{"id":16079,"date":"2026-01-08T12:02:52","date_gmt":"2026-01-08T12:02:52","guid":{"rendered":"https:\/\/ideainthebox.com\/index.php\/2026\/01\/08\/build-better-pay-for-performance-pfp-compensation-plans\/"},"modified":"2026-01-08T12:02:52","modified_gmt":"2026-01-08T12:02:52","slug":"build-better-pay-for-performance-pfp-compensation-plans","status":"publish","type":"post","link":"https:\/\/ideainthebox.com\/index.php\/2026\/01\/08\/build-better-pay-for-performance-pfp-compensation-plans\/","title":{"rendered":"Build Better Pay-for-Performance (PFP) Compensation Plans"},"content":{"rendered":"
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Carolyn Geason-Beissel\/MIT SMR | Getty Images<\/p>\n<\/figcaption><\/figure>\n<\/p>\n

An increasing number of companies<\/span> are tying employees\u2019 compensation to their performance, and for good reason. The pay-for-performance (PFP) model has always been common in sales but has expanded in recent years to public school systems<\/a> and even doctors\u2019 offices, where 45% of doctors now receive PFP<\/a>, up from 29% in 2012. These trends show no signs of stopping, especially as AI opens up possibilities<\/a> for personalized compensation plans that use real-time data to better connect pay and performance.<\/p>\n

This growth is not without cause. The latest research shows that compared with fixed pay, PFP is positively linked with higher job performance. These effects hold for either interesting or routine<\/a> tasks, work that requires creativity<\/a>, and for jobs ranging from blue-collar manufacturing to chief executives (think Elon Musk\u2019s trillion-dollar compensation package at Tesla). PFP can not only help incentivize current employees but also help shape the workforce, given that high performers are more attracted to organizations that have implemented it<\/a> while low performers tend to leave.<\/p>\n

But PFP also has a downside. It can create competition and jealousy<\/a> at work, undermining cooperation<\/a> and creating a cutthroat culture that can backfire to harm performance. It can also harm employees\u2019 health: Research shows a 4% to 6% increase<\/a> in the use of antidepressant and antianxiety medication after PFP is implemented. And it can increase burnout, leading to higher employee turnover and\/or low engagement. This creates a dilemma for business leaders: Is PFP a best practice for enhancing performance or a costly and unsustainable strategy to be avoided?<\/p>\n<\/p>\n

Zeroing In on Uncertainty<\/h3>\n

To answer that question, we isolated one specific aspect of PFP that we expected to be particularly detrimental \u2014 the uncertainty around how much one will earn. Our hypothesis was that uncertainty in pay will create added stress for employees, who will become hyperfocused on maximizing their earnings as a means of hedging against this uncertainty. After all, if you\u2019re unable to predict how much you will earn, you\u2019re likely to overwork to ensure that you make enough money to make ends meet. While this overworking may have performance benefits, working too much incurs costs for both employees (in terms of physical health and burnout) and employers (such as increased absenteeism, sick leaves, and turnover).<\/p>\n

We tested these predictions across five experiments with over 1,400 participants in both the United States and Spain, and the results were recently published<\/a> in the Journal of Applied Psychology<\/cite>. Our experiments were conducted both in the lab with community members and online with gig workers, who often contend with pay uncertainty. Simulating a cognitively demanding and repetitive work task, we asked participants to solve addition problems or captchas in exchange for tokens for each correct answer. These tokens were converted to cash at the end of the experiment.<\/p>\n<\/p>\n

With this setup, all participants were paid based on their performance \u2014 meaning the presence<\/em> of PFP was held constant. Our goal was to look within PFP to examine the specific impact that pay uncertainty has on employees. To do this, we divided participants into two groups. In the \u201cpay certainty\u201d group, participants earned 12 tokens for each correct answer, every time. In the \u201cpay uncertainty\u201d group, participants earned anywhere from 1 to 23 tokens for each correct answer. This means that both groups averaged 12 tokens per correct answer, so the total amount<\/em> they earned did not vary across the two groups. The only difference was in how certain their payoff was for any one correct answer. <\/p>\n

To understand how pay uncertainty affects employees\u2019 decision-making and information processing, we implemented an exchange rate that systematically decreased the value of the tokens for the pay uncertainty group as the experiment progressed. While participants could earn a decent wage during the first half of the experiment, earned token value decreased dramatically, so by the end, they were making a measly 0.024 cents for each correct answer. Importantly, participants were able to quit the addition or captcha task at any time and could spend the remainder of the experiment simply relaxing and browsing the internet. By providing this option, we could determine how people balance the drive to earn income with the need for rest and recovery and how that balance might shift depending on the extent of pay uncertainty. <\/p>\n

Across all five of our studies, we found that those people in the pay-uncertainty condition worked longer, on average, even when the financial rewards they received for doing so were negligible. While participants tended to leave the task to browse the internet as their financial rewards decreased, the rate at which they did so differed based on how they were paid. Those who were consistently paid 12 tokens quickly recognized when their efforts were no longer rewarded and left the task when their token pay level dropped. In contrast, those who were paid an uncertain number of tokens for each correct answer persisted for longer in the task, even when their pay decreased substantially. <\/p>\n

This persistence had costs for participants, however. Because those in the pay-uncertainty condition neglected necessary rest and recovery by quitting too late, they reported higher levels of stress at the end of the experiment. These results show that it\u2019s not PFP itself that is inherently harmful but rather the uncertainty that can come along with it that pushes people to overwork and neglect their own well-being.<\/p>\n<\/p>\n

Why would people keep working even when their pay becomes negligible? Our follow-up studies showed that those in the pay-uncertainty group felt more financially insecure. As a result, they developed tunnel vision, where they focused on working harder and longer to maximize their earnings. Because of this tunnel vision, however, they failed to take into consideration the falling value of the rewards. They were stuck on the hamster wheel, lacking the mental bandwidth to recognize that the rewards they were chasing were no longer worth the effort. <\/p>\n

Importantly, participants generally preferred to work in the pay-certainty group when given the option. This means that they were not working longer in the pay-uncertainty group because they enjoyed the task more or preferred uncertain rewards. Overall, this suggests that pay uncertainty pushed people to work longer and neglect recovery, not because they wanted to but because they were compelled by a sense of financial insecurity \u2014 not exactly the kind of driving force you want motivating your employees.<\/p>\n

Three Reasons Why It Matters<\/h3>\n

These findings are relevant for business leaders in several regards. First, this tendency to overwork in the face of pay uncertainty can result in substantial burnout-related costs to organizations<\/a> if left unchecked. Over time, employees\u2019 health will suffer, and that will have direct consequences for organizations in terms of sick days, turnover costs, and work-culture toxicity<\/a>. <\/p>\n

Second, employees who are thinking about financial insecurity will have less headspace to devote to the kinds of high-quality and innovative solutions that drive businesses forward. Financial insecurity acts as a distraction, limiting performance potential<\/a> and increasing the risks of workplace accidents. Employees might also be less willing to help one another as they focus only on maximizing their own earnings \u2014 thus poisoning the organizational culture. <\/p>\n

Third, our findings identified unforeseen risks of a pay strategy that has become increasingly common. The gig economy, for example, is rife with examples of companies intentionally increasing pay uncertainty through surge pricing and bonuses. But our research shows that companies do so at their own peril and should be well informed of the risks and potential downsides of this strategic choice.<\/p>\n<\/p>\n

How to Build Better Compensation Plans<\/h3>\n

Getting compensation strategy right is critical not only for maintaining competitiveness and employee engagement but also for protecting employee well-being and ensuring a sustainable workforce. The good news is that pay policies are changeable, unlike more complex organizational features that are difficult to evaluate, let alone change, such as company culture. In contrast, organizational leaders can directly alter pay policies and change incentives immediately, creating a lever for positive change. Consider these evidence-based recommendations for getting the most out of performance-based pay. <\/p>\n

1. Write clear rules that reduce uncertainty at review time.<\/strong> PFP can be beneficial, if implemented appropriately. To capitalize on its benefits while minimizing costs, we suggest that employers target the uncertainty<\/em> that often comes along with PFP. While discretionary, merit-based raises are a common form of PFP, they also often induce substantial uncertainty about what is required to obtain the bonus. If this is the case in your company, stop retrospectively determining annual raises based on each manager\u2019s perception of performance and return to the fundamentals. Consider implementing a classic \u201cmanagement by objective\u201d approach to pay increases by developing specific criteria for raises and bonuses based on goals or KPIs. Have managers discuss these criteria ahead of time with employees so they know what they need to do. <\/p>\n

Software company Adobe offers a blueprint for this approach. It has restructured its compensation process by requiring managers and employees to collectively set performance expectations for the following quarter. These goals are paired with frequent check-ins so employees always know where they stand. Raises and bonuses are determined based on how employees fared on those performance expectations, reducing the uncertainty that often surrounds such pay decisions.<\/p>\n

The clearer these rules and expectations are, the less uncertainty employees will feel. And with less uncertainty, employees will be able to devote their headspace to producing innovative work and helping colleagues excel, instead of worrying about what they need to do to earn that next bonus.<\/p>\n

2. Smooth out uncertain income.<\/strong> Employees\u2019 ability to make sales or reach key goals might vary widely from week to week or month to month, depending on the economic environment, organization-specific factors, or even ebbs and flows in their own capacity (due to illness or caregiving responsibilities, for example). This creates substantial earnings fluctuations, which lead to stress<\/a>. <\/p>\n

One solution for smoothing out this uncertainty is to consider performance over a longer period. If managers extend the time frame in which employees are evaluated, temporary ups and downs in market opportunities and employee performance are averaged out \u2014 reducing pay uncertainty in the process. Instead of awarding bonuses based on monthly or quarterly performance results, try awarding them based on annual results.<\/p>\n<\/p>\n

An alternative approach: Maintain these short-term performance incentives, but pay employees based on the average of the prior year\u2019s performance. Quarterly bonuses paid in 2026 would be the average bonus amount earned in 2025, and so on. This approach keeps frequent PFP intact while also giving employees some stability and predictability around their earnings for the following year. In line with this, last May Amazon announced<\/a> a shift toward weighing employees\u2019 performance over the past five years (rather than the past year alone) when determining pay raises. <\/p>\n

If you\u2019re already evaluating employees over a yearly time frame, consider implementing team-based performance incentives. Following the same logic, fluctuations in one team member\u2019s performance will likely be offset by that of fellow teammates, creating a more stable level of performance on which to base rewards. Research has shown that these team-level incentives<\/a> are just as effective as individual incentives at encouraging performance. <\/p>\n

In 2025, Boeing took team incentives to a new level by redesigning annual performance bonuses<\/a>, tying them to companywide performance rather than paying out bonuses at the business-unit level. Doing so should give employees a greater sense of stability around their pay as fluctuations in their own performance or that of team members are smoothed out by the company\u2019s performance as a whole.<\/p>\n

3. Alleviate financial insecurity.<\/strong> Our research found that the downsides associated with pay uncertainty occurred because study participants were concerned about their finances while performing the tasks. Easing feelings of financial insecurity, then, should reduce this tendency to overwork and to neglect recovery. One obvious solution is to increase base pay, especially for lower earners who might be contending with more financial insecurity. Industry giants like Target<\/a>, Costco<\/a>, and Bank of America<\/a> have announced increases in hourly pay for their lowest earners, for example.<\/p>\n

Another approach is to reduce employees\u2019 reliance on uncertain forms of PFP that engender financial insecurity in the first place. So, for example, instead of PFP making up 40% of total pay, try reducing it to 20% and increasing base pay to make up the difference. Total compensation remains unchanged, but employees experience less uncertainty as a result. This increases the guaranteed pay that employees can count on even when times are tough, such as during a recession or when there are industry-level shocks (such as the COVID-19 pandemic). Taking financial concerns off the table will make employees better equipped to cope with pay uncertainty and protect workers against risk.<\/p>\n

Employees themselves can also take steps to cope with pay uncertainty. For example, tracking income and earnings over time can expand employees\u2019 own time horizons, helping them to calculate more reliable estimates of their typical earnings. As Nobel laureate Richard Thaler has argued<\/a>, this kind of mental accounting matters. It helps individuals zoom out and see the bigger picture instead of getting caught up in weekly or monthly fluctuations. Companies can help by offering employer-sponsored savings accounts<\/a>, which incentivize employees to set aside money for unexpected expenses. Whole Foods Market, Delta, and Levi\u2019s have all offered this benefit in recent years, including matching employee contributions<\/a> up to a certain amount.<\/p>\n<\/p>\n

Because performance-based pay has a dual nature, business leaders walk a tightrope when implementing this compensation practice. Pay uncertainty is a particularly harmful component of the pay-for-performance model. This uncertainty causes employees to neglect rest and recovery, resulting in increased stress levels, and can contribute to burnout and turnover. By taking steps to reduce pay uncertainty, organizations can realize the performance benefits of PFP while reducing the potential downsides, enhancing long-term competitiveness and employee well-being in the process. <\/p>\n<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

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