Wednesday, October 24, 2007

How Does Performance Pay Work in Other Sectors?

There's been lots of banter since last week's NYC deal about how compensation works in other sectors. Consider Joel Klein's musings in yesterday's New York Sun:

In business...successful firms pay more for what's worth more: they create incentives that motivate employees to work harder and more effectively.

Or Bloomberg's comments last week:

In the private sector, cash incentives are a proven motivator for producing results....[later in the article, Bloomberg goes on to say] I'm a capitalist.

But do other sectors reward workers based on the quantifiable outcomes of their clients? Richard Rothstein wrote on this issue seven years ago, and here's what he concluded:

It is hard to find private sector examples for [merit pay] proposals….When quality of work is important, corporations do not generally evaluate college-educated employees by quantifiable goals.

Consider, [Professor Brian Hall of Harvard Business School] said, management consulting. You might think the pay of consultants could be tied to growth in the equity value of companies they had assisted. But, he said, ''if you were evaluating employees who advised Cisco Systems and tried to measure their effectiveness by Cisco's stock price, every consultant in the last five years would look great, yet some may have given bad advice.''

So for professionals, Professor Hall said, decisions on merit pay are mostly subjective. Firms typically do a ''360-degree evaluation -- they go all around an individual, asking advice from supervisors above, co-workers to the left and right, and subordinates below.''

And how much time do supervisors spend on these subjective evaluations?

Bain managers devote about 100 hours a year to evaluating five employees. ''When I try to imagine a school principal doing 30 reviews, I have trouble,'' [a Bain director] said.

How about in private schools? Rothstein explains:

Pay for performance in private schools also does not resemble ideas being floated for public education. Certainly, elite academies do not use test data to calculate teacher pay. Nor, typically, do private schools for the less privileged.

In health care, performance pay is allocated based on clinical hours worked, procedures performed, and the revenues brought in, not the outcomes of the patients. Physicians I talked to in preparing this post laughed at me when I asked if their performance bonuses were based on patient outcomes. The most common response was that those outcomes were largely out of their control, so their hospitals rewarded them based on their inputs - i.e. hours, procedures, and revenues.

In law, contingency contracts - i.e. the firm or lawyer gets a certain amount if they win the case - are partially based on client outcomes, and certainly this gets reflected in bonuses. But the lawyers I talked to in preparing this post explained that hours billed are more important in determining their bonuses - again, there is a focus on inputs rather than outputs.
To be clear, I have no great affection for the current compensation system. For example, there's no reason to give educators a premium for earning an education masters degree (a degree in their content area makes sense, but most teachers aren't getting these degrees). There's no reason that we can't create incentives for teachers to teach in low-performing schools, though the best incentive is good working conditions. And as I wrote yesterday, I am all for rewarding expert teachers financially for providing support to struggling colleagues.

But in attending exclusively to annual test scores, a short-term and narrow outcome measure that is easy to manipulate, we are trotting down a dangerous path paved with unintended consequences. This is a bad idea in the private sector - i.e. Enron - and it's a bad idea for education, too. First, there are more goals of education than producing this year's test scores, and these goals have short and long-term components, i.e. are we rewarding teachers for what sticks with their students in subsequent years? Second, measuring teacher and school effectiveness based on a single year of data entirely ignores the issue of measurement error and what we know from the best research about the need to observe teachers for multiple years in order to accurately differentiate teachers. (See explanation here.) Third, performance pay systems rarely take into account the differences in the student populations served by different schools and teachers, and measuring growth does not account for imporant differences in student populations. (Again, see link above.) And they do not control for differences in structures over which the school has little control - i.e. class size and large intradistrict differences in per-pupil expenditures - which are relevant for plans that plan to compare performance across schools, not only within a given school.

So performance pay proponents' claims that other sectors reward workers based on client outcomes are largely untrue. While there is pay differentiation, it is based on a comprehensive and holistic evaluation of each person's work - something that will be difficult for schools to emulate given current levels of supervision.


Roger Sweeny said...

First, there are more goals of education than producing this year's test scores, and these goals have short and long-term components, i.e. are we rewarding teachers for what sticks with their students in subsequent years?

Of course, we don't even know how much of what we test "sticks with their students in subsequent years."

Aren't those two paragraphs a scandal? We say we value various things but then we don't see if the students accomplish them, and we don't reward teachers when their students accomplish them.

I think this is one of the terrible consequences of a totally non-merit system. We don't try to find out how successful we've been because pay doesn't depend on it. Pay doesn't depend on it because we've made no effort to find out. And there's no incentive to change.

Anonymous said...

People often make sweeping generalizations about merit pay in the private sector with very little actual data to back them up. For an insider's view that challenges that conventional wisdom, see "Six Dangerous Myths About Pay" by Jeffrey Pfeffer, Harvard Business Review, May-June 1998, 109-119.