UNIT-IV - PERFORMANCE APPRAISAL AND COMPENSATION MANAGEMENT

Meaning of Performance appraisal

Performance appraisal is a process of evaluating an employee’s performance of a

job in terms of its requirements.

or

Performance Appraisal is a method of determining and measuring the performance of

employees working in an organization.

Features/ characteristics of Performance appraisal

 Evaluates Performance

It is a process which evaluates the performance of peoples working within the

organization. Performance appraisal detects all strengths and weaknesses of
employees and suggests ways of enhancing their performance.

 Systematic Process
Performance appraisal is a systematic process of tracking the performance of
employees. It follows a series of well-defined steps for finding out the areas
where employees are lacking and where they possess good skills.

 Bias Free
It is performed without any biasness by evaluator within the organization.
He should use fair and equitable methods for performance evaluation
without getting influenced by anyone.

 Continuous Approach
This is an ongoing approach that is followed till organization continues its
operations. Organizations need to evaluate the performance of their
employees on a continuous basis for maintaining the desired productivity.

 Periodicity
Performance appraisal is done periodically by organization that is in 3
months or 6 months. Evaluation is done continuously from time to time by
 evaluators. That show the changes in employee performance at different
period of time.

 Based On Definite Plan

This method works in accordance to the well-defined plan for tracking the
performance. There is a defined process comprising of many steps which are
followed in a systematic way for performing performance appraisal.
 Not Job Evaluation
Performance appraisal and job evaluation are two distinct terms.
Performance appraisal is the one which evaluates the performance level of
employees whereas job evaluation is concerned with analyzing the value and
worth of jobs within the organization.

Scope of Performance Appraisal

Scope of Performance Appraisal
 Provides Performance Feedback
Performance appraisal helps managers in providing feedback about
performance to its employees. Feedback enables employees to avoid their
mistakes and improve their productivity

 Decides Employee’s Compensation

Providing the right remuneration to employees is important for every
organisation. It should be paid fairly to all of them according to their efforts,
performance and skills.

 Validation Of Selection Process

Performance appraisal enables the validation of the selection process. Selecting
a proper selection channel is a must for recruiting better human resources.
Recruitment and selection require lots of organization time, effort, and money.

 Identify Employee’s Training Needs

Training and development programmes help in improving the productivity of
manpower. It should be provided by the organization to its employees from
time to time to improve their skills and confidence level.

 Motivates Employees
Performance appraisal helps in motivating employees toward their targeted
roles and objectives. Employers are able to evaluate the efficiency of their
workers through this. It can be ensured whether they are working efficiently or
 not towards the achievement of organisation objectives. When employees know
that their result will be checked it will motivate them to perform well.

 Helps In Promotion And Demotion

Giving of promotion and demotion to employees is an important decision to be
taken by managers. Performance appraisal helps them in taking these decisions
fairly and properly without biased

Facilitates Communication

Performance appraisal facilitates the efficient flow of information within the

organization between employers and employees. Employers are able to
understand their subordinate’s nature by measuring their output.

Objectives of the performance appraisal: P

a. Promotion Decisions
Performance appraisal is a tool which helps managers to take promotion or
demotion decisions. This method assesses the performance level of employees.
Efficient workers can be promoted to a higher level whereas inefficient one can
be demoted.

b. Provides Feedback
This process provides feedback to workers regarding their performance.
Performance appraisal identifies the strengths and weaknesses of employees
and suggests ways for enhancing their efficiency.

c. Development Of Employees
Performance appraisal helps in designing the training and development
programmes as per the requirements of employees. It by diagnosing the
performance level enables supervisors in identifying what kind of training
should be provided for developing the skills of peoples.

d. Motivates Employees
Motivation of employees towards their role is must for attaining desired goals.
This method by checking the efficiency of workers and awarding them
accordingly motivates them for better performance.

e. Compensation Decisions
 It plays an effective role in deciding various compensation decisions for
employees. Decisions like a hike in employees’ pay or incentives are taken by
managers by judging their performance level.

f. Improve Employer-Employee Relations

Performance appraisal facilitates communication between employers and
employees within the organization. Employers regularly check performances of
employees and provide them feedback on their work

Essential of effective performance measurement/ appraisal:

1. Mutual Trust: The existence of an atmosphere of confidence and trust so that both
supervisor and employee may discuss matters frankly and offer suggestions which may
be beneficial for the organisation and for an improvement of the employee

2. Clear Objectives: The objectives and uses of performance appraisal should be

made clear and specific. The objectives should be relevant, timely and open.

3. Standardisation: Well-defined performance factors and criteria should be

developed. These factors as well as appraisal form, procedures and techniques should
be standardised. It will help to ensure uniformity and comparison of ratings.

4. Training : Evaluators should be given training in philosophy and techniques of

appraisal. They should be provided with knowledge and skills in documenting
appraisals, conducting post appraisal interviews, rating errors, etc.

5. Job Relatedness: The evaluators should focus attention on job-related behaviour

and performance of employees. The results of performance rather than personality traits
should be given due weight.

6. Strength and Weaknesses: The raters should be required to justify their ratings. The
supervisor should try to analyse the strength and weaknesses of an employee and
advise him on correcting die weakness.

7. Individual Differences: While designing the appraisal system, individual differences

in organisations should be recognised. Organisations differ in terms of size, nature,
needs and environment. Therefore, the appraisal system should be tailor-made for the
particular organisation.

8. Feedback and Participation : Arrangements should be made to communicate the

ratings to both the employees and the raters. The employees should actively participate
in managing performance and in the ongoing process of evaluation. The superior should
play the role of coach and counseller.

PERFORMANCE APPRAISAL METHODS:

(A) TRADITIONAL METHODS:

1. Ranking Method: It is the oldest and simplest formal systematic method of

performance appraisal in which employee is compared with all others for the
purpose of placing order of worth. The employees are ranked from the highest to
the lowest or from the best to the worst.

2. Paired Comparison: In this method, each employee is compared with other

employees on one- on one basis, usually based on one trait only. The rater is
provided with a bunch of slips each coining pair of names, the rater puts a tick
mark against the employee whom he insiders the better of the two. The number of
times this employee is compared as better with others determines his or her final
ranki

3. Grading Method: In this method, certain categories of worth are established in

advance and carefully defined. There can be three categories established for
employees: outstanding, satisfactory and unsatisfactory. There can be more than
three grades. Employee performance is compared with grade definitions. The
employee is, then, allocated to the grade that best describes his or her performance.

Such type of grading is done is Semester pattern of examinations and in the

selection of a candidate in the public service sector. One of the major drawbacks of
this method is that the rater may rate most of the employees on the higher side of
their performance.

4. Forced Distribution Method: This method was evolved by Tiffen to eliminate

the central tendency of rating most of the employees at a higher end of the scale.
The method assumes that employees’ performance level confirms to a normal
statistical distribution i.e., 10,20,40,20 and 10 per cent. This is useful for rating a
large number of employees’ job performance and promo ability. It tends to
eliminate or reduce bias.

5. Check-List Method: The basic purpose of utilizing check-list method is to ease

the evaluation burden upon the rater. In this method, a series of statements, i.e.,
questions with their answers in ‘yes’ or ‘no’ are prepared by the HR department

6. Critical Incident Method: In this method, the rater focuses his or her attention on
those key or critical behaviors that make the difference between performing a job
in a noteworthy manner (effectively or ineffectively).

7. Graphic Rating Scale Method: The graphic rating scale is one of the most
popular and simplest techniques for appraising performance. It is also known as
linear rating scale. In this method, the printed appraisal form is used to appraise
each employee.

8. Essay Method: Essay method is the simplest one among various appraisal
methods available. In this method, the rater writes a narrative description on an
employee’s strengths, weaknesses, past performance, potential and suggestions for
improvement. Its positive point is that it is simple in use. It does not require
complex formats and extensive/specific training to complete it.

9. Field Review Method: When there is a reason to suspect rater’s biased ness or
his or her rating appears to be quite higher than others, these are neutralized with
the help of a review process. The review process is usually conducted by the
personnel officer in the HR department.

10. Confidential Report: It is the traditional way of appraising employees mainly

in the Government Departments. Evaluation is made by the immediate boss or
supervisor for giving effect to promotion and transfer. Usually a structured format
is devised to collect information on employee’s strength weakness, intelligence,
attitude, character, attendance, discipline, etc. report.
(B) MODERN METHODS:

1. Management by Objectives (MBO): Most of the traditional methods of

performance appraisal are subject to the antagonistic judgments of the raters. It was
to overcome this problem; Peter F. Drucker propounded a new concept, namely,
management by objectives (MBO) way back in 1954 in his book. The Practice of
management. The concept of MBO as was conceived by Drucker, can be described
as a “process whereby the superior and subordinate managers of an organization
jointly identify its common goals, define each individual’s major areas of
responsibility in terms of results expected of him and use these measures as guides
for operating the unit and assessing the contribution of each its members”.

2. Assessment Centres: The introduction of the concept of assessment centres as a

method of performance method is traced back in 1930s in the Germany used to
appraise its army officers. The concept gradually spread to the US and the UK in
1940s and to the Britain in 1960s.

The concept, then, traversed from the army to business arena during 1960s. The
concept of assessment centre is, of course, of a recent origin in India. In India,
Crompton Greaves, Eicher, Hindustan Lever and Modi Xerox have adopted this
technique of performance evaluation.

Advantages of the assessment centre method:

 Enhance a participant’s knowledge, boost his/her thought process, and

improve employee efficiency
 Can be tailored to fit different roles, competencies, and business needs
 Offer an insight of the employee’s personality (ethics, tolerance, problem-
solving skill, introversion/extroversion, adaptability, etc.)

3. 360 – Degree Appraisal: 360-degree feedback is a multidimensional

performance appraisal method that evaluates an employee using feedback collected
from the employee’s circle of influence namely managers, peers, customers, and
direct reports.
This method will not only eliminate bias in performance reviews but also offer a
clear understanding of an individual’s competence.

This appraisal method has five integral components like:

i. Self-appraisals Self-appraisals offer employees a chance to look back

at their performance and understand their strengths and weaknesses.
However, if self-appraisals are performed without structured forms or
formal procedures, it can become lenient, fickle, and biased.

ii. Managerial reviews Performance reviews done by managers are a part

of the traditional and basic form of appraisals. These reviews must
include individual employee ratings awarded by supervisors as well as
the evaluation of a team or program done by senior managers

iii. Peer reviews : As hierarchies move out of the organizational picture,

coworkers get a unique perspective on the employee’s performance
making them the most relevant evaluator. These reviews help
determine an employee’s ability to work well with the team, take up
initiatives, and be a reliable contributor. However, friendship or
animosity between peers may end up distorting the final evaluation
results.

iv. Subordinates Appraising manager (SAM) : This upward appraisal

component of the 360-degree feedback is a delicate and significant
step. Repartees tend to have the most unique perspective from a
managerial point of view. However, reluctance or fear of retribution
can skew appraisal results.

v. Customer or client reviews: The client component of this phase can

include either internal customers such as users of product within the
organization or external customers who are not a part of the company
but interact with this specific employee on a regular basis. Customer
 reviews can evaluate the output of an employee better, however, these
external users often do not see the impact of processes or policies on
an employee’s output.

4. Cost Accounting Method:

This method evaluates an employee’s performance from the monetary benefits the
employee yields to his/her organisation. This is ascertained by establishing a
relationship between the costs involved in retaining the employee, and the benefits
an organisation derives from Him/her.

5. Behaviorally anchored rating scale (BARS)

It is a method used to identify the most important areas of an employee’s

performance and how much he needs to improve in what aspect of his achieve his
objectives or goals.There is a predetermined behaviour that has shown the most
effective and efficient work performance. Thus, the employees’ behaviour is
measured by comparing them to the predetermined behaviour and how much they
deviate from this behaviour.

The first step in BARS creation is generation of critical incidents that depict typical
workplace behavior. The next step is editing these critical incidents into a common
format and removing any redundancy. After normalization, the critical instances
are randomized and assessed for effectiveness. Remaining critical incidents are
used to create BARS and evaluate employee performance.

Advantages of using BARS:

 Enjoy clear standards, improved feedback, accurate performance analysis,

and consistent evaluation
 Eliminate construct-irrelevant variance in performance appraisal ratings by
emphasis more on specific, concrete, and observable behaviors
 Decrease any chance for bias and ensure fairness throughout the appraisal
process
Common drawbacks of BARS:

1. High chance for subjectivity in evaluations

2. Hard to make compensation and promotion decisions
3. Time-consuming to create and implement
4. Demands more from managers and senior executives

Employee counseling :

Employee counseling is a support system that helps individuals deal with personal, emotional,
or work-related issues that might be affecting their job performance or well-being .

Promotion

Promotion means the movement of an employee from one position to

another position of a higher pay grade or salary.

Transfer

Transfer means the movement of an employee from one position to

another position at the same pay grade level or similar salary

Compensation:
Compensation refers to a wide range of financial and nonfinancial rewards to
employees for their services rendered to the organization.

It is paid in the form of wages,salaries and employee benefits such as paid

vacations, insurance, maternity leave, free travel facility, retirement benefits, etc.

Objectives of Compensation
Objectives / Principles of compensation are as follows :
1) Establish Equity :
One of the important reasons for making compensation plans is to establish equity.
It refers to increasing the wages of the employees who are paid low and
eliminating inequalities in the organisation.
2) Increase Worker's Efficiency :
One of the most important reasons for compensation is to increase the efficiency of
the employees. It plays vital role in the motivation of the employees

3) Macroeconomic Stabilization :
Compensation is aimed at achieving macroeconomic stability. This can be attained
by high employment rate and low inflation rate.

4) Effective Distribution of Labour :

Compensation is designed to distribute labour effectively in labour market which
means that employees can move wherever they find a profitable job

5) Maintain Income-Expenditure Ratio :

If there is a proper compensation plan, then the employees will get the amount of
wages they deserve. They will neither be under-paid nor over-paid. In that case,
employees will not switch the job and organisation will remain in a healthy
financial condition.

6) Avoid Conflicts :
If the compensation system is well planned, the workers will be satisfied and the
workers' union will have nothing to be unhappy and this will create harmony and
peace in the organisation.

7) Legal Compliance :
An effective compensation always complies with the laws. In this way, employer is
also saved from the legal problems.

Different Components of Employee Compensation

1.Basic Salary
The basic pay is the basic salary withdrawn by an employee in an organization. It
depends on the company’s policies and the laws of the company. It is that part of
the salary that is taxed

2.House Rent Allowance (HRA)

Few companies provide their employees with accommodation or home rent

allowances. This is in addition to the paid salary. It is generally calculated based on
the basic salary obtained by an employee.
3.Dearness Allowance (DA)

In some places where there is an inflation in the price of goods and services,
dearness allowance helps curb the impact of the price difference. This component
of employee compensation helps the employees adapt to the changes in standard of
living.

4.Travelling Allowance

Specific organizations provide travel allowances when an employee needs to

travel. It may or may not be included in the basic salary. Its calculation differs
from company to company and requires proof of travel. Often employees use their
funds to travel, which is later reimbursed by the company.

5.Other Special Allowances

Other special allowances are the monetary benefit given to the employee above the
basic salary to meet specific requirements. The employers offer these additional
benefits for the meeting expenditures, etc.

6.Variable Pay

Variable pay is that portion of the salary determined based on employee

performance. When an employee hits a target or does overtime, variable pay is
given in incentives, bonuses, or commissions. It is given out for the additional
contribution beyond an employee’s workload.

7.Stock Options

It is a part of employee compensation where companies employees and executives

of the company are granted equity. These shares are issued by the company and
cannot be sold. It is generally associated with a new company and is awarded to
the employees as an incentive for working hard towards the company’s growth. In
other words, it can also be said that the employees own a part of the organization
 INCENTIVE PLANS- MEANING:

Incentives are the rewards to an employee, over and above his base wage salary, in
recognition of his performance and contribution.

TYPES OF INCENTIVE PLANS

Incentive plans can be broadly categorized into individual, group, and

organizational (or company-wide).

Here's a more detailed look at different types of incentive plans:

I. Individual Incentives:
 Piece Rate System: Employees are paid based on the number of units they produce,
offering a direct link between output and earnings.
 Commission-Based Plans: Popular in sales roles, these plans reward employees with
a percentage of the sales they generate.
 Bonuses: Additional compensation, often tied to specific performance goals or
achievements.
 Merit Pay: Raises or promotions based on employee performance evaluations.
 Awards: Recognizing outstanding achievements or contributions.
 Management By Objectives (MBO) Bonus: Rewards employees for achieving pre-
defined, collaborative goals.
 Referral Bonuses: Incentives for employees to refer new hires or customers.

II. Group Incentives:

 Profit Sharing: A portion of the company's profits is distributed among employees.
 Gainsharing: Rewards employees for cost savings or productivity gains.
 Team Bonuses: Bonuses awarded to entire teams for achieving specific targets.
 Special Projects or Assignments: Incentivizing employees to contribute to specific
projects or initiatives.
 III. Organizational Incentives:
 Company-Wide Bonuses: Bonuses awarded to all employees based on overall
company performance.
 Stock Options: Giving employees the right to purchase company stock at a specific
price, potentially benefiting from stock price increases.
 Tuition Reimbursement: Helping employees pay for educational expenses to enhance
their skills.
 Professional Development Opportunities: Providing training or mentorship programs
to improve skills.
 Extra Time Off: Rewarding employees with additional vacation days or breaks.
 Public Recognition: Acknowledging employees' achievements in front of their peers or
the broader organization.
Additional Considerations:

FRINGE BENEFITS

MEANING:

Fringe benefits refer to those benefits and services that are extended by the
employer to his/her employees over and above their wages and salaries, such as
housing, transportation, subsidized meals, medical care, paid holidays, and the like.
In other words Fringe benefits are rewards given to employees as an extra to their
wage or Salary.

OR

“Fringe benefits are any wage cost not directly connected with the employees’
productive effort, performance, service, or sacrifice.”

OBJECTIVES OF FRINGE BENEFIT:

1. To recruit and retain the talented personnel in the organisation.

2. To maintain sound industrial relations and avoid unrest in the organisation.

 3. To identify unsatisfied needs of the employees and convert those into
satisfying needs by utilizing appropriate steps.

4. To protect social security of the employees during old age by providing

provident fund, gratuity and pension, maternity benefits.

5. To develop a sense of belongingness among employees of the organisation.

6. To comply various legislations related with fringe benefits which are

formulated by central and state Government.

7. To ensure cooperation, loyalty and faithfulness among employees of the

organisation.

8. To develop Brand Image of the organisation in the eyes of public.

Performance-linked compensation:

Performance-linked compensation refers to a system where an employee's

pay, bonuses, or incentives are directly tied to their individual or team
performance, or even the overall business's performance.
This approach aims to motivate employees, align their goals with company
objectives, and improve overall performance.

Employee Stock Ownership Plan(ESOP)

An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers
ownership interest in the company in the form of shares of stock.

Pay band compensation system

A pay band compensation system defines a range of salaries for a particular job or role
within an organization. It establishes a minimum and maximum salary level, with various
salary tiers within that range that align with different levels of experience or
qualifications.