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PROBLEMS WITH THE IMPLEMENTATION OF PERFORMANCE

MEASUREMENT SYSTEMS IN THE PUBLIC SECTOR WHERE

PERFORMANCE IS LINKED TO PAY: A LITERATURE REVIEW DRAWN

FROM THE UK

MIRAL METAWIE

PhD student in Industrial Relations KBS Annex

University of Kent at Canterbury Tel: 01227 82-3375

E-mail: mm248@kent.ac.uk

DR. MARK GILMAN Senior Lecturer in Industrial Relations/HRM

KBS University of Kent at Canterbury

CT2 7PE Tel: 01227 823797 Fax: 01227 761187

E-mail: m.w.gilman@kent.ac.uk

3rd Conference on Performance Measurements and Management Control (Nice September 22-23, 2005)

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Abstract

According to Robert Kaplan and David Norton, (1992; 1996; 2001; 2004), 'the final

linkage from high-level strategy to day-to-day actions occurs when companies link

individuals' reward programs to the Balanced Scorecard'. The objectives of this linkage are,

first, to focus employees' attention on strategic priorities, and second, to provide extrinsic

motivation by rewarding employees when they and the organisation reach their targets.

Performance related pay (PRP) which has been widely introduced especially in the public

sector holds out the promise of providing such a link. Yet, in practice performance

measurement in the public sector has been a problematic area with PRP. This paper will

attempt to address the problems of applying performance measurement systems (PMS) in

linkage to pay systems in the public sector through reviewing the literature of the UK.

An extensive portion of the literature on PMS has been concerned with the economic

benefits of the application of such systems as strategic control systems to increase

productivity through monitoring employees’ activities and influencing their behaviours

(Kaplan and Norton, 1996b; Neely, 1995). This however, brings attention to two issues that

raise doubts in the lucidity of this literature and the validity of using, mainly, economic

theories to assess the benefits of PMS. The first is that though one can note that the most

important element influencing organisational performance is the human factor, economists

and scholars have mostly referred to the success of performance measurement (PM) and

incentive systems in terms of productivity, which though incorporating both financial and

non-financial measures still ignores employee relations and organisational behaviour

theories. In fact if we look at the assessment of PRP systems in several industries within the

public sector (e.g. Civil Service, Local Government, and Nationalized Industries) we come to

the conclusion that whilst it may be successful in generating increased productivity;, its

impact on employees’ behaviours, such as motivation, has been proved negative in most

research. The second is that while there is a logical link between PRP and PMS, in practice

such links seem less coherent than suggested in the literature (e.g. Kaplan and Norton,

1992; 1996b). Yet there is a lack of research on what might be the cause of such

incoherence, even worse, there is a lack of research on the strength of such link. In other

words, overlooking the link between rewards and PMS, leads to neglecting the problems

inherent in measuring the performance of the public sector and the difficulties in finding

unproblematic performance measures.

By looking into different fields namely industrial-psychology, sociology and

economics this paper will identify problems of performance measurement when performance

is linked to pay (PRP). For the purpose of this paper, a literature review of the UK public

sector is conducted in order to highlight gaps in the research area of PRP and PM.

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INTRODUCTION INTRODUCTION INTRODUCTION INTRODUCTION

There has been a substantial body of literature on performance measurement in both the public and the private sector. Though there have been some differences of interest in researching both sectors – in the fact that while more clear examples of application and success have been reviewed in the private sector very few are found in the public sector where it has been reported more problematic – most papers assessing the work on performance measurement and performance measurement models have been mainly presented in the management accounting literature. Historically, PMS have, therefore, been restricted to the traditional financial accounting measures such as Return on Investment, Earning per Share, and Economic Value Added [Kaplan and Norton, 1992; Morisawa, 2002; Neely, 1995; Ballantine and Brignall, 1996], and to the use of frameworks and theories primarily drawn from the discipline of economics (Otley, 1999).

This approach, viewed as successful in the past; has proved more deficient in today’s rapidly changing environment driven by political, economic, technological, and social forces. Politically the increasing importance of corporate governance has held organisations accountable for not only its economic performance but also its social performance which affects the wider external environment. In other words, there has been a shift from adopting a shareholders approach where performance measurements are concerned with the profitability of the business to a stakeholders approach. Due to the growth of the importance of the human resources of organisations, there has also been an increased emphasis on the behavioural aspects of management accounting though still through an economic approach often related to the agency theory (Otley, 1999) – i.e. assessments of the impact of accounting systems on employees’ behaviours such as increased effort, distortion of results, and productivity rather than the softer aspects such as motivation, commitment, and job satisfaction. Similarly, economically, there has been a growth in the importance of the human factor as a calculative receptor, and hence in the need to affect its daily activity through a management control system. Consequently, since the early 1990s more balanced approaches incorporating multi-dimensional performance measures were developed. These include the balanced scorecard developed by Kaplan and Norton (1990-1992), the performance pyramid (the SMART system) developed by Cross and Lynch (1992), the results/determinants matrix (Fitzgerald et al., 1991), and the Performance Prism (Neely et al., 2000-2001).

Before a brief review of these approaches is presented it is important to turn attention

to defining performance measurement. In order to identify the problems of PMS, the following section includes a review of the definition of performance measurement, the rationale behind its implementation and a brief review of the advanced approaches mentioned above. The focus is on the balanced scorecard which has received more attention in the literature, is the most frequently used across sectors, and has also been used for reward reasons.

PERFORMANCE MEASUREMPERFORMANCE MEASUREMPERFORMANCE MEASUREMPERFORMANCE MEASUREMENT: DEFINITIONENT: DEFINITIONENT: DEFINITIONENT: DEFINITION

Though the term performance measurement has been used since the late 1970s, there has not been a universal definition for the term. The Government Accountability Office (GAO), 1980, defined performance measurement as “an assessment of an organisation’s performance, including the measures of:

• Productivity, which quantifies the outputs and inputs of an organisation and expresses the two as a ratio. Generally, the ratio is expressed as output to input.

• Effectiveness, which determines the relationship of an organisation’s outputs to what an organisation is intended to accomplish.

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• Quality, which examines an output or the process by which an output is produced. Quality is indicated by attributes such as accuracy (or error rate), thoroughness, and complexity.

• Timeliness, which evaluates the time involved producing an appropriate output.

(Citizen-Driven Government Performance, 2004)

The most commonly used definition of performance measurement is that of Neely, (1998): “the process of quantifying the efficiency and effectiveness of past actions through acquisition, collation, sorting, analysis, interpretation and dissemination of appropriate data” (as cited in Moullin, 2003, p.3). Though this definition has not stated what the nature of the data collected should be (i.e. financial vs. non-financial) it seems to be concerned with the process itself of measuring performance in the management accounting field rather than its purpose, and restricted to quantitative measures rather than qualitative ones. Hence, Moullin, (2002), defines performance measurement in terms of its purpose emphasizing the assessment of how well organisations are managed and the value they deliver for stakeholders.

Based on the above and using a contingency approach, particularly as in the public

sector uncertainty lies in the problems of linking the means (inputs) to the ends (outputs) (Johnsen, 2000), it will be highlighted that performance measurement is a contextually defined phenomenon in that similar measures may have varying importance and meaning in different organisations (Euske et al., 1993). Hence, scholars tend to focus on issues associated with the design of PMS (e.g. Neely et al., 1995), the values and characteristics of performance measurement (e.g. Newcomer, 1997), the identification of the measures the system should include in different industries (e.g. Haktanir and Harris, 2005, in the hotel industry; Goddard et al., 1999; Ballantine et al., 1998, in the public health services) and the development of new performance measurement frameworks.

It has been widely argued that organizations using balanced PMS report better

performance than those that do not (Lingle and Schiemann, 1996). PMS have undergone considerable changes in the last twenty years with a number of different models developing to help organisations define an appropriate set of balanced – financial and non-financial – performance measures. Yet the most popular model is that of Kaplan and Norton, (1990-1992), the balanced scorecard. The following section, hence, provides a brief review of the most commonly used balanced frameworks as well as the latest developments, highlighting both their strengths and weaknesses, which, in turn, will help identify problems of using these models in determining pay.

PERFORMANCPERFORMANCPERFORMANCPERFORMANCE MEASUREMENT MODELSE MEASUREMENT MODELSE MEASUREMENT MODELSE MEASUREMENT MODELS

Performance measurement has received considerable criticisms in the 1980s and early 1990s for being restricted to financial measures and robust accounting methods in evaluating the performance of organisations or more specifically their profitability. Mostly, it is argued, that these measures ignore the softer less measurable performance indicators as well as the relationship between different business units and their variable objectives (Euske et al., 1993; Ghalayini et al., 1997; Jagdev et al., 1997; Kaplan and Norton, 1992; Nanni et al., 1992; Neely, 1995). Many researchers have also referred to the number of problems that arise from relying on such systems such as short-termism (Crawford and Cox, 1990; Ghalayini et al., 1997; Hill, 1995; Kaplan and Cooper, 1998; Neely, 1995). In response to these criticisms and dissatisfactions with the traditional system new performance measurement frameworks have developed, out of which, the most well-known and commonly used is the balanced scorecard.

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Balanced scorecard

The balanced scorecard was developed by Norton and Kaplan, (1990-1992), to include both financial measures that report the results of actions already taken and operational measures on customer satisfaction, internal processes, and the improvement activities – operational measures that are drivers for the future financial performance (Kaplan and Norton, 1992, p.71). More specifically, the balanced scorecard is based on the combination of four key perspectives in performance measurement: financial perspective, customer perspective, internal business processes, and learning and growth. Evidently, unlike the traditional systems the balanced scorecard puts strategy, vision and communication in the centre rather than control.

Figure 1. balanced scorecard four key measures

(Source: Paul Arveson, 1998 accessed, 24/06/05)

Evidence on the success of the balanced scorecard has been reported across many industries and within the public sector in the US (Hepworth, 1998). Though, attention was drawn to the complexity of the system and the need for commitment towards accepting it for the success of its application, and many pitfalls and problems were identified in practice (Kaplan and Norton, 1996b), no failures of the concept were identified (Hepworth, 1998). According to Ghalayini et al., (1997, p.209), the main weakness of the balanced scorecard is that it is primarily designed to provide senior managers with an overall view of performance; thus, is not intended for, nor applicable, at the factory operations levels. Moreover, as a multi-stakeholders approach, the balanced scorecard has been criticized for not considering the interests of all stakeholders, such as suppliers, competitors, regulators, and community (Neely et al., 1995; Ghalayini and Noble, 1996; Atkinson et al., 1997). Brignal and Modell, (2000), further argue that the balanced scorecard literature has neglected the relative bargaining power of different stakeholders in determining whose interests will predominate in an organisation and the consequent effects on what aspects of performance are measured, reported and acted upon.

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The Performance Pyramid (SMART)

Cross and Lynch, (1992), have recognized the hierarchical levels that exist within an organisation and thus provided a link between the performance measures at each of those different levels so that each function and department strives towards the same objectives which they placed on the summit of the “pyramid”. This model shows recognition for the importance of the human resources in achieving the company’s vision by placing four key operational measures (quality, delivery, cycle, and waste) at department and workcentres on a daily basis at the bottom of the pyramid. The middle level indicators which bridge the gap between the top level indicators and the day-to-day operational indicators include customer satisfaction, productivity, and flexibility. Although this model considers layers between the business units and individual business activities, and hence integrates corporate objectives with operational performance indicators it also combines financial, non financial as well as operational and strategic indicators. It does not, however, provide any mechanisms to identify key performance indicators, nor does it explicitly integrate the concept of continuous improvement (Ghalayini et al., 1997). It should be also noted that the system has not been empirically tested.

The Performance Prism

The performance prism is considered the latest development in performance measurement. As the result of noting that none of the existing frameworks broadly focused on stakeholders, Neely et al., (2001), recognize the importance of taking a holistic approach to stakeholder management in today’s culture of involvement. Its advantages are that it explicitly addresses all stakeholders – not only investors but also customers, employees, suppliers, regulators and communities (Powell, 2004). According to the performance prism vision one of the fallacies of performance measurement is that measures should be derived from strategy. Yet to derive measures from strategy is to fundamentally misunderstand the purpose of measurement and the role of strategy. Hence performance prism starts its process by thinking about the stakeholders and what they want. In fact out of the five facets of the performance prism the first is stakeholders’ satisfaction. The other four include strategies, processes, capabilities, and stakeholders’ contribution. By calling it prism, Neely et al., recognize the complexities surrounding performance and its measurement. Though this model has only been developed recently, it has been tested in few cases (e.g. DHL, London Youth, and the House of Fraser), where feedback has been overwhelmingly positive (Neely et al., 2001). However, given that the attention is placed on the process of finding the right strategies that performance measurement should be based on, performance prism tends to neglect issues such as how the performance measures are going to be realized, hence, little concentration is given to the process of designing the system (Tangen, 2004).

At this stage it should be noted that although there are numerous balanced performance measurement frameworks, few researches have looked into their effectiveness and the economic benefits they yield (Neely et al., 2002) – with most research focusing on the balanced scorecard in particular as it remains the most popular measurement framework – and even less have explored the problems associated with their application.

This paper highlights the problems that still exist, although rather neglected, in the

application of current PMS in the public sector when performance is linked to pay. By using a variety of theoretical approaches, not just thos of economics and accounting, it will also identify new problems that were ignored in narrow evaluations of the systems. Given the purpose of this paper, the following section considers the nature of the public sector, the history of performance measurement, and the development of its application in relation to rewards across the sector.

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PERFORMANCE MEASUREMPERFORMANCE MEASUREMPERFORMANCE MEASUREMPERFORMANCE MEASUREMENT IN ENT IN ENT IN ENT IN THE PUBLIC SECTORTHE PUBLIC SECTORTHE PUBLIC SECTORTHE PUBLIC SECTOR

Like the private sector, public sector organisations around the world face pressure to improve service quality, lower their costs, become more accountable, customer focused and responsive to stakeholders’ needs. While PMS have long been advocated as successful in the private sector, it was once, considered impossible to measure performance in the public sector. The first attempts at the evaluation and review were associated with the failed attempts at large scale strategic planning in the 1970s and it was not until the appearance of organisational and managerial reforms introduced by the conservative governments in the 1980s and 1990s that public sector performance measurement became firmly established (Boland and Fowler, 2000, p.417). It should be noted at this stage that the justification of this paper for drawing evidence from the UK in particular is based on the fact that New Public Management prescriptions have been applied in that country more consistently than in many other countries over a quarter of a century (Cutler and Waine, 2005).

Over time there has been change in the form of PMS in the public sector in the UK

with most systems moving towards a balanced scorecard approach. In a review of the use of performance systems across the UK public sector, Goddard and Mannion, (2000), conclude that there have been clear shifts from collecting data on a narrow range of dimensions of performance to a broader range of performance indicators based on the assessment of the activities of the organisation. Additionally, shifts are also clear in the use of performance information; instead of being used for internal purposes they are now used for external control and accountability. There have also been shifts away from informal performance assessments to formal peer reviews, as well as linking PMS to financial rewards (Propper and Wilson, 2003).

Examples of PMS in the public sector exist in schools where there are two main

systems for measuring schools performance: OFSTED (Office for Standards in Education) established in 1992, which involves an in-depth evaluation of the school’s processes and outcomes, and PI (Performance Indicators) which involves the collection and publication of summary performance indicators including truancy rates and GCSE pass rates. Furthermore, in the NHS, the government has adopted a balanced scorecard approach in their measurement system “Performance Assessment Framework” (PAF). As noted in a recent consultation document:

“The Performance Assessment Framework … is based on the balanced

scorecard approach. The use of the balanced scorecard allows different

organisations to get more rounded view of performance by identifying different

key elements of performance and understanding how changes in them may have

implications for others.”

(Department of Health, 2001, p.2 as cited in, Chang et al., 2002, p.350)

Similarly, the government modernization agenda has been witnessed in the Civil Service Reform. In 2002, Sir Andrew Turnbull, (head of the home civil service) has stated his personal vision for the UK Civil Service in 2005 is:

“ Be respected as much for its capability to deliver as for its policy skills;

Think creatively and operate strategically; Be an organisation that young and

successful people want to join and work with; and Create value for the public

and have values of:

• integrity and trust

• impartiality and readiness to serve all citizens and governments

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• recruitment and advancement on merit

• a make-up that reflects our society ”

It was also stated that emphasis is placed on the civil servants’ own personal performance targets and how these relate to both their departments’ and government’s policy objectives and outcomes (Stephenson, 2003).

Overall, it can be stated that, performance measurement is a central aspect of the public sector reform.

It is essential to point out at this stage that performance measurement in the public sector has had several labels differing between disciplines and perspectives; for example “in public administration both review, evaluation, cost benefit, and policy analysis are employed as characterizations (Simon, 1947; 1997; Wildavsky, 1966, 1969, 1978); in contingency theory (Thompson, 1967) labels as search, surveillance and monitoring were used, and in the resource dependence perspective (Pfeffer and Salancik, 1978) performance measurement was termed as benchmarking, environmental scanning, and monitoring” (Johnsen, 2000, p.7).

While the term performance measurement has been restricted, in some papers, to

the old financial-based measurement systems in the public sector most PMS are now based on a balanced scorecard approach (with only few differences) but under different labels (i.e. Performance Assessment Framework, (PAF), in the NHS, and the Office for Standards in Education, (OFSTED)). Therefore in this paper the terms will be utilized interchangeably.

Although, as stated earlier, there is a gap in the literature about a clear and coherent

link between performance measurement and rewards, there seems to be some parallelism between the development of PMS in the public sector and their performance indicators and the development of PRP schemes. For example, in schools, PRP is based on pupils’ progress being the key performance indicator. Similarly, in 2002, the government has begun piloting “value added” school performance data to supplement the raw data that were previously based on schools’ scores. Equally, in the NHS, traditionally some basic information about the performance of hospitals in England and Wales were made available for internal use by hospital managers; however, it was argued that this information was of little use because there was no link of the performance to financial rewards. Evidence of the government’s support for a salient role for PRP in public sector performance can be found in the 1999 White Paper Modernizing Government where it was stated that:

“the links between pay and objectives are not always clear. We must use

our pay systems – and performance pay in particular – in creative ways to

provide effective incentives to sustained high-quality performance…” (Cabinet

Office, 1999, p.21, as cited in, Cutler and Waine, 2005, p.78).

Arguments in favour of the use of scorecard rewards include focusing employees’ attention on strategic priorities, providing extrinsic motivation by rewarding employees when they and their organisations reach their targets, minimizing gaming and sub-optimization (which will be covered later) through the inclusion of multi-dimensional performance measures.

Before trying to lay down some of the problems that exist from linking performance measurement to pay it would be helpful to explore the nature of the public sector, which might underpin some of those problems.

THE NATURETHE NATURETHE NATURETHE NATURE OF THE PUBLIC SECTO OF THE PUBLIC SECTO OF THE PUBLIC SECTO OF THE PUBLIC SECTORRRR

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Many scholars have referred to profit maximization as the main difference between the private and the public sector (e.g. Boland and Fowler, 2000), and hence the lack of a bottom line against which performance can be measured in the public sector. On the other hand, some argue, that since there still exists an equivalent financial measure to profitability in the public sector which is “value for money”, then, there is no considerable difference between both sectors (Jackson, 1990). In this respect, it can be argued that difficulties with PMS in the public sector do not lie in the lack of bottom line performance measure but in the complexities surrounding its measurements. Notably, however, given a profitability measure and the objective of making a profit, the various levels of a private firm can in principle relate their activities to the contribution they make to the firm’s profitability (Jackson, 1986). The lack of clear objectives for the public sector organisations, on the other hand, makes it problematic to set intermediate objectives for all levels of employees within the public sector. It should be noted at this stage that a key potential role of performance indicators in performance measurement in the public sector is clarification of objectives, which becomes even more important with the presence of PRP and performance management systems such as OFSTED in schools (Mayston, 2000).

According to Dixit, (2002), the one distinguishing feature of the public sector is the presence of multiple principles which influences the optimal performance measurement and incentive structure. Moreover, as a service provider, the public sector will be faced with the difficulties of quantifying their main performance measures such as customer satisfaction, and quality of service (Jackson, 1990); which also mainly rely on human resources who being calculative receptors have discretion over their effort and hence need consistent monitoring and directing towards the organisation’s goals (Neely et al., 1995). As mentioned earlier, reinforcing the daily performance indicators of general employees is done through linking performance measures to rewards. In fact one of the characteristics of performance measurements consistently mentioned is that PM should be derived from the organisations’ business strategies and hence can be used as a strategic control system to influence employees’ behaviours (Robert and Kaplan, 1992; Neely et al., 1995). This is particularly relevant to the public sector where the overall performance is dependent on the human factor. In fact, according to Lynch and Cross’s (1992) performance pyramid, the translation of measures goes from bottom up, where the bottom represents the departments and work centres which are daily monitored against four performance measures. Though Norton and Kaplan’s (1992) balanced scorecard ignores the hierarchical relation between factors leading to the end goal, when defining the measure of internal business perspective, they state that managers should focus on the internal operation from which customer satisfaction is derived.

Based on the above, it can be concluded that, first, performance measurement is not an end in itself and unless it can direct efforts towards organisational goals and influence future performance it would only represent a tool for measuring past activities. Second, it is by linking performance measurement to rewards that organizations can improve future performance. In fact, a recent survey of scorecard implementation in the US found that 70 per cent of the respondents already use the balanced scorecard for compensation purposes and 17 per cent actively considering its use for this purpose (Perrin, 1996, as cited in Ittner et al., 1997, p.5). Furthermore, several authors have highlighted the importance of linking business PMS to rewards (Kaplan and Norton, 1992; 1996; 2001; Eccles, 1991; Neely et al, 1995; Moon and Fitzgerald, 1996; Otley, 1999). However, most of the research in this area has been merely descriptive. For instance, while proponents of the balanced scorecard concept contend that this approach provides a powerful means for translating a firm’s vision and strategy into a tool that effectively communicates strategic intent and motivates performance against established goals, (Kaplan and Norton, 1996), the balanced scorecard literature provides little discussion of the scorecard’s role in compensation decisions, despite the fact that the majority of adopters use it for this purpose (Perrin, 1996, as cited in Ittner et al., 1997, p.2). Evidently, this has brought only the potential benefits of the system to the forefront making companies over-enthusiastic about its application. Nevertheless, there are many problems associated with performance measurement when it comes to measuring individual’s performance in the public sector and even worse when linking it to pay. These

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problems can be classified under two main categories, one related to an economic approach and the other to a psychological one. The rest of this paper will, hence, be organized in two sections, the first will review the economic literature and theoretical underpinning for performance measurement and PRP identifying problems emanating from the use of the economic approach; and the second will look into the psychological literature and its relevance for identifying problems with performance measurement and pay systems and will point at the fact that using the economic literature has rather simplified those problems.

PROBLEMS WITH PMPROBLEMS WITH PMPROBLEMS WITH PMPROBLEMS WITH PMSSSS AND AND AND AND PRPPRPPRPPRP IN THE PUBLIC SECTO IN THE PUBLIC SECTO IN THE PUBLIC SECTO IN THE PUBLIC SECTORRRR

ECONOMICECONOMICECONOMICECONOMIC APPROACH APPROACH APPROACH APPROACH

Principal-agent model

The moral hazard model of incentive design is the main tool economists have used to understand the construction of PMS and the provision of incentives (Courty and Marschke, 2003). According to economists, in many service professions such as in the public service’s individuals (agents) have discretion over their effort, hence, being self-interested, will tend to provide the minimum possible effort that may go unnoticed. Kreps, (1997), states that in the standard model of Agency Theory, without extrinsic incentives, effort is necessarily at the lowest possible level. Shareholders (principals) will, therefore, act to protect their interest through incentive compensation – described by Jensen and Meckling, (1976), as “Agency costs” – that steers the action of the agent towards the principal’s objectives. Given the nature of the public sector (often serving several principals: tax payers, service users, politicians, and professional organisations with conflicting goals), however, makes it problematic to identify the right performance indicators, which if not clearly defined and communicated, can result for dysfunctional and unintended behaviours.

Dysfunctional behaviour

In designing a PRP system principals should put higher incentives towards the tasks that can be accurately measured so there would be less manipulation on effort and results, however, this might cause agents to neglect the other less measurable tasks and spend more effort on the high powered rewards. With multi-tasking in the public sector linking performance measurement with pay to monitor and influence behaviour captures the notion that the investment allocation that maximizes performance outcomes does not necessarily correspond to the allocation that maximizes value-added (Courty and Marschke, 2003).

When individuals respond to performance indicators in a way that maximizes their

benefits this is known as the gaming response; and may include neglecting unrewarded tasks, and manipulating and distorting results. Examples of gaming exist across the whole of the public sector.

In the education sector, where performance measures were based on tests scores changing students’ grades and “teaching the test” in order to boost the results-based rewards in schools occurred. Additionally, there was a focus on pupil attainment neglecting some of the activities that lead to productivity but are not rewarded such as teaching citizenship, conflict resolution, and interpersonal skills whose development is an important aim in primary schools (Courty and Marschke, 2003).

The recognition of most of the problems mentioned earlier concerning public sector multi-tasking, multi-principals, and the lack of objectives, was one of the drivers for the development of a new system entailing additional performance measures including academic and non-academic indicators. Under the new scheme, first applied in July 2000, teachers’ performance indicators are assessed against five main criteria:

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•Pupil progress. •Wider professional effectiveness (two dimensions). •Teaching and assessment (three dimensions). •Knowledge and understanding. •Professional characteristics.

Source: (DfES, 2001a)

Clearly by placing pupils’ progress on top of the criteria there is a shift to value-added based rewards. Little research was conducted to evaluate the impact of the new school PRP system on teachers’ effort, based on the economic approach, and concluded that an increase effort and test score gains were evident (e.g. Burgess and Croxson, 2001; Burgess et al., 2001; Atkinson et al., 2004). However, by only focusing on one criterion (i.e. pupils’ progress) there is a lack of data on whether the improved results represented extra effort on performance as a whole or only on this criterion and, hence, is merely a diverted effort from other professional activities rather than improved performance. Consequently, in consistently following the agency theory approach, it can still be argued that since agents tend to produce the least effort or the necessary amount that leads to the benefits, then, under the new system problems of sub-optimization, distortion, and gaming still arise. However, this is only a suggestion based on a theoretical ground. Hence, more research is needed to evaluate the progress in other criteria such as professional effectiveness, professional characteristics and knowledge and understanding.

In respect to the gains in the test scores and improved pupil performance another

problem arise which is the sub-optimization of the educational outcomes compared to the wider social goals and misalignment of performance measurement objectives with the objectives of reward. Sub-optimization occurs when there is a lack of congruence between PRP measures and the global objectives of the organisation. Mayston, (2000), argues that one of the measures valued by society is student satisfaction. The current priority given to pupil’s progress and maximizing the reported examination results may lead students to experience additional stress and pressures from further increasing their examination results which will consequently reduce their satisfaction and sense of fulfillment from the educational process itself. Even worse the drop in students’ satisfaction, in turn, may impair their examination performance (Mayston, 2000).

Moreover, given that, PRP operating in schools is an individual-based scheme,

where teachers are assessed individually against the performance measures and are given an incremental progression up through a scale of nine increments which once reached become permanent in their salaries two hypothesis can be derived. The first is that, since PMS in this case are school-based as opposed to teachers’ individual assessment, there is a misalignment of the objectives of PRP and PMS. The second is based on the fact that since reward increments go into teachers’ permanent salary meaning that even if performance drops the salary will remain the same, then, performance measurement in linkage to pay would only be a tool for monitoring past performance and controlling the wage bill rather than improving future performance.

Evidence on unintended responses and dysfunctional behaviours is also apparent in

the health sector. Goddard et al., (2000), found evidence of gaming concerning efficiency, where respondents were reluctant to produce improvement in costs for fear that the following year’s efficiency targets would be set at a higher level. He also noted that “financial regime in which Trusts operate encouraged Trusts to fail to meet their financial target as these were often “bailed out” by the region” (p.105).

Clearly the performance assessment framework being based on a balanced

scorecard approach includes wider performance measures based on financial, clinical and patient-care indicators for hospitals (Popper and Wilson, 2003). Yet, the lack of measures

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relating to clinical outcomes was evident in Goddard’s et al., (2000) study on Performance Assessment Framework, which they called tunnel vision. In the same study, two other problems were reported. It can be assumed that the first one which is misrepresentation corresponds to distortion of data in the educational sector. Distortion and misrepresentation of data can exist in the appraisal process itself where agents (teachers or clinical staff) can only focus on the positive sides of their achievement (Forrester, 1998) since many of the data used to measure performance are under the direct control of those staff (Goddard et al., 2000). Similar to the reasons of gaming in the health sector, misrepresentation of data can sometimes be negative, extending waiting times because again there is tendency to provide additional funds to Trusts who fail to meet their objectives (Goddard et al., 2000). In this respect, selecting performance measures that optimally trade off the desire of controllability with the need of goal alignment are argued to be crucial for the success of PRP [Baker, 2002].

Subjectivity and perception of fairness

To avoid the problems associated with basing pay on more or less objective measures such as misallocation of effort by the agent, gaming, misrepresentation and distortion, and short-termism principals have to weaken the power of incentives on the more accurately measured tasks (Burgess and Ratto, 2003). This, however, gives rise to issues surrounding the difficulties of determining the relative weights to place on various measures when determining rewards. Evidently the flexibility in weighting quantitative performance measures against qualitative indicators will result in the introduction of subjectivity into the reward process. Consequently, problems such as inequity, unfairness, and mistrust will arise.

The issues of equity and fairness have been addressed by different theories, reciprocity theory, equity theory, and relative deprivation theory.

According to equity theory (Adam, 1963; Adams, 1965) people compare the ratios of their own perceived work outcomes to their own perceived work inputs to the corresponding ratios of a comparison with others (as cited in Greenberg, 1990, p.400). If employees’ investments are not proportionate with the rewards given, inequity arises and employees will attempt to restore the balance, which in turn, results in a range of undesired outcomes. In fact, recent research supporting the predictions of equity theory shows that neglecting internal comparisons of fairness may have a deleterious impact on the health of the psychological contract since inequity is associated with job satisfaction (Perry, 1993; Ago et al., 1993; Witt and Nye, 1992; Berg, 1991; Summers & Hendrix, 1991; Moorman, 1991; Covin et al., 1993, as cited in Balkin et al., 1998), absenteeism and turnover (Geurts, Schaufeli, & De Jonge, 1998; Iverson &Roy, 1994; Van Yperen, Hagedoorn, & Geurts, 1996 as cited in Taris et al., 2002; Covin et al. 1993; Weiner, 1980, as cited in Balkin et al., 1998), and lack of organisational commitment (Schaufeli, Van Dierendonck, & Van Gorp, 1996 as cited in Taris et al., 2002). Though it is difficult to argue with the basic principle: “that it is equitable to reward employees according to their contribution” (Thompson and Milestone, 2001, p.35), there is a large behavioural literature arguing that treating employees differently from each other is detrimental to employee morale (Baker et al., 1988). In their evaluation of PRP in the NHS, Richardson and Dowling, (1997, p. 354), further argued that the inclusion of qualitative data in performance measurement produced frequent scepticism, both on the possibility of measuring the job performance of NHS managers at all properly, and on the likelihood of subjective judgments .

While it was stated in that study that only a minority, 24 per cent felt that their appraisal interviews were not conducted appropriately, 26 per cent did not understand how their performance was measured, 30 per cent felt that their performance was not measured fairly, 67 per cent thought that there was a significant degree of subjective judgment in the making of PRP awards. Stronger evidence of unfairness is also apparent in the research conducted in BT (British Telecom) where only 6.5% of the respondents said PRP at BT had brought an improvement in managerial performance, while as many as 63% believed it had

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been applied unfairly in practice causing de-moralization (Kimble, 2005). In the Inland Revenue, it was added that de-motivation also arose from perceiving the whole concept as unfair. In order to maintain trust and effective working relationship with their peer group managers tend to distribute the pot of PRP fairly between the team rather than reward high performers. This, nevertheless, raised doubts in operating PRP fairly in a cash limited environment like the public sector. In respect to subjective performance measurement Lawler, (1971), concludes that “pay plans based on subjective criteria have little chance of success” because employees don’t trust superiors to accurately evaluate their performance. He, further, argues that, “the more subjective the measure, the higher the degree of trust needed, because without high trust there is little chance that the subordinate will believe that his pay is really fairly based on performance.” (p.171, as cited in Baker et al., 1988).

It should be noted that the notion of fairness not only exists in the appraisal process

but also in the process of negotiating the contract. It is the reciprocity theory that postulates that agents prefer a condition of fairness in their exchange relationship with the principal. In this respect, the perception of fairness of a contract is an important element of the psychological contract, which helps predict the kind of reward employees are expecting in exchange for their level of effort invested in the company (Hiltrop, 1996). However, once more, standard agency models tend to rather simplify this type of interaction between the agent and the principal (Herpen, et al., 2003).

Based on the above it can be hypothesized that by ignoring the psychological interaction in the process of performance measurement economists tend to ignore issues such as social comparison, equity, and trust.

Though equity has been treated within the economic literature, little attention has been placed on equity as one of the variable leading to motivation, thus more attention needs to be paid to the psychological consequences of systems such as performance measurement on behaviours.

PSYCHOLOGICAL APPROAPSYCHOLOGICAL APPROAPSYCHOLOGICAL APPROAPSYCHOLOGICAL APPROACH CH CH CH

Although agency theory has been used by most economists as a theoretical underpinning for PMS and incentives, economic literature has largely neglected the various psychological effects of monetary rewards on behaviour and thus on effort (Frey, 1997). Similarly, evidence of increased effort and productivity in the public sector is apparent in many of the studies based on an economic approach (e.g. Burgess and Croxson, 2001; Burgess et al., 2001; Atkinson et al., 2004) as well as a psychological approach (Richardson and Dowling, 1997; Marsden and French, 1994; Heery, 1996; Marsden and French, 1998); hence PRP systems were sustained. Yet, impact of these systems on employees’ behaviour such as motivation has been negative (Thompson, 1992; Marsden and French, 1998; Marsden and French, 1994; Richardson and Dowling, 1997; and Marsden, French and Kubo, 2001).

Despite the fact that agency theory contributes to understanding the behaviour of

agents and provides a rich fund of practical implications for the design of incentive contracts (Pfuff and Kunz, 2002), evidently, economists have taken a clinical approach to human motivation, meaning that the behaviour of agents is assumed to be rational (Herpen et al., 2003). Employee resistance towards pay for performance systems in the public sector may therefore be little understood by economists, given the perceived potential benefits of tying pay to performance. Industrial organisational psychology, organisational behaviour, and sociology, on the other hand, have paid greater attention to the complexities of the concept of motivation, looking at both, intrinsic and extrinsic motivation, thus, providing alternative explanations for why monetary rewards may be counter-productive.

The following section will draw attention to the importance of the psychological, social

psychological, sociological, and organisational behaviour theories and their relevance to

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performance measurement and rewards with the aim of highlighting their contribution to performance measurement and reward studies.

Problems with motivation

Though economic arguments for the introduction of PRP, based on agency theory, are often flawed, motivation is always referred to as the main reason for the increased level of efforts. Consequently, the rationale and objectives of PRP have been mostly reported as to better motivate staff by basing salary on performance rather than seniority. Hence, most empirical researches have tested the impact of PRP on employees’ motivation in the public sector through the lenses of two main theories; expectancy and goal-setting theory.

According to the expectancy theory motivation is affected by three factors. The first is expectancy which concerns the individual’s perception that effort is positively correlated with performance. The second factor is instrumentality, which concerns an individual’s expectation that this reward is closely tied to his performance; and the third is called valence and is a measure of the degree to which an individual values a particular reward. Although expectancy theory has been criticized for being based exclusively on extrinsic rewards, ignoring the role played by other intrinsic incentives in motivating individuals, it should be noted that the theory indicates that money can act as a motivator only if it is perceived as a means of achieving goals in the presence of a clear link between effort and reward. Thus, the emphasis is on the intrinsic motivation of the perceived relationship effort and good outcome for effort incentives (Sloof and Praag, 2005).

It is argued that the second and third factors of the model can be translated into the

agency model, where instrumentality is given by the incentive intensity in the agency model, while valence refers to the arguments that appear in the agent’s utility factor – i.e. wage and effort (Sloof and Praag, 2005, p.8). The only factor that differentiates the two theories is expectancy which might explain the agent’s reaction to the pay-performance sensitivity when they select their level of effort. Though it was found that levels of efforts are invariant to expectancy (Sloof and Praag, 2005), and thus productivity increased regardless of that factor, motivation was reported as negative (Thompson, 1992; Marsden and French, 1998; Marsden and French, 1994; Richardson and Dowling, 1997; and Marsden, French and Kubo, 2000).

From the above it is evident that imperfect performance measurement remains one

of the central reasons for employees’ disenchantments with PRP in the public sector. In fact, Marsden, (2004), maintains that the quality of appraisal which plays a central part in both expectancy and agency theory is the key independent variable for the perceived incentive and divisiveness of PRP.

Murnane and Cohen, (1986), claim that PRP works best where there are clearly

measurable outcomes, which, does not apply to the case of the service sectors [Chamberlin, et al., 2002, p34]. In the public sector jobs, where measurable outcomes are unclear, where PRP has been introduced, no evidence was reported of improved motivation. Marsden, (2004), provides summary evidence on employees’ responses to PRP in six areas of he public sector: Inland Revenue, (1991 and 1996), the Employment Service, two National Health Service Trusts Hospitals, and head teachers in primary and secondary schools in table 1.

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(Marsden, 2004, p.357)

In studying the effect of PRP on employees’ behaviours in four different local authorities in the local government, Heery, (1996), concludes that:

“… PRP schemes of the kind operated in local government tend to have

a rather limited impact on workers’ behaviour. The process of work in the four

authorities, it seems, runs along its established course and PRP has been

insufficient to jolt it down a radically new path… PRP in this respect appears to

be something of a damp squib” (p. 219).

Similarly, in their study conducted in the Inland Revenue, Marsden and Richardson, (1994), concluded that:

‘The positive motivational effects of Performance Pay . . . were at most

very modest . . . Even worse, there is clear evidence of some de-motivation’ (p.

253).

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Moreover, in the follow-up study conducted by Marsden and French in the Inland Revenue in 1996, a significant rise in the reported adverse behavioural effect with the system was evident, indicating that familiarity with the system do not generate more approval (Richardson, 1999). Similarly, in the Employment Services, Marsden and French, (1998), found that most staff did not believe it had raised their own motivation, and hence, concluded that the net effect of performance pay on motivation has been negative. Echoing the above results are teachers’ responses to the effect of PRP in two schools, where motivation has been reported negative (Marsden and French, 1998).

Contrary to the above, however, is the study of the NHS, where there were

significantly higher percentages of reported motivation; though not higher than 30 per cent, this number is still significant given that the rest of the respondents did not report de-motivation but rather no effects (Richardson and Dowling, 1997). It should be noted that, appraisal systems, in this case, operated in light of the goal-setting theory, which might set the explanation why the scheme appears to be more motivating to managers.

Goal-setting theory places less emphasis on rewards and stresses the motivating power of defining appropriate work goals and engaging employee commitment to them (Marsden, 2004, p.354). A number of studies have attempted to examine the relationship between goal-setting and performance. It was found that the majority of evidence suggests strong support for the theory. In fact, it is where managers were not sure of their objectives, doubts into the credibility of the system evolved. Marsden, et al., (2001), found that when employees thought PRP had led managers to set targets more clearly (because they have to appraise them afterwards), and if they thought their last appraisal fair, then they were more likely to experience positive incentive effects (p. 11). Additionally, evidence on the fact that PRP helps setting goals more clearly was apparent in the Inland Revenue and the NHS where the clarification of objectives, that the scheme had introduced, was seen as more effective motivator than money and was seen as one of the main pillars of the success of the scheme (Marsden and French, 1998).

Inevitably, however, some contrary findings are especially evident when identifying

performance dimensions by using a goal-setting theory is followed by another set of issues concerning how these dimensions and goals can be measured [Mullins, 1999]. In the Inland Revenue, there was no evidence that clearer goals helped motivation towards better performance particularly that the majority of individuals felt that they were already working at their maximum level of effort. Similarly, in 1996, research conducted in a multi-divisional company in Ireland argued that, despite the fact that 87 per cent of managers considered that their set objectives were 'clear and specific', 78 per cent still ranked 'measurement of performance' as one of the top three disadvantages with the system, indicating that clear and specific objectives do not necessarily result in an adequate measure of performance (Kelly and Monks, 1996). Additional difficulties with the measurement of performance were also evident in the comments which reflected the problems involved in defining and measuring goals, especially for managerial positions: 'True goals are hard to clarify and harder still to judge' (manager, 1996, as cited in Kelly and Monks, 1996).

Once more, the role of clear measures and fair performance measurement system is

apparent in need for a successful reward system as a motivator. Moreover, extrinsic rewards were not perceived as the prime motivator given the nature of the public sector (i.e. serving the community). In fact, it was claimed that PRP contradicts the personal standards or the ethos of the NHS, as one manager stated (Dowling and Richardson, 1997):

Pay in the NHS is definitely NOT a motivator. Most of my colleagues

work far in excess of their contracted hours for little or no financial rewards.

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…Having worked as a professional paramedic for 18 years before going

into general management I have never been motivated I believe by financial

reward and this continues to be the case in general management. My motivation

is to get the job done to the best of my ability. (p. 356)

From the above statement there is clear evidence that managers are more intrinsically motivated by the desire to produce public value from which the community will benefit.

Moreover, it is argued that setting financial rewards based on performance may

actually be counter-productive in that it may send the signal that the relationship between the workers and the organisation is a pure market relationship (Burgess and Ratto, 2003, p.10). Yet economists have tended to exclusively use the agency theory to analyse the linkage between and working of performance measurement and reward system, neglecting the importance of providing a balance between intrinsic and extrinsic motivation, and it was not until recently that attempts have been made to insert psychological approaches in economic theory (Frey, 1997; Frey and Jegen, 2001; Osterloh and Frey, 2000).

The basic idea that extrinsic rewards may have a deleterious effect on intrinsic

motivation stems from the psychological theory called cognitive evaluation theory (Deci, 1975) which argues that individuals strive to fulfil two basic needs: self-determination and competence. Subsequently, Deci, (1975), argues that providing financial rewards, places emphasis on the extrinsic motivation driving the focus away from the intrinsic one. Moreover, he differentiates between two aspects of every reward, a controlling and an informational one. If rewards place emphasis on the control factor, feelings of self-determination and competence decrease in light of restricting the individual’s action and hence, diminish intrinsic motivation; contrastingly, emphasizing the informational aspect can increase the intrinsic motivation since it provides individuals with information about their level of competence and self-determination (Kunz and Pfaff, 2002). Recently, the concept of intrinsic motivation has enjoyed increasing popularity in the economic field. The integration of psychological theories in the economic theory, consequently, resulted in the development of the motivation crowding theory (Frey, 1997), which is closely related to the cognitive evaluation theory. The crowding theory by suggesting that monetary incentives will crowd out intrinsic motivation opposes the economic view held by the agency theory that levels of effort will be affected by the level of incentives. Although, Frey, (1997), states that the motivation crowding theory explores the psychological effects of monetary rewards and effort in order to treat the weakness of economic theories which only considered the absolute monetary incentives and strategic benefit, more empirical research need to be done in that area in order to examine the effectiveness of performance measurement and reward systems and their impact on employees’ behaviours particularly on the long-term.

It is worth mentioning at this point that from an agency theory perspective, it might be

argued that the negative motivational impact and the divisiveness of PRP reported in the public sector could simply be the result of employees’ resentment to the system since according to the agency theory such systems oblige employees to produce more effort. By arguing that there is only a minority of employees in the public sector who would “shirk” because of high levels of organisational commitment among public servants Marsden, (2002), implies questioning one of the factors presented in the agency theory and its relevance to the public sector: providing minimum level of efforts. However, with recent studies referring to new employment relation and the changing state of the psychological contract in the public sector (Anderson and Schalk, 1998; Millward and Hopkins, 1998; Rousseau, 2000; Hecker et al., 2002; Rousseau, 2004) one should reconsider measuring the state of commitment among public servants. In fact, Le Grand, (1997), argues that the

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nature of public services is changing from one where employees were seen as serving the community to one where all parties are self-interested. On the other hand, this change in the nature of the psychological contract can be argued to be the result of more flexible measurement and pay systems, as it is noticed that this change only came about at the same time that rewards were transformed from being based on seniority to one where employment contracts lack security given a reward based on performance.

CONCLUSION CONCLUSION CONCLUSION CONCLUSION

Performance measurement systems, which assess an organisation’s performance against its performance indicators, have been widely applied in the public sector after the modernisation agenda characterised under the heading “Public Sector Management”. Although performance assessment is not a new phenomenon to the public sector, performance measurement has undergone considerable changes over the past decade with an increasing emphasis on the use of a combination of financial and non-financial performance measures following the extensive criticism traditional systems have received for being short-term and lacking a link to business strategy. One of the central aspects of this change and a central defining feature of the New Public Management is linking the measurement of the public services’ performance to financial rewards. In fact, several scholars have highlighted the importance of linking performance measurement systems and particularly the balanced scorecard to rewards. Hence, the past decade has witnessed a growing body of literature on performance measurement and performance related pay in the public sector.

Benefits of linking performance measurement to rewards include providing a powerful means of linking and communicating the organisation’s strategy to all levels employees, and motivating employees by clarifying goals and targets (e.g. Kaplan and Norton,1992; 1996; 2001; Eccles, 1991; Neely et al, 1995; Moon and Fitzgerald, 1996; Otley, 1999). However, by reviewing the literature of performance measurement and performance related pay, this paper suggests that there still remains a gap in the literature concerning three main issues. First, the literature on the balanced scorecard provides little discussion of the scorecard’s role in determining rewards. Thus, companies are left with deciding on the choice of multiple measures and their weights with little information on how to create a balance in the compensation scheme. Second, there is a lack of evidence on the strength of the linkage of performance measurement and reward systems in practice. Evidently, by reviewing the literature of both performance measurement systems and performance related pay systems in the public sector, this paper hypothesises that there is a misalignment of objectives between both systems. For example, in the education sector performance measurement systems (OFSTED) produce school-based reports while rewards are based on individual performances, which is claimed to discourage teamwork. However, few empirical researches have evaluated this linkage. Yet, their findings are not consistent. For instance, while Kaplan and Robert, (2004; 2001), show positive effects of using performance measurement in determining rewards, Ittner et al., (1997; 2003), and Goddard et al., (2002), show that linking performance measurement to rewards may result in dysfunctional behaviours, including gaming, tunnel vision, misrepresentation, neglecting tasks, and short-termism. Moreover, the level of subjectivity found in the process of measuring performance has proved to have a negative impact on employees’ behaviour and cause demoralisation when it comes to linking pay to performance (Marsden and French, 1998; Dowling and Richardson, 1997; Marsden and Richardson, 1994; Heery, 1996). The third gap arising here is that, though few researchers attempt to insert psychological approaches in economic theory most research in this area has been presented in the economic field and has rather simplified its interrelation with other fields such as sociology, industrial relations, and organisational psychology, which in fact draw more attention to the importance of the human resources and hence to the psychological aspects and consequences of performance related pay on employees’ behaviours. Subsequently, again this seems to weaken the linkage between performance measurement and performance related pay systems.

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A central element to reviewing performance measurement systems is the nature of

the public sector. Many scholars have recognised the differences between the nature of the public sector and the private one, referring to the presence of multiple tasks and multiple principles as well as the lack of profit maximisation as the main differences and hence the main complexities surrounding the application of performance measurement and performance related pay systems in the public sector. However, there has been a disregard or rather a simplification of the psychological aspects inherent in the public sector namely public service ethos. Traditionally under the notion of public sector ethos employees benefited from an open-ended employment contract, which, in turn, created a psychological contract that is relational in nature where employees were motivated and committed to providing maximum effort and best quality services to the community in exchange for long-term job security. With the New Public Management Reform increasingly importing practices from the private sector in order to improve quality and performance, it is suggested that the public sector economy is becoming more market-driven which is suggested may be endangering the public sector ethos (Morgan and Allington, 2003) and changing the nature of the psychological contract (Hiltrop, 1996). It is argued that changing rewards from seniority based to more flexible rewards based on performance, have affected employees’ feelings of job security, and hence, tend to reduce the peculiar commitment and motivation previously found among public sector workers.

Although, as stated earlier, advocates of the agency theory might argue that the resentment of employees against systems such as performance measurement and performance related pay is due to the fact that agents are expected to ‘shirk’ and with the studies suggesting a change in the psychological contract, one would believe such argument, Marsden et al., (2001), concluded that employee commitment was the main factor sustaining performance related pay systems in the public sector albeit combined with a negative impact on behaviour. It is, hence, important to draw more attention to the level of commitment in the public sector, the nature of the psychological contract, and the impact of such systems on not only behaviours (i.e. motivation) but also attitude (i.e. commitment). Finally this means that more attention and investigation is required into the nature of the effort bargain from multiple perspectives: economic, sociological and psychological, to name but a few.

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