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Why Money isn't Necessarily the Best Incentive

Paying big bonuses doesn’t always lead to better performance

In recent times, a lot of criticism has been aimed at top executives and their exorbitant salaries. Much of this has been directed towards the banking sector where bonus payments seem to bear no relation to actual performance. In fact, the worse they do, the more they seem to get paid. Not surprisingly, the phrase ‘reward for failure’ has been a popular tabloid headline.

So why do companies continue to pay huge bonuses to people who consistently under perform? And why isn’t all that financial inducement motivating them to do better? Surely offering more money is the best incentive there is? Well, apparently not. And in case you needed more proof than Britain’s ailing banks and fat cat bosses, researcher Dan Airley and his colleagues decided to conduct a study.

They arranged to send five economics graduate students from Narayanan University to local villages near Madurai in Southern India. The tasks required students to use skills such as attention, memory, concentration and creativity. For example, one task was to play a memory game whilst throwing tennis balls at a target. Another involved assembling a puzzle whilst throwing a wellington boot at the life size image of a banker.

That was a particularly popular one.

They wanted to see how performance was affected by offering rewards of various sizes. They promised a third of them one day’s pay if they performed well, another third were promised two weeks’ pay and the last third could earn a full five months’ pay.

And they found that big bonuses didn’t improve performance.

The low-and medium-bonus groups performed the same and the big-bonus group performed worst of all.

In eight of the nine tasks they examined across the three experiments, higher incentives led to worse performance.

According to psychologists, ‘supersized’ incentives can be cognitively distracting. The theory goes that there’s so much at stake, it impairs performance rather than improves it. In high pressure situations some people tend to either panic or choke. Panic is when you don’t think enough about something and plunge right in – like when you panic buy. Choking is about thinking too much and suffering a loss of instinct. According to Ariely this is what happened to the students who were offered the biggest cash incentive. They thought too much about the task in hand, as well as how bad they were going to feel if they failed to take advantage of this chance in a lifetime.

So if a cash incentive is no guarantee of improved performance, what is? Well, an experiment by Dean Karlan involving people determined to stop smoking, suggests that ‘commitment contracts’ are a better bet. According to Karlan, there are two kinds of motivation: intrinsic and extrinsic. The first kind comes from within a person such as their passion for the task, the pleasure they derive from it, and the sense of moral value. Whereas extrinsic motivation is provided externally and usually involves earning money or some other kind of valuable reward.

Researchers discovered that monetary compensation practically kills any kind of creativity. On the other hand, it does motivate people to perform mechanical tasks at a faster rate. Hence the reason why workers in factories and farms often get paid piecemeal. As a student, I once spent a summer picking asparagus.

The pay was lousy but the tips were great.

I spoil you sometimes.

To back this up, an analysis of 51 studies by the London School of Economics found overwhelming evidence that financial incentives may actually reduce an employee’s natural inclination to complete a task as well as derive pleasure from it. Perhaps more importantly, it also suggests that any ethical reasons are greatly diminished, such as complying with workplace social norms and fairness. Which would explain why a lot of fat cats don’t seem to give a bugger.

So, does money incentivise people? The answer appears to be ‘yes’ if it’s not too much for the individual, but ‘no’ if it’s so large that you can’t think about anything other than protecting it. As Henry Kissinger once said ‘Power corrupts. Absolute power corrupts absolutely’.

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