About a year ago, my employer adjusted the way I am paid. The changes were minor, but I still haven’t forgiven them. There were two aspects of the plan the irked me: the fact that my pay was reduced by 1% and the fact that it would be given back if I reached certain volume-based targets. I didn’t feel that reducing my pay by 1%Ā  was enough to affect the company’s profitability, so why do it? It was like a slap in the face. Worse, when the volume-based targets were implemented, I thought I would easily reach them… until the market crashed. I don’t miss the 1%, but I do resent the company for taking it away from me.

I believe this is referred to as a financial incentive and is considered good management. Managers in market-based economies tend to believe that they can improve performance through tweaking financial incentives. Economists generally posit that any outcome can be determined if the incentives are right. My experience, however, contradicts the academic viewpoint.

The first clue to what is wrong with financial incentives came to me from Alfie Kohn’s book Unconditional Parenting. The author writes about the destructive aspects of rewards and punishments. When you step back from the situation and look at the entire idea, it becomes clear that rewards and punishments are, by design, manipulative. Financial incentives are like a reward and punishment rolled into one, in that money will be given or withheld. Money is used an an incentive to motivate or manipulate employees. This sends two messages. The idea that employees should be manipulated into working toward the goals of management shows that management isn’t willing to convince employees that corporate goals are worthwhile and doesn’t value the personal priorities of the employees. Worse, offering more money for better performance implies that employees are withholding their best effort, holding out for better pay.

Implementing financial incentives in a corporation is an attempt to manipulate employees into compliance. There are, however, side effects. Alfie Kohn cites research showing that people who are rewarded for certain behaviours find less enjoyment in the behaviour. The thought process is probably something like, “this job must be really distasteful if they have to pay me extra to complete it.” Maybe we don’t expect workers to enjoy their jobs; after all, we have to pay them to do it. But Steven Levitt, the economist author of Freakonomics, points out an unintended consequence using the example of high-stakes exams. In summary, higher student scores translate into higher pay and better job security for teachers. Using some original data mining, he shows that certain teachers cheat or help students cheat on the exams. After all, cheating is a much more controllable method for determining the outcome than hoping that facts can be recalled by uncaring students in a high-pressure situation.

Incentives don’t always fail. Dan Pink, author of Drive, points out that financial incentives can work with mechanical tasks. When the outcome is entirely controllable and requires focus, incentives have the most benefit. On the other hand, narrowed focus inhibits creative problem solving. Financial incentives actually cause worse performance in the case where solutions lie on the periphery. As an aside, a very entertaining animation of a 10 minute summary of his ideas is available on YouTube.

In my work, I can choose between two compensation schemes, either based on sales volume or based on investment account values. I’m not talented at sales, so I’ve chosen the second option (which I also believe is friendlier to clients). However, as we’ve seen over the last two years, investment values are unpredictable. Because the desired outcome (higher investment values) is uncontrollable, I find the financial incentives to be distracting. I try to ignore it, since my actions have little effect on my income. If I were only offered a (reasonable) salary, I would still do my best work for my clients. The difference is that there would be no incentive to cheat (not that I’m tempted) as it turns out Madoff did.

What carrots and sticks have been implemented by your employer? Do they work? What would have to happen for you to perform at a higher level at work?

Financial Incentives

4 thoughts on “Financial Incentives

  • July 7, 2010 at 7:59 am
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    Good post.

    My employer used to just set aside a pool of money and then leave it to managers to dole out to employees when the company did well but management always felt that it was giving away money for nothing without having a measurable yardstick to compare against and then people just began to expect that extra money. Then the recession hit and put an end to that.

    I agree with the point you made about getting paid to do your job so no incentives or carrots should be needed just to encourage me to do what I’m already being paid to do. If I’m not performing well, I know I’ll get terminated at some point in the future. Bonuses should be for going that extra mile – doing something that wasn’t expected of you and doing it well. But again, how do you quantify and measure that and most importantly how do you get agreement that A is responsible for something and not B. It’s not surprising to me that many companies either reward everyone equally or a few standouts when it’s easily apparent to everyone who deserves a bonus.

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    • July 7, 2010 at 8:12 am
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      Steve, thanks for sharing your experience. When you mention “rewarding everyone equally”, it makes me think of a profit sharing plan. Wouldn’t it be nice if not only executives, but all employees shared some of the profit when the company is successful? Of course, owners must receive their dividends, so profits may be split too many ways, with each person receiving so little that it is no longer meaningful. I don’t know if owners would stand for that (I’m not sure I would).

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  • July 7, 2010 at 9:03 am
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    Robert – Yeah, it was essentially a profit sharing plan and the intent behind it was great – good year for the company means everyone in the company got to share in the good times. But again – how do you divvy it up? I think management was right in deciding to that X percentage of the profit would go toward profit sharing. It gives them a finite number to work with. But then divvying it up becomes a nightmare.

    It’s one thing to say we have a pool of one million dollars to share but quite another to hear that your share of that is going to $500. It makes everyone suspicious about who got what and why.

    In the end we tried to base it on three parameters: being length of service, percentage of your salary and manager discretion, but in the end that mostly rewarded those that already had high salaries in the first place, those that had been with the company longest next, and those that were newest got the shaft.

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