Up for Review: Unravelling the Link between Formal Evaluations and Performance‐Based Rewards

• Date: 01 January 2019
• Published date: 01 January 2019
• DOI: http://doi.org/10.1111/irel.12223
• Author: Tor Eriksson,Jaime Ortega,Rocio Bonet

Up for Review: Unravelling the Link between

Formal Evaluations and Performance-Based

Rewards

*

ROCIO BONET, TOR ERIKSSON and JAIME ORTEGA

We study whether organizations that reward individual performance should give

autonomy or should control how managers evaluate their subordinates. The

normal way to establish control is to formalize the evaluations, so that managers

cannot choose when and how to evaluate. We argue that organizations face a

trade-off because formalization helps reduce biases but also introduces rigidities.

Using linked employer–employee data, we study the link between formal perfor-

mance appraisals and firm financial performance.

Introduction

An important question for organizations is how much autonomy they should

give managers regarding personnel matters. In this paper we consider in partic-

ular autonomy in conducting a key managerial task—the performance evalua-

tion of employees. Performance evaluations can have important consequences

for the organization, particularly when they are used to guide administrative

decisions that link employee performance with organizational rewards and

punishments, such as pay, promotions, or dismissals (Rynes, Gerhart, and

Parks 2005). However, we lack empirical evidence that disentangles the effect

of formal evaluations from that of performance-based rewards.

According to academic research, the answer to the control versus autonomy

question is not obvious because of the trade-offs involved. Control is useful to

*The authors’affiliations are, respectively, IE Business School, Madrid, Spain. E-mail: rocio.bonet@ie.edu;

Aarhus University, Aarhus, Denmark. E-mail: tor@econ.au.dk; and Universidad Carlos III de Madrid,

Madrid, Spain. E-mail: jortega@emp.uc3m.es. The authors thank the editors Steven Raphael and Chris Rid-

dell and the referees for their interest and valuable comments. They also thank Kasper Kristensen for provid-

ing expert research assistance, and participants at the 3rd Wharton People and Organizations Conference, 1st

Madrid Work and Organizations Workshop, Strategic Management Society 31st Annual International Con-

ference, 73rd Annual Meeting of the Academy of Management, 28th EGOS Colloquium, and the University

of Aberdeen and SIRE Conference on New Research in Performance-Related Pay for their suggestions.

Jaime Ortega acknowledges financial support from the Spanish Ministry of Economics, Industry and Com-

petitiveness (grants ECO2012-33308 and ECO2015-69615-R). Rocio Bonet acknowledges financial support

from the European Commission grant WSCA-Grant Agreement No. 239217-7FP-People-IRG.

INDUSTRIAL RELATIONS, DOI: 10.1111/irel.12223. Vol. 58, No. 1 (January 2019). ©2018 The Regents of

the Univers ity of Califo rnia Published by Wiley Periodicals, Inc., 350 Main Street, Malden,

MA 02148, USA, and 9600 Garsington Road, Oxford, OX4 2DQ, UK.

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align managers’decisions with broader organizational goals, forcing them to

internalize these goals (Bolton and Dewatripont 2013), but it arguably reduces

flexibility, limiting their ability to act according to the specific knowledge they

acquire (Baker 1992; Prendergast 2002). In the case of performance evalua-

tions, one of the main concerns with autonomy is managers’conscious or

unconscious biases (Castilla 2008). On the other hand, knowledge of their

workers is to a large extent specific, and excessive control may hamper man-

agers’ability to use this knowledge. In the absence of formalization, it could

be easier for managers to tailor rewards to individual circumstances to better

motivate their subordinates.

For firms, the standard way to exercise control over the evaluations is to

formalize them, so that managers are not completely free to choose when and

how to evaluate. Some examples are rules on the frequency with which man-

agers should evaluate, compulsory use of questionnaires with closed formats,

or restrictions on the scores that managers can give. Though widely spread

and often considered a good practice, formalization is also unpopular among

managers and some academics have questioned the value of formal evalua-

tions. According to one of the main critics, “reviewing performance is good

(...) but employees need evaluations they can believe, not the fraudulent ones

they receive. They need evaluations that are dictated by need, not a date on

the calendar. They need evaluations that make them strive to improve, not pre-

tend to be perfect”(Culbert 2010: 2).

In practice, and paralleling these mixed theoretical views, firms use different

approaches. Performance appraisal processes seem to be a standard practice,

but there are notable counterexamples. Renowned firms such as Adobe, Juni-

per Networks, Accenture, PwC, SAP, and perhaps even more noteworthy due

to their strong tradition on emphasis on numbers, Goldman Sachs and General

Electric, have been featured in the news for their radical approach to change

their performance appraisal system: getting rid of formal evaluations.

In a recent piece, Cappelli and Conyon (2018) provide descriptive evidence

inconsistent with the critics’idea that performance ratings are uninformative.

This idea is generally based on the argument that managers tend to give very

similar evaluations and do not give poor ratings. Using data from a large retail

U.S. corporation, they find that there is large variation in the ratings and that

the distribution of the ratings is close to a normal distribution. They also

explore other claims, such as supervisors giving higher ratings to employees

they know for a long time, and find no evidence consistent with those claims.

Furthermore, Cappelli and Conyon (2018) find that pay levels are related to

changes in the ratings, i.e., employees who improve are rewarded and those

who regress are penalized. This is consistent with a relational model in which

managers are trying to motivate employees to improve future performance, as

Formal Evaluations and Firm Performance / 109