Human Capital: Designing and Managing Market-Based and More	 
Performance-Oriented Pay Systems (27-SEP-05, GAO-05-1048T).	 
                                                                 
The federal government must have the capacity to plan more	 
strategically, react more expeditiously, and focus on achieving  
results. Critical to the success of this transformation are the  
federal government's people--its human capital. Yet, in many	 
cases the federal government has not transformed how it 	 
classifies, compensates, develops, and motivates its employees to
achieve maximum results within available resources and existing  
authorities. A key question is how to update the federal	 
government's compensation system to be market-based and more	 
performance-oriented. To further the discussion of federal pay	 
reform, GAO partnered with key human capital stakeholders to	 
convene a symposium in March 2005 to discuss public, private, and
nonprofit organizations' successes and challenges in designing	 
and managing market-based and more performance-oriented pay	 
systems. This testimony presents the strategies that		 
organizations considered in designing and managing market-based  
and more performance-oriented pay systems and describes how they 
are implementing them.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-1048T					        
    ACCNO:   A38278						        
  TITLE:     Human Capital: Designing and Managing Market-Based and   
More Performance-Oriented Pay Systems				 
     DATE:   09/27/2005 
  SUBJECT:   Compensation					 
	     Federal employees					 
	     Human capital					 
	     Pay for performance				 
	     Performance management				 
	     Strategic planning 				 
	     Human capital management				 

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GAO-05-1048T

United States Government Accountability Office

GAO Testimony

Before the Subcommittee on Oversight of Government Management, the Federal
Workforce, and the District of Columbia, Committee on Homeland Security
and Governmental Affairs, U.S. Senate

For Release on Delivery Expected at 10:00 a.m. EDT Tuesday, September 27,
2005

HUMAN CAPITAL

 Designing and Managing Market-Based and More Performance-Oriented Pay Systems

Statement of David M. Walker Comptroller General of the United States

                                       A

GAO-05-1048T

[IMG]

September 27, 2005

HUMAN CAPITAL

Designing and Managing Market-Based and More Performance-Oriented Pay Systems

  What GAO Found

GAO strongly supports the need to expand pay reform in the federal
government. While implementing market-based and more performanceoriented
pay systems is both doable and desirable, organizations' experiences in
designing and managing their pay systems underscored three key themes that
can guide federal agencies' efforts.

o  	The shift to market-based and more performance-oriented pay must be
part of a broader strategy of change management and performance
improvement initiatives.

o  	Market-based and more performance-oriented pay cannot be simply
overlaid on most organizations' existing performance management systems.
Rather, as a precondition to effective pay reform, individual expectations
must be clearly aligned with organizational results, communication on
individual contributions to annual goals must be ongoing and two-way,
meaningful distinctions in employee performance must be made, and cultural
changes must be undertaken.

o  	Organizations need to build up the basic management capacity of their
organizations. Training and developing new and current staff to fill new
roles and work in different ways will play a crucial part in building the
capacity of the organizations.

Organizations presenting at our symposium considered the following
strategies in designing and managing their pay systems.

1. Focus on a set of values and objectives to guide the pay system.

2. 	Examine the value of employees' total compensation to remain
competitive in the market.

3. 	Build in safeguards to enhance the transparency and help ensure the
fairness of pay decisions.

4. Devolve decision making on pay to appropriate levels.

5. 	Provide training on leadership, management, and interpersonal skills
to facilitate effective communication.

6. Build consensus to gain ownership and acceptance for pay reforms.

7. Monitor and refine the implementation of the pay system.

Moving forward, it is possible to enact broad-based reforms that would
enable agencies to move to market-based and more performance-oriented pay
systems. However, before implementing reform, each executive branch agency
should demonstrate and the Office of Personnel Management should certify
that the agency has the institutional infrastructure in place to help
ensure that the pay reform is effectively and equally implemented. At a
minimum, this infrastructure includes a modern, effective, credible, and
validated performance management system in place that provides a clear
linkage between institutional, unit, and individual performance-oriented
outcomes; results in meaningful distinctions in ratings; and incorporates
adequate safeguards.

                 United States Government Accountability Office

Chairman Voinovich, Senator Akaka, and Members of the Subcommittee:

I appreciate the opportunity to be here today to discuss what has been
learned from alternative personnel systems' implementation of pay for
performance. As the federal government transforms to be better positioned
to address 21st century challenges, a key question is "How should the
federal government update its compensation systems to be more market-based
and performance-oriented?"1 The federal government must have the
institutional capacity to plan more strategically, react more
expeditiously, and focus on achieving results. Critical to the success of
this transformation are the federal government's people-its human capital.
Yet the government has not transformed, in many cases, how it classifies,
compensates, develops, and motivates its employees to achieve maximum
results within available resources and existing authorities.

Recognizing that the federal government's pay system does not align well
with modern compensation principles, Congress has provided various
agencies exemptions from current statute in performance management and pay
administration.2 Most recently, the Departments of Homeland Security (DHS)
and Defense (DOD) received the authority to establish "flexible and
contemporary" human capital and pay systems.3 We at GAO have also received
human capital authorities and strive to lead by example, especially in
implementing more market-based and performance-oriented classification and
compensation systems.

GAO strongly supports the need to expand pay reform in the federal
government. To further the discussion of federal pay reform, GAO partnered
with the U.S. Office of Personnel Management (OPM), the U.S. Merit Systems
Protection Board, the National Academy of Public Administration, and the
Partnership for Public Service and convened a

1GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, GAO05-325SP (Washington, D.C.: February 2005).

2GAO, Human Capital: Selected Agencies' Statutory Authorities Could Offer
Options in Developing a Framework for Governmentwide Reform, GAO-05-398R
(Washington, D.C.: Apr. 21, 2005).

3For more information on DHS's and DOD's human capital authorities, see
GAO, Human Capital: Preliminary Observations on Final Department of
Homeland Security Human Capital Regulations, GAO-05-320T (Washington,
D.C.: Feb. 10, 2005) and GAO, Human Capital: Preliminary Observations on
Proposed DOD National Security Personnel System Regulations, GAO-05-432T
(Washington, D.C.: Mar. 15, 2005).

symposium in March 2005 to discuss public, private, and nonprofit
organizations' successes and challenges with designing and managing
market-based and more performance-oriented pay systems.4

While we believe that implementing market-based and more
performanceoriented pay systems is both doable and desirable, these
organizations' experiences in designing and managing their pay systems
underscored three key themes that can guide federal agencies' efforts to
better link pay with performance.

o 	First, the shift to market-based and more performance-oriented pay must
be part of a broader strategy of change management and performance
improvement initiatives. Market-based and more performance-oriented pay is
only one part-albeit a critical one-of a larger effort to improve the
performance of an organization.

o 	Second, market-based and more performance-oriented pay cannot be simply
overlaid on most organizations' existing performance management systems.
Rather, as a precondition to effective pay reform, individual expectations
must be clearly aligned with organizational results, communication on
individual contributions to annual goals must be ongoing and two-way,
meaningful distinctions in employee performance must be made, and cultural
changes must be undertaken. Specifically, these organizations recognize
that pay increases are no longer an entitlement but should be based on
employees' contributions to the organization's mission and goals.

o 	Third, organizations need to build up the basic management capacity of
their organizations. Training and developing new and current staff to fill
new roles and work in different ways will play a crucial part in building
the capacity of the organizations. In particular, there needs to be growth
and development at every level of the organization: top leaders with the
vision, commitment, capabilities, and persistence to lead and facilitate
the change; managers with the skills and abilities to fairly and honestly
assess employee performance; and individual employees who are engaged and
empowered to seek opportunities to enhance their careers.

4The organizations included the Federal Deposit Insurance Corporation,
Office of the Comptroller of the Currency, Commonwealth of Virginia, IBM
Corporation, and American Red Cross. For more information, see GAO, Human
Capital: Symposium on Designing and Managing Market-Based and More
Performance-Oriented Pay Systems, GAO-05832SP (Washington, D.C.: July 27,
2005).

Federal agencies have also been experimenting with pay for performance
through OPM's personnel demonstration projects authorized under Title 5.
We reported that these demonstration projects show an understanding that
linking pay to performance is very much a work in progress and that
additional work is needed to strengthen efforts to ensure that performance
management systems are tools to help them manage on a day-to-day basis.5
In particular, there are opportunities to translate employee performance
so that managers make meaningful distinctions between top and poor
performers with objective and fact-based information and provide
information to employees about the results of the performance appraisal
and pay decisions to ensure reasonable transparency and appropriate
accountability mechanisms are in place, among other things.6

In addition, as agencies develop their pay for performance systems, they
will need to consider the appropriate mix between pay awarded as base pay
increases versus one-time cash increases while still maintaining fiscally
sustainable compensation systems that reward performance. A key question
to consider is how the government can make an increasing percentage of
federal compensation dependent on achieving individual and organizational
results by, for example, providing more compensation as one-time cash
bonuses rather than as permanent salary increases. However, agencies' use
of cash bonuses or other monetary incentives has an impact on employees'
retirement calculations since they are not included in calculating
retirement benefits. Congress should consider potential legislative
changes to allow cash bonuses to be calculated toward retirement and
thrift savings benefits by specifically factoring bonuses into the
employee's basic pay for purposes of calculating the employee's "high3"
for retirement benefits and making contributions to the thrift savings
plan.

Nevertheless, we need to move forward with human capital reforms, but how
it is done, when it is done, and the basis on which it is done can make
all the difference in whether such efforts are successful. Human capital
reforms to date recognize that the "one-size-fits-all" approach is not
appropriate to each agency's demands, challenges, and missions. However,
we have reported that a reasonable degree of consistency across the

5GAO, Human Capital: Implementing Pay for Performance at Selected
Personnel Demonstration Projects, GAO-04-83 (Washington, D.C.: Jan. 23,
2004).

6For more information on our review of OPM's demonstration projects and
other GAO human capital reports, see app. I.

government is still desirable and that broader reforms should be guided by
a framework consisting of a common set of principles, criteria, and
processes.7

Before implementing any human capital reforms, executive branch agencies
should follow a phased approach that meets the "show me" test. That is,
each agency should be authorized to implement a reform only after it has
shown it has met certain requirements, including an assessment of its
demonstrated institutional infrastructure and an independent certification
by OPM of this infrastructure. This institutional infrastructure includes
(1) a strategic human capital planning process linked to the agency's
overall strategic plan; (2) capabilities to design and implement a new
human capital system effectively; (3) a modern, effective, credible, and
validated performance management system that provides a clear linkage
between institutional, unit, and individual performance-oriented outcomes,
and results in meaningful distinctions in ratings; and (4) adequate
internal and external safeguards to ensure the fair, effective, and
nondiscriminatory implementation of the system.

GAO will continue to work with Congress, OPM, and other key stakeholders
on future human capital reforms. This morning I will highlight the
strategies that organizations considered in designing and managing
market-based and more performance-oriented pay systems and how they are
implementing them. These organizations include selected OPM demonstration
projects, organizations presenting at the symposium, and GAO.

  Strategies for Designing and Managing Market-Based and More
  Performance-Oriented Pay Systems

Even though people are critical to an agency's successful transformation,
a number of agencies still try to manage their people with a
"one-size-fits-all" approach to compensation. For example, employees are
compensated through an outmoded system that (1) rewards length of service
rather than individual performance and contributions; (2) automatically
provides across-the-board annual pay increases, even to poor performers;
and (3) compensates employees living in various localities without
adequately considering the local labor market rates for these employees.
We have

7GAO and the National Commission on the Public Service Implementation
Initiative, Highlights of a Forum: Human Capital: Principles, Criteria,
and Processes for Governmentwide Federal Human Capital Reform, GAO-05-69SP
(Washington, D.C.: Dec. 1, 2004).

observed that a competitive compensation system can help organizations
attract and retain a quality workforce. To develop such a system,
organizations assess the skills and knowledge they need; compare
compensation against other public, private, or nonprofit entities
competing for the same talent in a given locality; and classify positions
along levels of responsibility.

The strategies that the organizations at our symposium considered in
designing and managing market-based and more performance-oriented pay
systems and examples of how organizations are implementing them are as
follows.

1. Focus on a set of values and objectives to guide the pay system.
Organizations need to focus on a set of values and objectives when
designing and managing their market-based and more performanceoriented pay
systems. Values are inherent and enduring principles that represent the
organization's beliefs and boundaries. For example, GAO's core
values-accountability, integrity, and reliability-were a focus in
identifying and validating the competencies for our new performance
management system. With authority from Congress, we have implemented a
market-based compensation system that places greater emphasis on a
person's skills, knowledge, and job performance and not the passage of
time while, at a minimum, protecting the purchasing power of employees who
are performing acceptably and are paid within competitive compensation
ranges. Under the new market-based pay system, which is in the first phase
of implementation, employee compensation now considers current salary and
allocates individual performance-based compensation amounts between a
merit increase (i.e., salary increase) and a performance bonus (i.e.,
cash). In addition, we received authority from Congress to adjust the
rates of basic pay on a separate basis from the annual adjustments
authorized for employees in the executive branch. We also recently
finalized a performance-based compensation system with pay banding for the
remainder of GAO's workforce, the administrative professional and support
staff.

While core values define the organization's beliefs and boundaries,
objectives articulate the strategy the organization plans to take to
implement a market-based and more performance-oriented pay system to help
it recognize and reward employees and maintain a competitive position in
the market. For example, the Red Cross recognizes that salary is its main
lever to fulfill its mission and values, and thus one of its objectives is
to pay salaries that are externally competitive and internally equitable.
To

meet this objective, the Red Cross sets its employees' pay slightly higher
than the market in order to remain competitive and attract, motivate, and
retain its employees. Similarly, a main objective of the Office of the
Comptroller of the Currency's (OCC) pay system is to maintain
comparability regarding compensation and benefits with the other federal
financial regulatory agencies, such as the Federal Deposit Insurance
Corporation (FDIC) and the U.S. Securities and Exchange Commission. To
maintain comparability in compensation and benefits, OCC participates in
an annual survey that gathers information and data on the financial
regulatory agencies' total compensation packages. This information helps
OCC set its pay increase budget for the next year based on the average pay
for its market.

2. Examine the value of employees' total compensation to remain
competitive in the market. The organizations at our symposium found that
it is important to be flexible in the mix of what constitutes total
compensation so they can remain competitive with the market. Organizations
should consider a mix of base pay plus other monetary incentives,
benefits, and deferred compensation, such as retirement pay, as part of a
competitive compensation system. For example, to help it compete in the
market and retain its employees, IBM offers its employees a "total
rewards" package including work-life benefits such as tuition
reimbursement for employee development, along with retirement and health
care benefits.

At GAO, we believe that providing employees with individualized total
compensation summary statements each year helps provide clarity on the
employees' total compensation packages and specifically, how employees'
pay increases received during the year fit into their total compensation.
The annual summary statements include GAO's contributions to employees'
benefits, incentives and other awards, and other GAO paid or subsidized
benefits. The statements include items such as student loan repayments and
transit subsidies, as well as adjustments to employees' pay, such as
across-the-board salary adjustments, performance-based pay adjustments,
and promotion-related increases.

Transparency is becoming an urgent matter today as federal agencies face
tough choices ahead managing the serious and growing long-term fiscal
challenges facing the nation. We recently reported that DOD's historical
piecemeal approach to military compensation has resulted in a lack of
transparency that creates an inability to, for example, assess the
allocation

of total compensation investments to cash and benefits.8 In order to help
improve the transparency over total compensation, we recommended that DOD
develop a comprehensive communication and education plan to inform
servicemembers of the value of their pay and benefits and the
competitiveness of their total compensation package when compared to their
civilian counterparts that could be used as a recruiting and retention
tool.

3. Build in safeguards to enhance the transparency and help ensure the
fairness of pay decisions. Agencies need to have modern, effective,
credible, and as appropriate validated performance management systems in
place with adequate safeguards to ensure fairness and prevent
politicization and abuse. These systems are the precondition to linking
pay, incentive, and reward systems with employee knowledge, skills, and
contributions to organizational results.

GAO's performance management and pay system has built in numerous
safeguards, including multiple levels of review, to ensure consistency and
fairness in the process and resulting decisions. Specifically, before
performance ratings are finalized, they receive second-level reviews,
typically by a senior executive within the employee's team. This reviewer
checks if raters have consistently and reasonably applied the performance
standards. Subsequently, the Human Capital Office and the Office of
Opportunity and Inclusiveness review the performance ratings and pay
decisions across all of GAO to determine whether there are any
irregularities or potential adverse impacts to be addressed. To further
help ensure consistency in ratings and in applying performance standards
within and across GAO's teams, we implemented standardized rating scores
(SRS) for employees for the first time in the fiscal year 2004 performance
appraisal cycle. The SRS indicates the employee's position relative to the
average rating of that employee's team. Employees in different teams with
the same SRS have the same relative performance, thus achieving better
comparability in ratings across teams. Employees' SRS and the midpoint for
their pay range are key factors in calculating their performance-based
compensation for that year. We are continually working with the employees
to identify the best way to communicate the

8GAO, Military Personnel: DOD Needs to Improve the Transparency and
Reassess the Reasonableness, Appropriateness, Affordability, and
Sustainability of Its Military Compensation System, GAO-05-798
(Washington, D.C.: July 19, 2005).

SRS information as part of GAO's ongoing commitment to employee feedback
on the new system and transparency about pay decisions.

IBM built in several accountability mechanisms to help achieve consistency
and equity in pay decisions across employee groups and teams. For example,
to help ensure there is no discrimination in pay decisions, IBM conducts a
base pay equity analysis to review the pay of women or minority employees
if their proposed pay is one standard deviation away from the mean of the
majority of employees and looks for an explanation for these pay
differences, such as poor performance, a recent promotion into the pay
band, or an extended leave of absence. In addition, IBM built in
secondlevel reviews of pay decisions before employees receive any pay
increases to ensure consistency in the compensation process. The
first-line managers discuss their proposed pay decisions with managers at
the next level-the up-line managers-to ensure the performance assessments
and justifications are consistent across groups. Up-line managers can also
shift pay allocations across groups if necessary in order to ensure
employees who perform similarly are compensated the same regardless of
their firstline managers. As a final check, the senior managers sign off
on the pay decisions for each employee.

To help provide transparency on how employees' performance compares to the
rest of the organization, we previously reported that the Naval Sea
Systems Command Warfare Center's Newport division publishes the results of
its annual performance cycle. Newport aggregates the data so that no
individual employee's rating or payout can be determined to protect
confidentiality. Employees can compare their performance rating category
against others in the same unit, other units, and the entire division.

4. Devolve decision making on pay to appropriate levels. In implementing
market-based and more performance-oriented pay systems, organizations need
to determine what parts of their pay systems should be maintained
centrally and what parts can be devolved to "lower" levels of the
organization. When devolving these types of decisions, organizations have
maintained overall core processes to help ensure reasonable consistency in
how the systems are implemented.

Virginia shifted the responsibility for administering pay from its central
office to the commonwealth's agencies and their managers as part of its
compensation reforms and developed core processes outlining how agencies
should develop and implement their pay systems. Specifically, Virginia
developed a salary plan that provides broad guidelines regarding

the commonwealth's overall compensation philosophy, funding for pay
increases, and the pay ranges for the employees' positions that reflect
market conditions. Each agency is held accountable for developing its own
salary administration plan which is approved by the central office prior
to being implemented. As part of this plan, the agency is to select from
among designated "pay practices" that it considers useful to best meet its
specific needs, such as promotions or in-band pay adjustments to recognize
employees for taking on additional duties.

5. Provide training on leadership, management, and interpersonal skills to
facilitate effective communication. We have reported that training and
developing new and current staff to fill new roles and work in different
ways will play a crucial part in the federal government's endeavors to
meet its transformation challenges.9 Agencies will need to invest
resources to ensure that employees have the information, skills, and
competencies they need to work effectively in a rapidly changing and
complex environment.

Organizations found that training employees and managers on performance
management skills, such as setting expectations, linking individual
performance to organizational results, and effectively giving and
receiving feedback, as well as placing an emphasis on communicating the
content of the pay reforms in a simple and clear format, are needed to
make marketbased and more performance-oriented pay succeed. For example,
FDIC emphasized the importance of training its managers on how to make the
necessary distinctions in ratings and pay since it found that some
managers have trouble making the distinctions and would prefer to give all
employees the same pay increase.

Virginia found that employees needed the information on its compensation
reforms in as simple and clear a format as possible without using
technical compensation terms or "HR" terminology. As a result, Virginia
used its Employee Advisory Committee to help develop training and
supporting materials on the compensation reform initiatives and
communicate the information to the other employees. Virginia found that
using the committee was very effective and allowed employees to better
understand how the reforms would affect them directly.

9GAO, Human Capital: A Guide for Assessing Strategic Training and
Development Efforts in the Federal Government, GAO-04-546G (Washington,
D.C.: March 2004).

Regarding the frequency of the training, we found that the OPM pay for
performance demonstration projects trained employees on the performance
management system prior to implementation to make employees aware of the
new approach, as well as periodically after implementation to refresh
employee familiarity with the system. For example, the Civilian
Acquisition Workforce Personnel Demonstration Project (AcqDemo) found
that, in addition to training prior to implementation, it needed more
in-depth and varied training in later years for current AcqDemo employees
to refresh their proficiency in the system; for new participants to
familiarize them with appraisal and payout processes; as well as for
senior management, pay pool managers and members, and human resources
personnel to give them greater detail on the process. The training prior
to implementation and throughout the project was designed to help
employees understand competencies and performance standards; develop
performance plans; write self-appraisals; become familiar with how
performance is evaluated and how pay increases and awards decisions are
made; and know the roles and responsibilities of managers, supervisors,
and employees in the appraisal and payout processes.

Virginia defined a new role for its employees by holding them accountable
for identifying the training they need to enhance the skills necessary to
develop their careers. For example, Virginia developed career guides to
inform employees on what they may personally need to do to develop,
advance, or change their careers. The guides provide important
occupational information for employees interested in developing their
careers and improving opportunities for advancement in any work
environment. Virginia found that an added benefit is that these career
guides help employees understand that they have knowledge, skills, and
abilities that cut across different occupations and are transferable
across the commonwealth's government.

6. Build consensus to gain ownership and acceptance for pay reforms.
Involving employees and other stakeholders helps to improve overall
confidence and belief in the fairness of the system, enhance their
understanding of how the system works, and increase their understanding
and ownership of organizational goals and objectives. Organizations have
found that the inclusion of employees and their representatives needs to
be meaningful, not just pro forma.

At GAO, to obtain direct feedback from employees, we created the elected
Employee Advisory Council (EAC) to serve as an advisory body to the

Comptroller General and other senior executives on management and employee
issues. Comprising employees who represent a cross-section of the agency,
the EAC's participation is an important source of front-end input and
feedback on our human capital and other major management initiatives.
Specifically, EAC members convey the views and concerns of the groups they
represent, while remaining sensitive to the collective best interest of
all GAO employees; propose solutions to concerns raised by employees;
provide input to and comment on GAO policies, procedures, plans, and
practices; and help to communicate management's issues and concerns to
employees. Similarly, FDIC found that in its experience it was better to
have the union involved in the implementation of its pay reforms. When
negotiating compensation for its bargaining unit employees with
representatives of the National Treasury Employees Union, FDIC views them
as true partners instead of following an "us versus them" approach. FDIC
noted that both parties want to work together to reach an agreement in
terms of compensation levels that will satisfy them.

In designing its compensation reforms, Virginia involved stakeholders,
such as representatives from Virginia's legislative and executive
branches, as well as human resource representatives from private sector
organizations. Virginia also formed an Employee Advisory Committee of
nonsupervisory employees from diverse occupations, demographic groups, and
geographic locations to help the commonwealth as a whole improve its
compensation program, not just for their select interest groups. Further,
to implement the compensation reforms, Virginia developed implementation
teams-composed of human resource staff across the agencies-to help ensure
the details of the compensation reforms were consistently communicated to
all the employees across the commonwealth. The teams represented various
priority areas, such as funding, compensation management, performance
management, training, and communications.

7. Monitor and refine the implementation of the pay system. Highperforming
organizations understand they need to continuously review and revise their
performance management systems to achieve results and accelerate change.
These organizations continually review and revise their human capital
management systems based on data-driven lessons learned and changing needs
in the environment. We have reported that agencies seeking human capital
reform should consider doing evaluations that are broadly modeled on the
evaluation requirements of the OPM

demonstration projects.10 Under the demonstration project authority,
agencies must evaluate and periodically report on results, implementation
of the demonstration project, cost and benefits, impacts on veterans and
other equal employment opportunity groups, adherence to merit system
principles, and the extent to which the lessons from the project can be
applied governmentwide. Such an evaluation could facilitate congressional
oversight; allow for any midcourse corrections; assist the agency in
benchmarking its progress with other efforts; and provide for documenting
best practices and sharing lessons learned with employees, stakeholders,
other federal agencies, and the public.

For example, at GAO, we recently saw the need to restructure part of our
pay banding system to better reflect real differences in responsibilities
and competencies as well as respective pay within the pay band for our
senior analysts by creating two sub-band categories. To begin the process
of this restructuring effort, GAO formed task teams to study and develop
proposals, and engaged employees by holding town hall meetings, focus
groups, meeting with employee representatives, and having a review and
comment period for each phase of the restructuring.

Organizations monitor their systems by listening to employees' and
stakeholders' views-informally and formally-on the pay systems. FDIC found
that listening to the "level of noise" among employees and stakeholders,
such as the union, is essential in evaluating whether a new initiative is
working or not. To track employee views, IBM sends out a pulse survey
quarterly with only a few questions on the compensation program to a
sample of its 300,000 employees. IBM believes it is doing well in
implementing the program if over 70 percent of the employees' responses to
these questions are "neutral" or "favorable." When consolidating its
classification structure, Virginia made some revisions as a result of
employee feedback so that employees could more easily see where they fit
into the structure. Virginia plans to continually monitor the structure
and identify needed refinements by soliciting employee feedback at least
annually.

Organizations also use other metrics as an indicator of the employees'
acceptance of pay and performance management decisions to track the
effectiveness of their pay systems. For example, IBM tracks its attrition
rates to determine why employees are leaving and compares them to its

10GAO-05-69SP.

competitors' attrition rates. Virginia tracks the number of employee
grievances and works with managers to educate them on what the metrics
mean and how they affect their agencies and employees.

Monitoring the implementation of new pay systems is important because
unintended consequences may arise. Organizations have found they should be
open to refining their systems. For example, in order to spread the pay
increases among as many employees as possible, FDIC found that managers
tended not to award merit pay increases to top-performing employees when
they were to be promoted in the career ladder and as a result, these
high-performing employees were not getting the merit pay increases they
deserved. FDIC recognized that this unintended consequence needed to be
corrected in future iterations of the pay system and managers needed help
in learning how to make the necessary distinctions in employees'
contributions.

While the need for refining the system is inevitable, organizations found
that there is value in stabilizing the pay system for a period of time to
let employees get accustomed to the new initiative and see how it works.
For example, OCC plans to reassess its labor market pay differentials
every 3 years rather than annually to provide continuity in implementing
the system. This continuity benefits employees because they know how much
their geographic differential will be for a period of time and benefits
OCC because it makes managing the pay system more stable.

  Next Steps for Results-Oriented Pay and Human Capital Reform

In summary, there is widespread agreement that the basic approach to
federal pay is broken and we need to move to a market-based and more
performance-oriented approach. Doing so will be essential if we expect to
maximize the performance within available resources and assure the
accountability of the federal government for the benefit of the American
people. While reasonable people can and will disagree about the merits of
individual reform proposals, there is widespread recognition that pay
increases are no longer an entitlement but should be based on employees'
contributions to the organization's mission and goals. Experience shows
that this shift to market-based and more performance-oriented pay must be
part of a broader strategy of change management and performance
improvement initiatives and cannot be simply overlaid on most
organizations' existing performance management systems. Before
implementing any pay reform, each executive branch agency should have
demonstrated and OPM should have certified that the agency has in place

the institutional infrastructure to help ensure that this reform is
effectively and equally implemented.

We need to move forward with human capital reforms. In the short term,
such reforms could include select and targeted authorities, such as
prohibiting guaranteed pay increases for persons who do not perform at
acceptable levels; allowing agency heads to make a limited number of term
appointments awarded noncompetitively; and rightsizing and restructuring
that can place additional emphasis on factors such as knowledge, skills,
and performance. As momentum continues to accelerate to make strategic
human capital management the centerpiece of the government's overall
management transformation effort, comprehensive reforms should be guided
by a framework consisting of a common set of principles, criteria, and
processes.

Chairman Voinovich, Senator Akaka, and Members of the Subcommittee, this
concludes my statement. I would be pleased to respond to any questions
that you may have.

Contact and 	For further information regarding this statement, please
contact Lisa Shames, Acting Director, Strategic Issues, at (202) 512-6806
or

Acknowledgments	[email protected]. Individuals making key contributions to
this statement include Janice Latimer and Katherine H. Walker.

Appendix I

                      "Highlights" of Selected GAO Reports

                           Highlights of GAO-05-832SP

Critical to the success of the federal government's transformation are its
people- human capital. Yet the government has not transformed, in many
cases, how it classifies, compensates, develops, and motivates its
employees to achieve maximum results within available resources and
existing authorities. One of the questions being addressed as the federal
government transforms is how to update its compensation system to be more
market based and performance oriented.

To further the discussion of federal pay reform, GAO, the U.S. Office of
Personnel Management, the U.S. Merit Systems Protection Board, the
National Academy of Public Administration, and the Partnership for Public
Service convened a symposium on March 9, 2005, to discuss organizations'
experiences with market-based and more performance-oriented pay systems.
Representatives from public, private, and nonprofit organizations made
presentations on the successes and challenges they experienced in
designing and managing their market-based and more performance-oriented
pay systems. A cross section of human capital stakeholders was invited to
further explore these successes and challenges and engage in open
discussion. While participants were asked to review the overall substance
and context of the draft summary, GAO did not seek consensus on the key
themes and supporting examples.

www.gao.gov/cgi-bin/getrpt?GAO-05-832SP.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact J. Christopher Mihm at (202)
512-6806 or [email protected].

July 2005

HUMAN CAPITAL

  Symposium on Designing and Managing Market-Based and More Performance-Oriented
  Pay Systems

While implementing market-based and more performance-oriented pay systems
is both doable and desirable, organizations' experiences show that the
shift to market-based and more performance-oriented pay must be part of a
broader strategy of change management and performance improvement
initiatives. GAO identified the following key themes that highlight the
leadership and management strategies these organizations collectively
considered in designing and managing market-based and more
performanceoriented pay systems.

1. Focus on a set of values and objectives to guide the pay system. Values
represent an organization's beliefs and boundaries and objectives
articulate the strategy to implement the system.

2. Examine the value of employees' total compensation to remain
competitive in the market. Organizations consider a mix of base pay plus
other monetary incentives, benefits, and deferred compensation, such as
retirement pay, as part of a competitive compensation system.

3. Build in safeguards to enhance the transparency and ensure the fairness
of pay decisions. Safeguards are the precondition to linking pay systems
with employee knowledge, skills, and contributions to results.

4. Devolve decision making on pay to appropriate levels. When devolving
such decision making, overall core processes help ensure reasonable
consistency in how the system is implemented.

5. Provide training on leadership, management, and interpersonal skills to
facilitate effective communication. Such skills as setting expectations,
linking individual performance to organizational results, and giving and
receiving feedback need renewed emphasis to make such systems succeed.

6. Build consensus to gain ownership and acceptance for pay reforms.
Employee and stakeholder involvement needs to be meaningful and not pro
forma.

7. Monitor and refine the implementation of the pay system. While changes
are usually inevitable, listening to employee views and using metrics
helps identify and correct problems over time.

These organizations found that the key challenge with implementing
marketbased and more performance-oriented pay is changing the culture. To
begin to make this change, organizations need to build up their basic
management capacity at every level of the organization. Transitioning to
these pay systems is a huge undertaking and will require constant
monitoring and refining in order to implement and sustain the reforms.

Appendix I "Highlights" of Selected GAO Reports

Appendix I "Highlights" of Selected GAO Reports

Appendix I "Highlights" of Selected GAO Reports

March 2003

RESULTS-ORIENTED CULTURES

Creating a Clear Linkage between

  Highlights of GAO-03-488, a report to Individual Performance and congressional
  requesters Organizational Success

The federal government is in a Public sector organizations both in the
United States and abroad have period of profound transition and
implemented a selected, generally consistent set of key practices forfaces
an array of challenges and effective performance management that
collectively create a clear linkage- opportunities to enhance "line of
sight"-between individual performance and organizational success.

performance, ensure
accountability, and position the These key practices include the
following.

nation for the future. High
performing organizations have 1. Align individual performance expectations
with organizational
found that to successfully goals. An explicit alignment helps individuals
see the connection between

transform themselves, they must their daily activities and organizational
goals.

often fundamentally change their
cultures so that they are more 2. Connect performance expectations to
crosscutting goals. Placing
results-oriented, customer-focused, an emphasis on collaboration,
interaction, and teamwork across
and collaborative in nature. To organizational boundaries helps strengthen
accountability for results.

foster such cultures, these

organizations recognize that an 3. Provide and routinely use performance
information to track

effective performance management organizational priorities. Individuals
use performance information to
system can be a strategic tool to
drive internal change and achieve manage during the year, identify
performance gaps, and pinpoint
desired results. improvement opportunities.

Based on previously issued reports 4. Require follow-up actions to address
organizational priorities. By

on public sector organizations' requiring and tracking follow-up actions
on performance gaps, organizations

approaches to reinforce individual underscore the importance of holding
individuals accountable for making accountability for results, GAO
progress on their priorities. identified key practices that federal

agencies can consider as they 5. Use competencies to provide a fuller
assessment of performance.develop modern, effective, and Competencies
define the skills and supporting behaviors that individuals credible
performance management need to effectively contribute to organizational
results.

systems.

6. Link pay to individual and organizational performance. Pay, incentive,
and reward systems that link employee knowledge, skills, and contributions
to organizational results are based on valid, reliable, and transparent
performance management systems with adequate safeguards.

7. Make meaningful distinctions in performance. Effective performance
management systems strive to provide candid and constructive feedback and
the necessary objective information and documentation to reward top
performers and deal with poor performers.

8. Involve employees and stakeholders to gain ownership of performance
management systems. Early and direct involvement helps increase employees'
and stakeholders' understanding and ownership of the system and belief in
its fairness.

www.gao.gov/cgi-bin/getrpt?GAO-03-488.

To view the full report, including the scope 9. Maintain continuity during
transitions. Because cultural

and methodology, click on the link above. transformations take time,
performance management systems reinforce
For more information, contact J. Christopher
Mihm at (202) 512-6806 or [email protected]. accountability for change
management and other organizational goals.

Appendix I "Highlights" of Selected GAO Reports

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