Performance appraisal and compensation in small firms

Most small Canadian firms don't use formal performance appraisal systems

This article, the third in a series on HR management in small firms, addresses performance appraisal and compensation. It is based on a survey of more than 350 small businesses (fewer than 100 employees) in the Halifax area. The survey excluded not-for-profit workplaces and branch facilities.

The organizations were quite small, with 63 per cent having 10 or fewer employees, 30 per cent having 11 to 50, and seven per cent having between 50 and 100 staff. About 11 per cent of the firms were unionized, 20 per cent were in manufacturing, 41 per cent in the retail or wholesale trade sector and 39 per cent in other business services.

For more on findings from the survey check out the related articles links at the bottom of this page.

Even though formal performance appraisal systems are vital to effective human resources management, the majority of small Canadian firms aren’t making use of them.

Participants in a survey of small firms were asked if their organization had a formal performance appraisal program that regularly evaluated employees. Less than 38 per cent reported that such a program existed. In addition, among firms with performance appraisals, slightly less than half (49.6 per cent) indicated that training was provided to individuals responsible for conducting performance reviews.

When asked to describe what the information from performance reviews was used for, the most common response was for making salary decisions. Other common uses included identifying training needs and deciding which employees would receive promotions.

Additional analysis was conducted to see if any factors distinguished firms with or without a formal performance review system.

The presence of formal training was related to the size of the business and the presence of an HR department. Only about 29 per cent of businesses with 10 or fewer employees had a performance appraisal system while 72 per cent of firms in the 51 to 100 employee category had such a program. This finding is consistent with earlier research suggesting that as firms increase in size, they are more likely to develop more formal human resource practices. Similarly, 77 per cent of firms with an employee who was responsible for HR issues conducted formal performance appraisals, compared with only 32 per cent of businesses without an HR professional.

Having a formal system of performance review was also strongly associated with the presence of a more sophisticated HR strategy and a greater array of HR practices. The findings suggest that organizations that involve the HR function in strategic decision-making, align business and HR management strategies, and develop “bundles” or systems of HR management practices are more likely to view performance management as important.

Compensation practices

Respondents were also asked a set of questions about compensation and benefits.

To help set wage and salary levels, about three in 10 small businesses used industry-level survey information. More than half (54 per cent) of the firms indicated that they had some type of incentive program tied to productivity, slightly less (50 per cent) reported that they paid a bonus to high-performing employees, and just more than 24 per cent of firms had a profit-sharing plan.

There is a growing body of research outlining the importance of employee compensation as a critical component of high performance work systems, and our research suggests that a number of small businesses that are developing both formal and informal human resource systems are placing considerable emphasis on employee compensation issues.

Respondents were asked how they determined pay levels. They were asked to rate the factors using a six-point scale (with 1 indicating that the factor was never used and 6 indicating frequent use). The two major factors were management experience (average score of 4.7) and job requirements (average score of 4.4). Some businesses also considered performance appraisal results (average score of 3.6) but relatively few relied on a piece-rate system.

Compensation and benefits programs

What compensation and benefits programs are most commonly available to employees in small firms? (See the chart below for the use of selected programs.) Most employers provide employees with some paid holidays beyond statutory requirements and a slight majority have a life insurance plan.

Also, just more than half of the respondents said they provide workers with paid sick leave. However, less than one-quarter have a pension or retirement plan for employees. With regard to compensation programs, about 26 per cent of businesses provide group or team incentives, and only about one in 10 small firms had a productivity sharing plan or an employee stock ownership program. Not surprisingly, the most important predictor of the presence of specific compensation and benefits programs was the size of the business, with larger firms more likely to have the resources to invest in such programs.


The findings from this research have important implications. First, a large number of small firms do not have a formal appraisal system. While an informal appraisal system that provides feedback to employees on a regular basis can be very effective, such systems require an ongoing commitment from supervisory personnel. In addition, the lack of a formal system of performance appraisal may have a negative effect on the business in some instances.

Consider, for instance, a firm that wants to dismiss an employee for poor performance. In dismissal cases, the employer bears the onus of establishing just cause. The absence of formal performance appraisal information and documented performance shortcomings markedly reduces the likelihood that the employer will prevail.

Second, we recognize that a number of small businesses may decide, from a strategic perspective, that a high commitment HR strategy is not appropriate or attainable. However, academic research suggests that compensation practices are often critical components of high performance human resource systems. In addition, a firm’s compensation strategy may play an important role in the ability of the organization to attract and retain valued employees.

Terry H. Wagar is professor of industrial relations at Saint Mary’s University in Halifax and Lynn Langrock is an EMBA graduate of Saint Mary’s University. Terry can be reached by e-mail at [email protected].

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