When do financial incentives fail to improve workforce performance?

Let’s do some experiments at your office. Get a simple jigsaw puzzle and a few employees as volunteers. Separately ask each employee to solve it in 10 minutes. Promise some of them a monetary prize (e.g., $10) for solving the puzzle. Don’t offer anything to the others. How do you think the people with a promise of a reward will perform compared to the ones without one?

The answer is essential because businesses often make use of such financial incentives to motivate people and improve performance. Such practices may be more common in the current tight labor market where there seems more work to be done and fewer people to do them. Contingent financial incentives such as performance-based bonuses get used routinely to drive performance and reduced attrition. For the most part, this method appears to work well. Does it?

As it turns out, we humans have a bizarre relationship with money. Money changes our behavior, whether we are aware of it or not. Some of those changes are desirable, while others are not. Recently, much work has been done to understand our behavior in the context of money. These work have given rise to a fast-growing field of behavioral economics. We now know that performance-based contingent financial incentive induces unintended or even undesirable behaviors in many more ways than we knew before.

Let us make something clear. By financial incentives, we are not talking about standard compensation, such as salaries and benefits. One does not need a Ph.D. in behavioral economics to know that a competitive salary and benefits are crucial motivators. Here, we are talking solely about financial incentives that are contingent on performance. 

By undesirable behavior, we are also not talking about unethical or illegal behavior, although we know that contingent financial incentives occasionally produce such acts. In 2007, Enron gave us a multi-billion dollar lesson on unchecked financial incentive gone haywire. Lest we forget it, Wells Fargo Bank followed suit less than a decade later with its version.

You may have an inkling of what we are talking about if you are a parent who has tried to “bribe” your children to perform routine tasks. You may know that such rewards may produce the desired result once or twice but becomes counter-productive in the long term. The luster of the awards fades quickly, and the performance degrades unless a financial reward in heavier “dose,” is administered.

If this sounds like addiction to you, it is. Scientists have found, using fMRI brain scans, that some of the neurological processes triggered by contingent rewards are similar to those triggered by other forms of addictions. Moreover, similarly is not only limited to the craving and irritability associated with addiction but also with impaired decision making.  In other words, contingent rewards may impair our ability to make decisions. 

You may think that contingent reward becomes counter-productive only if we use it repeatedly.  It may seem that, as long as one does not make a habit out of it, occasional doses of such compensation surely improve performance in the short term. Do they? How do you think the jigsaw puzzle experiment is going to turn out? 

To better understand how performance fares when lured by contingent rewards, researchers at a few business schools in the US conducted controlled experiments. They offered participants bonuses to solve tasks that require cognitive skills such as attention, memory, concentration, and creativity. It may not come as a surprise that participants with medium-size bonuses (compared to their base compensation) did not perform any better than those with smaller ones. What may come as a surprise is that, in every task, those with much larger bonuses consistently performed worse than the others. These and other findings have lead behavioral scientists to conclude that contingent rewards can impair even the most rudimentary problem-solving skills.

You may relate to the outcomes of these experiments if you have had to perform logically challenging tasks, the skill of our left brain. How about the capabilities of our right brain, our creative side? As it turns out, creativity is not immune either. Researchers have concluded, through controlled experiments, that creative skills also suffer when performed under the lure of financial incentives.

Having said this, we know that financial incentives can be useful in specific ways. They motivate people to focus on their tasks and put in the additional effort needed to complete them. It is now well known that such incentives work well on tasks that are highly mechanical and require little or no cognitive skills. However, in our modern economy, most of such automated tasks have been (or will be) handed off to machines or bots. As we rely more and more on the creative skills of our workforce, we need to have a better understanding of the incentives that improve workforce outcomes. We now know that contingent financial incentive is not it. It has the unintended consequence of delivering less of what we want and more of what we don’t.