Financial Incentives – do they work?3 min read

Revisit an Important Topic – a repeat posting from 2013

It is accepted wisdom in human resource management practice that financial incentives, wages and bonuses, drive work performance ((Note that we are talking about individuals here. Organizations, for profit, non-profits and government, definitely react positively to financial incentives and disincentives)). This is a part of our business and political culture. ((In fact the notion that people make “rational” decisions based in part on financial rewards is a central pillar of our “if we only let markets work, everything will run smoothly” culture.)) Though studies and surveys have shown for decades that people find many other factors (growth of skills, engagement, sense of purpose, social connection, and many others) to be important in their work, the key to every human resource management strategy has been the compensation plan. Increasingly over the past couple of decades human resource management professionals have devised ever more complex methods for connecting various performance metrics to compensation plans. 

Do Financial Incentives Work?

financial incentives?Economics and psychology research conclusively demonstrates the need to change our human resource management strategies to reflect why really people work and what makes them work more effectively

Multiple research studies show that for work involving mental engagement financial incentives, especially large ones, actually reduce work performance.  

You might argue that this does not explain away the body of academic studies that show that there is a positive relationship between financial incentives for executives and company performance. I will leave it to someone else to wade through that material. I will only offer up the simple gross fact that CEO compensation as a multiple of average worker pay has risen from 20 to 1 in 1950 to over 200 to 1 today. (( Top CEO Pay Ratios))

Has corporate performance in real terms increased by 10 times over that period? Obviously not.

Daniel Pink argues in his TED Talk that the key motivators in work are:

  • Autonomy – control over one’s work, how you approach it, where you do it, at what time
  • Mastery – learning and mastering new skills – enhancing capabilities

  • Purpose – working on tasks that are greater than the individual or the company – something good for the greater whole.

These three are at least a good, provocative starting place. The key is to start thinking about how your human resource management strategy is structuring work to respond to these needs and not simply throwing money at the problem of performance.

Money Does Matter – Relatively

We might close with a note that money does matter in one dimension. Employees need to feel that they are being compensated fairly. In order for non-financial intrinsic motivators to work, they need to know that they are not being ripped off. If you pay strategy puts your compensation significantly below the average for your type of work in your local area, you will very likely spend more time thinking about finding a new employer rather than how much autonomy, mastery or purpose is being fulfilled. Essentially you need to pay in a fashion that takes that issue off the table.