Digest 42. The dark side of pay-for-performance: Effects on employee mental health
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Pay-for-performance (PFP) is often used by organizations as part of their compensation system and, if well designed, is a powerful tool to increase employee performance and attract and retain the best talent (see Digest 38). However, PFP can come with a dark side, as it may generate feelings of inequity and unfairness (see Digest 39), decrease creativity (see Digest 40), and even cause mental health problems, such as depression and anxiety, among workers. A recent book by the famous Stanford Professor Jeffrey Pfeffer also discusses how management practices that are intended to increase productivity may do so (or even fail!) at the expenses of workers’ health.
A wide array of reasons can explain why PFP could lead to poor mental health in all employees except top performers. First, PFP plans are likely to increase employees’ perceptions of risk and uncertainty; push them to compare themselves, their outputs and the related pay with their colleagues, producing feelings of inequity and envy; and cause stress by endorsing a vision of time as money. Second, PFP can bring a cultural shift in organizations by encouraging competition at the expense of pro-social behaviors – and we know that supportive and cooperative cultures are key to foster well-being (see here for an example). Third, PFP affects income by reducing the wages of low performers, which inevitably takes a toll on their mental health by making them worry about the future. Finally, PFP could promote greater risk-taking behaviors, leading to more accidents and injuries in the workplace, and dysfunctional coping – that is, people trying to deal with the stress of PFP through drug and alcohol abuse. It is apparent how this can backfire and threaten both physical and mental health. While all these immediately appear as understandable arguments, and may even be easily linked to anecdotical evidence, scientific evidence would be needed.
Does PFP really harm employees’ mental health? How serious and lasting are its effects? Are some employees more vulnerable than others?
Answering these questions is crucial to protect employees and limit the well-known organizational, economic and social costs of ill-being, including absenteeism, presenteeism, medical costs, and spill-over effects in the community. To this purpose, Dahl and Pierce (2020) took advantage of publicly available data on the Danish population and conducted a unique study on 318,717 full-time employees at 1,309 firms between 1995 and 2006. They analyzed the evidence linking the organizational adoption of PFP to the employee use of medications to treat anxiety and depression as prescribed by a medical doctor following a diagnosis.
The researchers found that, after organizations introduce PFP, the use of mental health medications increases by 5.7% among their employees, suggesting that individuals may indeed suffer from PFP. Put differently, PFP generated 1,905 additional prescriptions on average within the firms introducing the compensation practice. As the authors note, if we extend the estimates from the Danish data to a much bigger country such as the United States, the adoption of performance-based pay would create an additional half million prescriptions.
In addition, the study suggests that people with a propensity for or with previously existing mental health problems quit the firm following PFP adoption, and are replaced by individuals with lower propensity. This means that turnover is used as a coping mechanism to deal with the stress generated by PFP. It also speaks to the sorting effect of relative pay (that is, employees spontaneously sort in and out of a company depending on performance and associated pay) based on the individual tolerance of the risks associated with such a compensation practice. Interestingly, the effect of PFP on turnover is stronger for women than men, making women’s career trajectories more susceptible to organizational practices and implying the operating of psychological mechanisms. For example, due to societal expectations, men may stay in an organization despite stress or anxiety to avoid being stigmatized and comply with stereotypical work norms.
Finally, the researchers showed that older employees (> 50 years old) report larger increases in mental health medications than their younger colleagues. Older employees might be more reluctant to organizational change and at the same time are often “forced” to stay in the firm due to facing discrimination in recruitment and less job mobility opportunities. Also, workers whose wages decreased as a result of PFP adoption suffer more than their peers, confirming wage reduction as one of the reasons why PFP deteriorates mental health.
Organizational implications
Organizations should exert caution when designing and introducing performance-based pay as it can lead to employee stress and further develop into serious mental health conditions such as depression and anxiety.
In a related vein, organizations should consider the costs of PFP when devising compensation systems. Employee poor mental health is linked to lower individual performance and higher absenteeism and presenteeism (i.e., continuing to work when sick), bearing high psychological, financial, and societal costs. Therefore, the possible costs associated with PFP could outweigh the benefits, leading to reduced organizational productivity and higher medical expenses.
When introducing PFP, support can be carefully planned to help specific groups of employees, such as older people, women, and those with greater mental health vulnerability who may suffer the most from its adoption. Support can be built around reducing the perception of risk and uncertainty that PFP can bring.
Attention should be devoted to discouraging social comparison and related feelings of inequity and unfairness by, for example, assigning performance-based rewards to teams rather than individuals.
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Reference:
Dahl, M. S., & Pierce, L. (2020). Pay-for-performance and employee mental health: Large sample evidence using employee prescription drug usage. Academy of Management Discoveries, 6, 12-38. https://doi.org/10.5465/amd.2018.0007