The Dark Side of Performance Bonuses

 
 
To motivate workers, employers often turn to incentives such as money or recognition. What's become clear is that these programs can also result in unintended consequences—like a financial crisis.
 
 
by Sean Silverthorne
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Companies continually test ways to incent employees to perform more effectively, often turning to worker-motivation tools such as bonuses, “up or out” employee ranking tournaments, and employee of the month rewards.

Behavioral scientists warn that these programs, if not constructed carefully, can open a box full of unintended consequences that ultimately harm rather than help the organization.

The financial crisis of 2008 was partially fueled by origination bonuses paid to bank loan officers who were incented to approve bad loans. Less well understood, but uncovered in HBS research several years ago, is that those bank bonuses also caused loan officers to perceive reality differently—they believed those loans would succeed.

It’s not just financial incentives that are under study. Employers seek to change the behavior of workers in all manner of ways: to make more ethical decisions, to get flu shots, to lose weight, to be wiser about personal financial planning. Behavioral scientists are becoming the new HR superstars in some organizations.

Research through the years at Harvard Business School has explored this good intentions-bad outcomes dilemma in many settings, from the glitzy world of Las Vegas to steamy laundry plants in Asia. The results these studies have uncovered are important to understand for org designers, compensation committees, and any function such as sales that depends on incentives to drive performance.

Here is a sample of research from HBS into the dark side of employee motivation programs:

When Good Incentives Lead to Bad Decisions

Leading up to the financial crisis, bank loan officers were often incentivized to approve sketchy applications. But researchers discovered the incentives did more than motivate underwriting of bad loans; they changed how those loan officers perceived reality.

The Most Powerful Workplace Motivator

Money isn’t always the most powerful work motivator. In this field experiment participants were willing to pay money to be ranked higher. Why?

How to Demotivate Your Best Employees

Do awards such as "employee of the month" motivate higher performance? Not really—and they may turn off your best employees altogether.

Altruistic Capital: Harnessing Your Employees’ Intrinsic Goodwill

Everyone comes to the table with some amount of "altruistic capital," a stock of intrinsic desire to serve. This field research studies what motivates hairdressers in Zambia to provide HIV/AIDS education in their salons.

Is Group Loyalty a Force for Good or Evil?

Many organizations try to foster employee loyalty, but at a risk. Researchers discover when group loyalty fosters ethical behavior—and when it fosters corruption.

The Importance of ‘Don’t’ in Inducing Ethical Employee Behavior

Let’s say your company’s reputation depends upon the ethical behavior of your staff. To encourage that value in employees, is it better to promote good deeds or prevent bad deeds? It turns out that employees tend to act more ethically when focused on what not to do.

Should Pay-for-Performance Compensation Be Replaced?

In spite of its naysayers, pay-for-performance compensation still makes sense to most of us. But there is a difference of opinion about when and how it works and how it should be structured.

Money and Quotas Motivate the Sales Force Best

Bonus programs are effective for motivating sales people, but also costly for companies to maintain. Which compensation schemes work best?

If the CEO’s High Salary Isn't Justified to Employees, Firm Performance May Suffer

Rank-and-file employees understand the boss deserves a big salary, but only when the number is fully explained.

Research Papers

Driven by Social Comparisons: How Feedback about Coworkers’ Effort Influences Individual Productivity

At a Japanese bank, researchers examine the extent to which job performance is affected when employees learn where they stand relative to their coworkers. Does telling an employee that her job performance falls in the bottom of her group better her performance?

CEO Bonus Plans: And How to Fix Them

While compensation committees know how much they pay in bonuses and are generally aware of performance measures used in CEO bonus plans, relatively little attention is paid to the design of the bonus plan or unintended consequences.

Equality and Equity in Compensation

Why do some firms such as technology startups offer the same equity compensation packages to all new employees despite very different cash salaries? Researchers present evidence that workers dislike inequality in equity compensation more than salary compensation because of the perceived scarcity of equity.

Subjectivity in Tournaments: Implicit Rewards and Penalties and Subsequent Performance

Employees can be more motivated by the anticipation of a reward or punishment than the actual payoff.

What do you think of this research?

Have you seen incentive programs that incented the wrong behavior? Give us your insights below.

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