Performance-related

Compensation
 COMPARASION
PERFORMANCE APPRAISAL
Performance Appraisal
implies a rational assessment
of the performance of an
individual, based on pre-
determined standards.
 While Performance Appraisal
is a yearly system.
PERFORMANCE
MANAGEMENT
Performance Management
refers to the
management/development
of performance of the
manpower working in an
organization.
Performance Management is
a continuous process that
does not occur eventually.
 Introduction
Effective performance management system (PMS) ensures good quality of
human resources.

• The performance system links the ability and contributions of

employees, individually and as a team, to the overall performance of the
organization.

• Thus effective design of employee compensation should focus on PMS.

•Performance-linked pay or compensation has a strategic significance.

• It helps organizations optimize the cost of compensation and at the

same time rewards good performers.

• Reward for good performance motivates employees and helps the

organization become an employer of choice.
 Compensation Management and PMS
From compensation management point of view, PMS helps in
achieving the following critical goals.

•It helps in recognizing the efforts and contributions of employees

objectively, and thus facilitates effective job pricing through cost
optimization and rewarding of talented performers.

•It facilitates suitable compensation design by providing for rewarding

employees based on performance metrics

•It helps intrinsically improve employee motivation by helping

employees understand their strengths and weaknesses as part of
feedback on performance; employees develop themselves through self-
introspection and thereby feel intrinsically motivated
 Compensation Management and PMS

• It also helps the employees getting extrin­sically motivated through

provision of performance-based pay; motivational constructs lead
to improved perfor­mance

• It helps employees develop their core competencies and achieve

their goals

• It helps retain good performers through competitive compensation

design, offer flexibility for increased income based on performance
 Performance-related Pay

Performance-related pay (PRP) encompasses several company-wide

schemes such as employee participation and share ownership
schemes awarded to the employees.

Employee participation is measured in terms of commitment to team

work and involvement of the employee in problem-solving.

Performance-related pay schemes are designed and administered

from a company’s perspective.
 Developing performance standards
Effective compensation design is possible through developing performance
standards.

Performance standards can be either a top-down or a bottom-up

collaborative approach.

Simply benchmarking performance standards with competing

organizations may not always be the right approach.

Excessive expectation in setting performance standards and thereby

requiring employees to overstretch is a common organizational syndrome,
particularly with new start-ups which aim to grow disproportionately.

Performance standards should be aligned with the job descriptions,

mission, goals, and objectives that by default help in evolving the right
performance appraisal model. Performance standards should be specific.
PMS Includes…
Work plan – A document that describes the work to
be completed by an employee within the performance
cycle, the performance expected, and how the
performance will be measured.

Corrective action plan – A short-term action plan

that is initiated when an employee’s performance fails
to meet expectations. Its purpose is to achieve an
improvement in performance.
 Contd…

Individual development plan – An action plan for

enhancing an employee’s level of performance in
order to excel in the current job or prepare for
new responsibilities.

Performance appraisal – A confidential document

that includes the employee’s performance
expectations, a summary of the employee’s
actual performance relative to those
expectations, an overall rating of the employee’s
performance, and the supervisor’s and
employee’s signatures.
 Contd…

Performance documentation – A letter, memo,

completed form, or note on which the supervisor
indicates the extent to which the employee is
currently meeting expectations and provides
evidence to support that conclusion.

Fair appraisal – Appraising employees in a manner

that accurately reflects how they performed relative
to the expectations defined in their work plan and
in a manner that is not influenced by factors
irrelevant to performance.
Performance Cycle
SETTING
EXPECTATIONS

PROVIDING OBSERVING
ACTIONABLE BEHAVIOUR AND
COACHING & MEASURING
FEEDBACK RESULTS
HIGHLIGHTS OF THE SYSTEM

The appraiser and the appraisee jointly set the Key

Result Areas (KRA’s) & Key Performance Indicators
(KPI’s) and assign mutually agreed weightage
expressed as a percentage

Simple mathematical relationship between set

weightage and accomplishment gives a final
numerical score on KRA’s
WHAT IS A KEY RESULT AREA ?

A KRA refers to a target that needs to be achieved by

the appraisee in a given time

KRA’s are the set of performance expectations from the

appraisee

The focus is on tangible outputs. However this does not

mean that tasks that have a qualitative output cannot
form a KRA
Setting KRA in case of a Functional Reporting
Relationship
Functional reporting cases will require input from the
functional superior in setting KRAs for the appraisee.

The appraiser , the appraisee and the functional superior will

have to mutually agree upon the KRAs for the appraisee.

In case of a disagreement , it will be the functional

superior’s responsibility to convince the administrative
superior to reach an agreement on the KRAs and
communicate the same to the appraisee.

In some cases, functional goals could be super-ordinate to

business goals.
Components of PMS
Performance Standards

Performance Measures

Reporting of Progress

Quality Improvement
Importance of PMS
A Performance Management System enables a business to
sustain profitability and performance by linking the
employees' pay to competency and contribution .

It provides opportunities for concerted personal

development and career growth .

It brings all the employees under a single strategic

umbrella.
 Contd…

Most importantly, it gives supervisors and subordinates an

equal opportunity to express themselves under structured
conditions

Organizations can effectively manage the performance

appraisal process with our online performance
management system

It calls for a high level of co-ordination, channeled

information flow, and timely review
Appraise Need For Further Discussion
The reviewer meets the appraiser to investigate the
point of disagreement.

The reviewer hears his / her views.

The reviewer examines the case and communicates

his / her decision to the appraiser.

The appraiser communicates the decision of the

reviewer to the appraisee.
 FURTHER LINKS EMERGING FROM THE
PMS
Rewards and Recognition

Training and Development

Potential Appraisal

Career and Succession Planning

Guidelines for developing performance standards

Organizations must keep in mind the following guidelines while

developing performance standards.

• Performance standards should be related to the employee’s

assigned work and job requirements

• Reporting systems should be adequate to measure and,

therefore, should have more quantitative data

• Quantifiable measures may not apply to all functions; describe

in clear and specific terms the characteristics of performance
quality that are verifiable, and that would meet or exceed
expectations
 Developing a performance metric
A performance metric is a standard measure to assess performance in a
particular area.
customer-focused processes, management systems, and any programme
directed at continuous improvement
Metrics are based on.

Most organizations use traditional performance measures such as profit

performance, return on investment, or earnings per share to determine
their success.

These measures provide reasonable estimates of whether a company

achieved its ultimate goal of making profits, but do not reveal how the
business achieved this position.

Many organizations have created complete operating as well as process

measures and ratios to track how well the business manages each process
and use of resources.
 Developing performance matrix

Organization can develop a performance matrix by taking into account

performance metrics.

Developing a performance matrix and emulating examples of world-class

performance excellence models help organizations to scientifically list the
action plans for improving PMS.

Performance matrix is a construct of performance system which

sequentially illustrates decisions to be taken to improve PMS in an
organization.

A simple model of performance matrix deals at three levels—policy,

strategy, and tactics.
 Dimensions of performance
Dimensions of performance are as follows:

 Output or result dimension

 Input dimension
 Time dimension
 Quality dimension
 Cost dimension
 PMS and the balanced scorecard
A new approach to strategic management was developed in the early 1990s by
Robert Kaplan and David Norton. They named this system as balanced scorecard
(BSC). This system provides a clear prescription as to what companies should
measure in order to balance the financial perspective.

BSC is a management system. It is more than just a measurement system. It

enables organizations to clarify their vision and strategy and translate them into
action. It provides feedback around both the internal business processes and
external outcomes in order to continuously improve strategic performance and
results.
BSC suggests that organizations be viewed from the following four perspec­tives:
 learning and growth perspective
 business process perspective
 customer perspective
 financial perspective

Organizations develop metrics, collect data, and analyse the collected

data relative to each of these perspectives.
 Introduction of EVA
 EVA was developed by a New York consulting firm, Stern
Steward & Co. in 1982 to promote value-maximisig
behaviour in corporate managers.

 Value-based measure to evaluate business strategies,

capital projects and to maximise long-term shareholders
wealth.

 EVA sets managerial performance target and links it to

reward systems.

 Unlike simple traditional budgeting. EVA focuses on ends

and not means.
 Definition for EVA
EVA is defined as net profit after taxes and after the cost of
capital.
FORMUALE for EVA

EVA

Net operating profit Taxes Cost of capital

• What is EVA?
Economic Value Added (EVA) is a measure of financial performance
based on the concept that all capital has a cost and that earning more
than the cost of capital creates value for shareholders. It is net
operating profit after-tax (NOPAT) minus a capital charge. It is true
economic profit consisting of all costs including the cost of capital. If a
company’s return on capital exceeds its cost of capital it is creating
true value for the shareholder.

• EVA Calculation
EVA = (r-c) x Capital
EVA = (r x Capital) – (c x Capital)
EVA = NOPAT- c x Capital

where: r = rate of return, and

c = cost of capital, or the weighted average cost of capital.
 NOPAT

• NOPAT is profits derived from a company’s operations

after taxes but before financing costs and noncash-
bookkeeping entries. It is the total pool of profits available
to provide a cash return to those who provide capital to
the firm.
• Capital is the amount of cash invested in the business, net
of depreciation. It can be calculated as the sum of net
assets less non-interest-bearing current liabilities.
 Cost of Capital
Meaning: The cost of capital is the rate of return required by the
shareholders and lenders to finance the operations of the business.

Types of Cost of Capital

Equity Capital: Equity Capital is provided by the Shareholders.

Borrowed Capital: It is the Capital borrowed

by the company from Banks and other Financial
Institutes.
Calculating Net Operating After Tax (NOPAT)
NOPAT is easy to calculate.
From the income statement we
take the operating incomes and subtract taxes.

Particulars Amount (Rs.)

e.g. XYZ
Sales 24,36,000/-
Company
Cost of Goods sold (-) 17,00,000/-
Gross Profit 7,36,000/-
Selling, general & Admin 4,00,000/-
Exp. (-)
Operating Profit 3,36,000/-
Taxes (-) 1,34,000/-
NOPAT 2,02,000/-
• RONA - Another perspective on EVA can be gained by
looking at a firm’s Return on Net Assets (RONA). RONA is
a ratio that is calculated by dividing a firm’s NOPAT by
the amount of capital it employs (RONA =
NOPAT/Capital) after making the necessary adjustments
of the data reported by a conventional financial
accounting system.

• EVA = (Net Investments)(RONA – Required minimum

return) 
If RONA is above the threshold rate, EVA is positive.
 Strategies for Increasing EVA
Increase the return on existing projects (improve
operating performance).

Invest in new projects that have a return greater than the cost of
capital.

Use less capital to achieve the same return.

Reduce the cost of capital.

Liquidate capital or curtail further investment in sub-standard

operations where inadequate returns are being earned.
 Advantages of EVA

EVA provides for better assessment of decisions that affect

balance sheet and income statement or tradeoffs between each
through the use of the capital charge against NOPAT.

EVA covers all aspects of the business cycle.

EVA aligns and speeds decision making, and

enhances communication and teamwork.
 Limitations of EVA

EVA is based on financial accounting methods that can be

manipulated by managers .

EVA may focus on immediate results which diminishes innovation.

EVA provides information that is obvious but offers no solutions in

much the same way as historical financial statement do.
 Conclusion

As a performance measure, Economic Value Added forces the

organization to make the creation of shareholder value the
number one priority. EVA is changing the way managers run their
businesses. When business decisions are aligned with the interest
of the shareholders, it is only a matter of time before these efforts
are reflected in a higher stock price.