The main concern of the question is the side projects, not whether the employee is performing adequately. This two questions are inherently tied together. If the employee wasn't performing then they would be fired regardless of the side projects.

So in order for the side projects to be a concern, it implies the employee is still performing their job at normal levels. So then the question becomes, why does the engineer have time and motivation to work on the side projects?

And ultimately I think, the answer to that question is that there's some failure on the part of company leadership, as other commenters have pointed out, regarding motivation, available work, and how over accomplishing is valued.

It'll also vary greatly, even within a single company. How I manage my guys probably varies a lot from some of my peers.