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Organizations require consistent levels of high performance from their

employees in order to survive in a highly competitive environment. Many firms use
some form of results-oriented planning and control systems. Management By
Objectives (MBO) is a cyclical process that often consists of four steps as a way to
attain desired performance:

1. Objective setting joint determination by manager and

employee of appropriate levels of future performance for the
employee, within the context of overall unit goals and resources.
These objectives are often set for the next calendar year.
2. Action planning participative or even independent planning by
the employee as to how to reach those objectives. Providing some
autonomy to employees is invaluable; they are more likely to use
their integrity, as well as feel more committed to the plans
3. Periodic reviews joint assessment of progress toward
objectives by manager and employee, performed informally and
sometimes spontaneously.
4. Annual evaluation more formal assessment of
success in achieving the employees annual objectives,
coupled with a renewal of the planning cycle. Some
MBO systems also use performance appraisal to tie rewards
for employees to the level of results attained.

Appraisal Philosophy

A generation ago, appraisal programs tended to emphasize employee traits,

deficiencies and abilities, but modern appraisal philosophy emphasizes present
performance and future goals. Modern philosophy also stresses employee participation
in mutually setting goals with the supervisor and knowledge of results. Thus the
hallmarks of modern appraisal philosophy are as follows:

1. Performance Orientation it is not enough for employees to put forth effort;

that effort must result in the attainment of desired outcomes (products or
2. Focus on goals or objectives as the discussion of MBO shows, employees
need to have a clear idea of what they are supposed to be doing and the
priorities among their tasks; as the saying goes, If you know where you want to
go, you are more likely to get there.
3. Mutual goal setting between supervisor and employee this is the belief
that people will work harder for goals or objectives that they have participated
in setting. Among their desires are to perform a worthwhile task, share in a
group effort, share in setting their objectives, share in the rewards of their
efforts, and continue personal growth. The Theory Y assumption is that
people want to satisfy some of their needs through work and they will do so if
management will provide them with a supportive environment.
4. Clarification of behavioral expectations this is often done via a
behaviorally anchored rating scale (BARS), which provides the employee and
manager with concrete examples of various levels of behaviors. Brief
descriptions of outstanding, very good, acceptable, below average, and
unacceptable behaviors are specified for each major dimension of a job, thus
cueing the employee in advance regarding the organizations expectations. BARS
help reduce a managers tendency to focus on attitudes, personality and quirks
of an employee and shift the emphasis toward productive behaviors.
5. Extensive feedback systems employees can fine-tune their performance
better if they know how they are doing in the eyes of the organization


Performance appraisal is a key aspect of performance management. It may be

defined as the process of evaluating the performance of employees, sharing that
information with them, and searching for ways to improve their performance.

Functions of Performance Appraisal

Performance appraisal is undertaken for the following reasons:

1. To give employees feedback on performance;

2. To identify the employees developmental needs;
3. To make promotion and reward decisions;
4. To make demotion and termination decisions; and
5. To develop information about the organizations selection and placement

Criteria for Performance Appraisal

In performance appraisal, there are certain criteria that are used. The three
most popular sets of criteria are;

1. individual task outcomes;

2. behaviors; and
3. traits.
Individual Task Outcomes. One way of appraising performance is evaluating the
employees task outcomes. For instance, the manager of a bank could be judged on
criteria such as deposit generation and loans collected. In the same light, a credit
investigator could be judged on the number of good accounts that turned out from the
credit applications he investigated and recommended for approval.

Behavior. There are instances when it is difficult to measure an individuals

task outcomes. This is so on advisory jobs or support positions and those who are
assigned to work in a group. Examples of jobs encountering this difficulty are those of
teachers, nurses, and filing clerks. In such cases, management tend to evaluate the
employees behavior. Teachers, for instance, are evaluated according to how well they
manage classroom activities, the quantity and quality of professional training attend,
research output, community service, and the like.

Traits. Many organizations use traits as criteria in appraising employee

performance. This is true even if it is a very weak means. It is weak because it has
little connection with the actual performance of the job. The traits commonly used as
basis for performance appraisal include:

1. good attitude
2. showing confidence
3. being dependable
4. looking busy
5. possessing a wealth of experience

The Process of Performance Appraisal

Performance appraisal is a process in an organization whereby each employee is

evaluated to determine how he or she is performing. It consists of the following steps:

1. establishment of performance standards

2. mutually set measurable goals
3. measure actual performance
4. compare actual performance with standards
5. discuss the appraisal with the employee
6. if necessary, initiate corrective action

Performance standards are those by which performance is to be evaluated. It

should be clearly defined and communicated to the employee. These standards should
be based on job-related requirements derived from job analysis and reflected in the job
descriptions and job specifications. An example of performance standard is: all
customer orders will be filled in 4 hours with a 98 percent accuracy rate.

When goals are set with the active participation of the employees, appraising
employee performance will be an easy task.
Measuring performance is the third step in the appraisal process. To determine
what actual performance is, it is necessary to acquire information about it.
Information may be derived from the following sources.

1. Personal Observation
2. Statistical Reports
3. Oral Reports
4. Written Reports

Methods of Performance Appraisal

There are three different approaches which can be used for appraising

1. Absolute standards;
2. Relative standards; and
3. Objectives

Absolute Standards

Under this approach, the subjects of appraisal are not compared with other
persons. This approach consists of the following methods: the essay appraisal, the
critical incident appraisal, the checklist, the adjective rating scale, forced choice, and
behaviorally anchored rating scales.

Essay Appraisal

The Essay Appraisal is a performance appraisal method whereby an

appraiser writes a narrative about the employee. The employees strengths and
weaknesses are described and recommendations for development are indicated.

The essay method provides an excellent opportunity to point out the

unique characteristic of the employee being appraised. The disadvantages,
however, are the following:
1. It is very time consuming;
2. The quality of the appraisal may be influenced by the appraisers
writing skill and composition style;
3. It tends to be subjective and may not focus on relevant aspects of job

Critical Incident Appraisal

The Critical Incident Appraisal is a performance appraisal method

which requires effective or ineffective performance for each employee being
appraised. These incidents are critical incidents.

An example of a good critical incident is:

June 7 Pedro arrived thirty minutes early for work and there
were five customers who were already waiting to be served. Pedro
promptly fixed his wares and started serving the customers. He
was polite and smiling.

An example of a bad critical incident is:

July 1 Pedro took a ten minute personal call on his cellphone.

Three of the waiting customers could not afford to wait and left
without being served by Pedro.

The critical incident appraisal can be very useful if the appraiser is given
enough time to observe the subject employee.


The checklist is a performance appraisal method wherein

the evaluator uses a list of behavioral descriptions and checks off
those behaviors that apply to the employee.


A checklist developed for motorcycle salespersons might include a

number of statements like the following:

_________ Is able to explain motorcycle products clearly

_________ Keeps abreast of new developments in motorcycle technology

_________ Tends to be a steady worker

_________ Reacts quickly to customer needs

_________ Processes orders correctly

The advantage of the checklist method is that it reduces some bias since
the rater and the scorer are different. The disadvantage is when there are many
job categories, a checklist of items must be prepared for each job categories and
that is costly in terms of materials and time consumed.

Adjective Rating Scale

The adjective rating scale, also known as graphic rating scale, is a

performance appraisal method that lists a number of traits and a range of
performance for each. The traits listed are assumed to be necessary to
successful job performance. Examples of traits are quality of work, job
knowledge and dependability. Each trait is accompanied by a five or seven-point
rating scale.

The advantages of adjective rating scale is that it is practical and cost

little to develop. The disadvantages, however, are as follows:

1. It does not clearly indicate what a person must do to achieve a given

2. It does not provide a good mechanism for providing specific,
nonthreatening feedback.
3. Accurate ratings are not likely to be achieved because the points on
the rating scale are not clearly defined.

Forced-choice Appraisal

The forced-choice appraisal is a type of performance appraisal in which

the rater must choose between two or more specific statements about an
employees work behavior. The supervisor or others familiar with the ratees
performance evaluate how applicable each statement is. Oftentimes, the
statements are ranked from most to least descriptive.
Forced-choice appraisal can be used by superiors, peers, subordinates,
or a combination of these in evaluating employees.


Behaviorally Anchored Rating Scale (BARS)

Behaviorally anchored rating scale (BARS) is a rating instrument

comprised of traits anchored by job behaviors. Appraisers select the behavior
that best describes the workers performance level. The typical BARS includes
seven or eight traits called dimension each anchored by a seven or nine-point

A BARS anchors each trait with examples of specific behaviors that

reflect varying levels of performance.

The greatest advantage of BARS is its ability to direct and monitor
behavior. The behavioral anchors let employees know what types of behavior are
expected of them which gives appraisers the opportunity to provide behaviorally
based feedback.

The weakness of BARS is the difficulty of selecting the one behavior on

the scale that is most indicative of the employees performance level.
Sometimes, an employee may exhibit behaviors at both ends of the scale, so the
rather would not know which rating to assign.

Relative Standards

This category of appraisal methods compare individuals against other

individuals. The most popular in this category are:

1. group order ranking

2. individual ranking
3. paired comparison

Group order ranking

Group order ranking is a relative standard of performance characterized
as placing employees into a particular classification such as top one-fifth.
Under this method, the evaluators are asked to rank the employees as follows:
top 5 percent, second 5 percent, third 5 percent, and the like. This evaluation
method prevents evaluators from inflating their evaluations of from
homogenizing the evaluations. The disadvantage of this method is its
inapplicability when the number of subjects is small.

Individual ranking

The individual ranking method requires the evaluator merely to list the
employees in order from highest to lowest. This method does not show the
difference between the first and second, or between the second and third.

Paired Comparison

Paired comparison is an appraisal method whereby subordinates are

placed in all possible pair and the supervisor must choose which of the two in
each pair is the better performer. An example is provided as follows:

The best performer in this example is Pedro, followed by Juan, then

Josefa, and the last of all, Maria.

This method ensures that each employee is compared against each other,
but the method can become unwieldy when large numbers of employees are
being compared.


The third approach to appraisal makes use of objectives. This approach, also
known as management by objectives (MBO), is a process of joint goal setting between
a supervisor and a subordinate. It is also a process of converting organizational
objectives into individual objectives.
The advantages of MBO are the following:

1. it improves job performance by monitoring and directing behavior;

2. it is practical and inexpensive; and
3. it fosters better communication between employees and supervisors.

The disadvantages of MBO are the following:

1. it does not specify the behavior required to reach goals;

2. it tends to focus on short-term goals;
3. the successful achievement of MBO goals may be partly a function of
factors outside the workers controls;
4. MBO does not provide a common basis for comparison of performance
standards; and
5. It often fails to gain acceptance.

Errors in Performance Appraisal

A perfect performance appraisal is an ideal goal and to make it happen, errors

should be prevented from happening. To eliminate the possibility of errors, they must
first be identified.

The following are brief descriptions of errors in performance appraisal.

Halo Error. This is a rating error that occurs when a rater assigns ratings on
the basis of an overall impression (positive or negative) of the person being rated. For
example, a teacher who topped the board examination for electrical engineers is
regarded as outstanding in the aspect of professional qualification. If that impression
spills over the other aspects of evaluation, a halo error is committed.

Leniency Error. This is a raters tendency to give relatively high ratings to

virtually everyone. The opposite of this is strictness error where the raters tend to give
everyone a low rating. Most often, leniency errors happen when peers asses one

Central Tendency Error. This occurs when a rater lump everyone together
around the average, or middle, category. The idea is that there are no very good or very
poor performers on the dimension being rated. As a result, no true performance
discrimination is made.

Recency Error. This is a biased rating that develops by allowing the individuals
most recent behavior to speak for his or her overall performance on a particular
dimension. The result is a false picture of the individuals job performance during the
entire period.
Personal Biased Error. This occurs when a rater allows specific biases, such
as racial, age, and gender, to enter into performance appraisals. For example, a rater
may intentionally give higher rating to a member of a certain fraternity than to a non-


An economic incentive system of some type can be applied to almost any job.
The basic idea of such systems is to induce a high level of individual, group, or
organizational performance by making an employees pay contingent on one or more of
those dimensions. Additional objectives include making it easier to recruit and retain
good employees, stimulating desirable role behaviors such as creativity, encouraging
the development of valued skills, and satisfying key employee needs. The criteria for
these incentives could include employee output, company profit, cost savings, units
shipped, level of customer service, or the ratio of labor cost to total sales. Evaluation of
performance may be individual or collective, and the payment may be immediate or
delayed, as in profit-sharing plan.

The discussion of economic incentives focuses on their overall nature, purpose,

and behavior implications. Only the major types of incentives will be discussed as
there are so many types of incentives. The wage incentives, which are a widely used
individual incentive, and profit sharing and gain sharing, which are popular group
incentives. Skills-based pay systems are increasing in popularity, especially in new
industrial operations.

Incentives Linking Pay with Performance

There are several broad types of incentives that link pay with performance.
Major ones are shown in Figure 1. Perhaps the most popular measure is for the
amount of output to determine pay, as illustrated by a sales commission or a piece
rate. It provides a simple, direct connection between performance and reward. Those
workers who produce more are rewarded more. Often pay is determined by a
combination quantity-quality measure in order to ensure that a high quality product
or service is maintained.

Incentive Measure Example

Amount of output Piece rate; sales commission
Piece rate only for pieces meeting the
Quality of output standard; commission only for sales that
are without bad debts
Bonus for selling an established number
Success in reaching goals of items during a predetermined time
Amount of profit Profit sharing
Cost efficiency Gain sharing
Employee skills Skill-based pay
Figure 1. Major incentive measures to link pay with performance.

In other instances an incentive bonus is given only to those employees who

reach the established goals. Rewards may also be given on the basis of profit success,
as in profit-sharing plan. Another measure is to link pay with cost efficiency, as in gain
sharing plan. Skill-based pay systems reward individuals for their capabilities.
Regardless of the type of incentive that is used, its objective is to link a portion of a
workers pay to some measure of employee or organizational performance.

Advantages of Linking Pay with Performance

1. Incentives increase employee beliefs (instrumentality) that reward will follow

high performance. If we assume that money has valence to an employee, then
motivation should increase.
2. Incentives appear favorable from the point of view of equity theory. Those who
perform better are rewarded more. This kind of input-outcome balance is
perceived by many people to be equitable. Further, if more pay is a valued
reward, then incentive systems are favorable from the point of view of behavior
modification. They provide desirable consequence (pay) that should reinforce
behavior. Rewards, such as sales commissions, are often rather immediate and
frequent, which is consistent with the philosophy of behavior modification
3. Incentives are comparatively objective. From the employees point of view,
incentives can be computed from the number of pieces, dollars, or similar
objective criteria. Compared with a supervisors subjective performance ratings,
the objective approach tends to have higher acceptance by employees.

Disadvantages of Linking Pay with Performance

1. Potential equity is offset by other developments that are perceived as inequities.

2. In behavior modification terms, certain unfavorable consequences exist
alongside the favorable consequences of more pay, so they tend to reduce
potential advantages of consequences of incentive pay.
3. The cost-reward analyses of workers may result to that of costs has risen along
with the rewards.
4. Incentive may offset much of the economic gain expected.
5. As for the organization, it Is difficult to establish a fair basis for incentive pay
one that motivates higher performance across a broad range of employees
without producing undesirable side effects.
6. Some incentive systems are also costly to monitor, requiring extensive record-
keeping procedures.

Wage Incentives
Wage incentives provide more pay for more production. The main reason for use
of wage incentives is clear: They nearly always increase productivity while decreasing
unit labor costs. Workers under normal conditions without wage incentives have the
capacity to produce more, and wage incentives are one way to release that potential.
The increased productivity often is substantial.

In order to be successful, a wage incentive needs to be simple enough for

employees to have a strong belief that reward will follow performance. If the plan is so
complex that workers have difficulty relating performance to reward, then higher
motivation is less likely to develop. The objectives, eligibility requirements,
performance criteria, and payment system all need to be established and understood
by the participants.

When incentive systems operate successfully, they are evaluated favorably by

participants, probably because they provide psychological as well as economic
rewards. Employees receive satisfaction from a job well done, which fulfills their
achievement drive. Their self-image may improve because of greater feelings of
competence. They may even feel they are making a contribution to society by helping
in the attempt to regain a productivity leadership position among nations. Some
incentives may encourage cooperation between workers because of the need for
employees to work together to earn incentive awards.

Disadvantages of Wage Incentives

1. Wage incentives normally require establishment of performance standards. Rate

setting is the process of determining the standard output for each job, which
becomes the fair days work for the operator.
2. Wage incentives may make the supervisors job more complex. Supervisors
must be familiar with the system, so that they can explain it to employees.
Paperwork increases, resulting in greater chance of error and more employee
3. Wage incentives involve loose rates. A rate is loose when employees are able to
reach standard output with less than normal effort. When management adjusts
the rate to a higher standard, employees predictably experience a feeling in
4. Wage incentives may cause disharmony between incentive works and hourly
workers. When the two groups perform work in a sequence, hourly workers may
feel discriminated against because they earn less. If the incentive workers
increase output, hourly workers farther along the process must work faster to
prevent a bottleneck.
5. Wage incentives may result in output restriction, by which workers limit their
production and thus defeat the purpose of the incentive.
Profit Sharing
Profit sharing is a system that distributes to employees some portion of the
profits of business, either immediately (in the form of cash bonus) or deferred until a
later date (held in trust in the form of employee-owned shares). The growth of profit
sharing has been encouraged by federal tax laws that allow employee income taxes to
be deferred on funds placed in profit-sharing pension plans.

Basic pay rates, performance pay increases, and most other incentive systems
recognize individual differences, whereas profit sharing recognizes mutual interests.
Employees become interested in the economic success of their employer when they see
that their own rewards are affected by it. Greater institutional teamwork tends to

Smaller organizations in competitive industries that demand high commitment

from employees in order to make technological breakthrough or bring new products to
the market faster are prime candidates for profit-sharing programs. If the firms are
successful, the rewards are great. This possibly builds strong motivation among
employees to see the big picture and allows the organization to forge ahead of its

In general, profit sharing tends to work better for fast-growing, profitable

organizations in which there are opportunities for substantial employee rewards. It
also works better, of course, when general economic conditions are favorable. It is less
likely to be useful in stable and declining organizations with low profit margins and
intense competition. Profit sharing generally is well received and understood by
managers and high-level professional people, because their decisions and actions are
more likely to have a significant effect on their firms profits. Since operating workers,
especially in large firms, have more difficulty connecting their individual actions with
the firms profitability, profit sharing may have less initial appeal to them. In situations
where it has worked effectively, managers have openly shared financial reports with all
levels of workers, actively trained employees to understand financial statements, and
provided on-site computer terminals for immediate access to relevant information
whenever employees want it.

Disadvantages of Profit Sharing

1. Profits are not directly related to an employees effort on the job. Poor market
conditions may nullify an employees hard work.
2. Employees must wait for their reward, and this lengthy delay diminishes its
3. Since profits are somewhat unpredictable, total worker income may vary from
year to year. Some workers may prefer the security of a more stable wage or
4. Some union leaders have historically been suspicious of profit sharing. They
fear that it would undermine union loyalty, result in varied total earnings from
company to company, and weaken their organizing company.


Gain Sharing

Gain sharing is another type of group incentive which is also called production
sharing. A gain-sharing plan is a program that established a historical base period of
organizational performance, measures improvements, and shares the gains with
employees on some formula basis. Examples of performance factors measured include
inventory levels, labor hours per unit of product, usage of materials and supplies, and
quality of finished goods. The idea is to pinpoint areas that are controllable by
employees and then give them an incentive for identifying and implementing ideas that
will result in cost savings.

Behavioral Basis

Gain-sharing plans use several fundamental ideas from organizational

behavior and are much more than pay systems. They encourage employee
suggestions, provide an incentive for coordination and teamwork, and promote
improved communication. Union-management relations often improve, since the
union gains status because it takes responsibility for the benefits gained.
Attitudes toward technological change improve because workers are aware that
greater efficiency leads to larger bonuses. Gain sharing broadens the
understanding of employees as they see a larger picture of the system through
their participation rather than confining their outlook to the narrow specialty of
their job.

Contingency Factors

The success of gain sharing is contingent upon a number of key factors

such as moderately small size of the unit, sufficient operating history to allow
creation of standards, existence of controllable cost areas, and relative stability
of the business. In addition, management must be receptive to employee
participation, the organization must be willing to share the benefits of the
production increases with employees, and the union should be favorable to
such cooperative effort. Managers need to be receptive to ideas and tolerant of
criticism from employees.


Skill-Based Pay
In contrast to salaries (which pay someone to hold a job) and wage incentives
(which pay for the level of performance), skill-based pay (also called knowledge-based
pay or multi-skill pay) rewards individuals for what they know how to do. Employees
are paid for the range, depth, and type of skills in which they demonstrate capabilities.
They start working at a flat hourly rate and receive increases for either developing
skills within their primary job or learning how to perform other jobs within their work
unit. Some companies provide increases for each new job learned; most others require
employees to acquire blocks of related new skills, which may take several years to
learn. Substantial amounts of training must be made available for the system to work,
and methods for fairly pricing jobs and certifying employee skill levels need to be
established. Some skill-based pay systems have supervisors evaluate the knowledge
and skill of the employees; others allow work teams to assess the progress of each

Advantages of Skill-Based Pay

1. Provide strong motivation for employees to develop their work-related skills, they
reinforce an employees sense of self-esteem, and provide the organization with a
highly flexible workforce that can fill in when someone is absent.
2. Boredom is reduced since workers rotate among jobs to learn them.
3. The employees hourly rate received is often higher than the rate that would be
paid for the task being performed, since only in a perfect system would all
employees be constantly using their highest skill.
4. Workers perceived the system as equitable both in the sense of their costs and
rewards being matched and in the knowledge that all employees with the same
skills earn the same pay.

Disadvantages of Skill-Based Pay

1. The average hourly pay rate will be greater than normal since most employees
will voluntarily learn higher-level jobs.
2. A substantial investment in employee training must be made, especially in the
time spent coaching by supervisors and peers.
3. Not all employees like skill-based pay because it places pressure on them to
move up the skill ladder. The subsequent dissatisfaction may lead to a variety of
consequences, including employee turnover.
4. Some employees will qualify themselves for skill areas that they will be unlikely
to use, causing the organization to pay them higher rates than they deserve
from a performance standpoint.

Skill-based pay, like other incentive programs, works best when the organizational
culture of the firm is generally supportive and trusting. The system should be
understood by employees, they must have realistic expectations about their prospects
for higher pay levels, it must be possible for them to learn new skills and to have these
skills promptly evaluated, and there must be some limits on which skills they can
qualify for. Under these conditions, the program is consistent with the other incentives
discussed, since it links employee pay with the potential for increased performance.