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Fortune

Why Performance Bonuses and Merit Raises Don't Work

By Anne Fisher

February 24, 2016

In theory, it sounds like a no-brainer: Come up with a compensation system that rewards and encourages top-notch employees with bonuses and other short-term incentives. Fund it, without blowing up the overall pay budget, by giving mediocre (or worse) performers tiny raises, or none at all.

In practice, though, it's a different story.

Senior managers at 150 large and midsized companies in a new Willis Towers Watson study admit their incentive pay plans don't actually work. Barely one-third (32%) of the executives polled think their programs are "effective at differentiating pay based on individual performance."

Only half say annual incentives, like bonuses for top employees, make any difference in how well people do their jobs. Least effective of all: Merit raises, which managers are supposed to give (or not) to employees based on, well, merit. Just one in five (20%) of the executives surveyed thinks merit pay "drives higher levels of individual performance" in their companies.

This wouldn't matter quite so much if pay for performance plans weren't so popular. But, since reaching a record high in 2014, the number of companies counting on incentive pay to produce stellar results has kept on rising. "Companies are spending hundreds of millions of dollars a year on these disappointing programs," observes Laura Sejen, global chief of rewards at Willis Towers Watson. "If this were any other business process, certainly we'd all have moved to improve the ROI by now."

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