Do financial incentives work?

According to Jeffrey Pfeffer and Bob Sutton, in Hard Facts, Dangerous Half-Truths And Total Nonsense: Profiting From Evidence-Based Management, the short answer is "no."  And if they do have an impact on employee behavior, it is often in unexpectedly negative ways.

Incentives programs, for one thing, rest on the assumption that money is the prime motivator. Incentive pay for teachers is often in the news. But let’s be honest: if I am motivated primarily by money, I am not likely to take up teaching as a profession. The career just doesn’t pay that well. So, if I make a life-long career decision based on something other than money, why does it make sense that a small financial incentive is going to drive my day to day performance?

The authors report on research by Chip Heath that is an eye opener. His work shows that most of us report that we are not much motivated by money. At the same time, most of us say we think others are motivated by money. Both cannot be true! Another study reported that senior executives supported the incentive plans in their companies, because they believed the plans guided employee action and decisions. The same executives, however, reported that they seldom, if ever, considered the incentives when making their own decisions at work.  (For an interesting take on the real motivators of work, see Dave Opton's post.)

The other difficulty with financial incentives, of course, is that most results are not the outcome of a single person’s efforts. Most results take collaboration, and depend on external events. Neither of these is under an individual’s control.  Game theory suggests that group incentives would tempt the rational person to attempt a free-ride.  Why work hard if others will do so and earn the reward for you?

Finally, incentives require individuals to be differentiated, and to receive differential rewards. The evidence shows that this sort of pay differentiation only works when company results truly are the sum of individual results, and no collaboration is required. If any team work is required, incentives worsen performance.

So, how to use incentives? Here’s what the authors suggest:

1. Don’t use incentives to solve every problem the company faces.
2. Incentives don’t have to be big to be effective. The Men’s Wearhouse had great success with storewide incentives based on shrinkage. The incentive amounted to no more than $40/month per employee – enough to be noticed, but not so big that it made people do stupid things.
3. Think through how people will really act if they take the incentives seriously. Think about the negative behaviors that might result.
4. Pay attention to the differences in pay in your organization, and make sure they don’t get too big. Some of the best performing organizations have a relatively low spread between the lowest paid employee and the CEO.