically, managers of employees if their level was no more than 5 from the Chairman) who:
- Compare the performance of employees against other in a peer group
- Forced ranked employees based on perceived contributions, work output and impact to meet the distribution curve allowed for each rating
- Managers lobby for their staff and were compelled to lower or improve employee rankings based on group consensus of what other managers would communicate about the employee performance and how others in the group felt that employee ranked against all others in the group.
- As a result, managers often had ratings at year-end inconsistent with those in the mid-year review and had to explain to employees that the change was due to other performers outside their circle of influence, control, goals and quota availability.
- The vast majority of employees (those rated 3 – 5) felt unfairly represented and underpaid, some employees received fair compensation based on performance and forced ranking outcomes, several on the top 30% received overpayments due to better lobbyist managers or higher ranking manager who influenced the roundtable process.
The large insurer used the Forced Ranking performance system for over five years; three years in, it was apparent to all leaders that the organization’s overall performance had started to decline. Sales suffered, customer service opportunities for new business ceased, new hires were enthusiastic the first year of their employment but experienced sharp decline in their second year.
In three separate employee surveys, the insurance company could see evidence that rumors of unfair performance assessments had in fact affected employee’s motivation to work as a team to achieve better results. The system was viewed as inequitable; the comparison system was inconsistent due to the varying objectives of the employees being compared. The goals set for employees were constrained by their roles and departmental circumstances. The comparison pool had to be at least 25 in order to achieve the desired curve of % performers in each category. This led to including employees who were in totally different roles and had a variety of challenges that may or may not be offered to all the employees in the pool.
Under these circumstances, the survey revealed overpayment inequity of 50/75 ratio because many employees contributing the same inputs may be receiving 25% more compensation (PSU, n.d., screen 4).
From the surveys conducted by the insurer in our case and the financial outcome while under the “Forced Ranking” performance system, the experiments on equity theory by Prichard, 1969 (as cited in PSU, n.d., screen 4), are sustained: “That is, negative inequity generally does lead to lowered performance”.
In today’s business environment high performance is not just desirable, but indispensable in order to compete. In a recent Andersen survey, less than 5 percent of managers and employees alike were very satisfied with the process in place at their companies (Workforce, Sprenkle, 2002).
Importance of Procedural Justice
While distributive justice is an important aspect of equity theory, there is often very little information regarding the actual distribution of outcomes. However, fairness in procedures is often quite visible and is generally widely known. A distinct relationship exists between distributive justice and procedural justice. This relationship is explained in Kees van den Bos’ Fairness Heuristic Theory which states, “ When people do not have information about outcomes of others they indeed use procedural fairness as a heuristic substitute to assess how to react to their outcome,” (Van den Bos, 2001, pp 68). In other words, when employees are not able to see whether or not resources are distributed fairly, they instead examine the procedures to determine the fairness of an outcome. The Fairness Heuristic Theory also explains that in, “…situations –in which information about the authority’s trustworthiness is missing- people refer to the fairness of the authority’s procedures to decide how to react to the outcome,” (Van den Bos, 2001, pp 73). The most important aspect of equity theory is how an individual perceives the fairness of the outcomes in relation to input; the Fairness Heuristic Theory explains the profound effect that procedural justice has on individual perception of fairness.
The inequity perceived in our case example is due,in part, to procedural injustice. The procedure of the ranking system was not consistent and could be perceived as unfair. While the rankings should have been based on actual employee performance, they were instead based on the effectiveness of a manager's lobby. While much of the inequity was based on distributive injustice, with an overpayment inequity ratio of 50/75, if a fair procedure had been in place there could be the potential for many employees to tolerate the inequity. The Fairness Heuristic Theory can be used to explain how the unfair procedures of the forced ranking system, contributed to the overall tension cause by the perceived inequity.
How do we perceive (in)equity?
According to equity theory (Adams, 1965), perceived (in)equity comes from social comparisons. There are three variables that make up perceived inequity: inputs, outcomes and the comparison other. Inputs consist of the contributions an employee makes to the organization. Outcomes are what an employee would receive from the organization in return for the inputs they have invested. Employees compare what they perceive they put into the organization with what they receive in return. This comparison of inputs and outcomes is knows as the input/outcome ratio. In addition to an employee comparing their personal inputs and outcomes they also compare inputs and outputs
The comparison of inputs, outcomes and the comparison other cause employees to develop one of three conclusions related to their perceived (in)equity:
Who is the comparison other?
The equity theory does not state who the comparison other has to be; therefore, it is up to the individual to decide (PSU, WC). Anyone can be the comparison other, whether it be another co-worker or someone in the same field as you or even yourself.
I will use myself as an example to show how one can be compared to themselves. I use to work in retail selling handbags for $10 an hour. It was only seasonal so once the season was up it was time for me to find a new job. I was hired at a restaurant as a hostess making far less than $10 an hour. I decided to request the baker position in the kitchen after some time had passed because I wanted to may the $10 an hour I was making before. My boss said sure, I could apply for the position; the pay is $9 an hour. Now I knew that if I accepted this I would be doing so much more work than before and still being paid a less amount. I went to my boss and I told him that I use to stand around selling handbags for $10 an hour, so I did not know if I wanted the position any longer. I was comparing two totally different jobs because I could not get over how much more work this baker position would be.
In 2014 Mary Barra was deemed the first female CEO of General Motors making her the first woman to run a major automaker. Mary was being compared to her male predecessor, Dan Akerson who reportedly started with more than half of the pay that Mary is expected to make. “Barra will get $4.4 million in total compensation, including a base salary of $1.6 million, in 2014." Compared to Dan Akerson's estimated $9 million in compensation last year, which includes a $1.7 million base salary and $7.3 million in stock. That's about two times more than Barra's pay package (Mosbergen 2014).
Consequences of (in)equity
Inequity creates a state of psychological tension and dissatisfaction that they will be motivated to reduce. Specifically, underpayment induces anger, and overpayment induces guilt. The greater the inequity: the greater the motivation to reduce it. As with need theories of motivation where only unmet needs are motivating, feelings of inequity are necessary to motivate individuals because equity results in a state of equilibrium, which will not motivate behavior. In fact, perceived inequity can be viewed as an unmet need and equity as a satisfied need as in need theories. (PSU, WC)
Employees will typically react to (in)equity by attempting to restore balance by adjusting their input/output ratio to match that of the comparison other. Due to the unlikely probability of changing the inputs and outputs of the comparison other an employee would attempt to change their own inputs and outcomes. One option for an employee who perceives they are under rewarded is to reduce inputs to match outputs. Another option would be to talk to management to increase the outcomes. Additionally, an employee may simply attempt to rationalize their own inputs or outcomes in response to a perceived inequity. The last possible outcome of perceived inequity would be to change the comparison other to someone who is more of an equal in terms of status. This allows for a realistic comparison and minimizes the chances of issue arising.
Adams, J.S. (1965). Inequity in Social Exchange. Behavioral Research Service. Retrieved from: http://beta.orionsshoulders.com/Resources/articles/19_22185_Adams%20J%20(1965).pdf
Equity Theory. (n.d.). Work Attitudes and Motivation, PSYCH 484. Lesson 5 Commentary, Penn State World Campus, The Pennsylvania State University. Retrieved fromhttps://courses.worldcampus.psu.edu/fa15/psych484/001/content/lesson05/lesson05_16.html
Mosbergen, D. (2014, February 4). Mary Barra, First Female CEO Of GM, Gets Paid Half What Her Male Predecessor Made (UPDATE). Retrieved September 25, 2015, from http://www.huffingtonpost.com/2014/02/04/mary-barra-pay_n_4724849.html
PSU, n.d., PSYCH 484 Lesson 5: Equity Theory: Is what I get for my work fair compared to others?. Retrieved from : https://courses.worldcampus.psu.edu/fa15/psych484/001/content/lesson05/printlesson.html
Van Den Bos, K. (2001). Fairness Heuristic Theory. Theoretical and Cultural Perspectives on Organizational Justice. Information Age Publishing. Retrieved from: https://scholar.google.com/citations?view_op=view_citation&hl=en&user=e3-KmTAAAAAJ&cstart=20&citation_for_view=e3-KmTAAAAAJ:kNdYIx-mwKoC
Workforce, Lisa Sprenkle, June 20, 2002, Forced Ranking – A Good Thing for Business?. Retrieved from: http://www.workforce.com/articles/forced-ranking-a-good-thing-for-business