The Downside of Bonus

Dan Ariely, the renowned behavioral economist and the author of the widely popular book “Predictably Irrational” has some interesting things to say about the effect of massive bonuses and their true effect on job performance in his New York Times article.

Ariely and his co-researchers use some cleverly designed experiments to study the relationship between the magnitude of a performance incentive and its effect on an individual’s performance. In one experiment, participants are presented with “an array of tasks that demanded attention, memory, concentration and creativity.” They are divided into three groups: One group of participants is told that they would get a small reward if they performed well in the tasks; The second group is promised a slightly larger reward, and the third group, a significantly larger reward. At the end of the experiment, when the researchers compare the relative performance of individuals from the three groups, they find some surprising results.

Ariely writes:

“The results defied conventional wisdom. The group offered the highest bonus did worse than the other two groups – in every single task. On top of that, the people offered medium bonuses performed no better or worse than those offered low bonuses.”

The researchers repeated similar experiments at MIT using tasks that required cognitive skills and those that required very repetitive mechanical effort, and found more interesting results. They conclude that for tasks that are very mechanical in nature and require little or no mental effort, higher incentives tend to motivate the individuals towards better performance. On the other hand, if the tasks required cognitive skills, then large incentives actually prove counterproductive. They reason that the lure of a large reward and the fear of not performing well enough to receive the reward distract individuals, and affects their focus on tasks requiring cognitive skills. Individuals working on menial and repetitive tasks may actually manage to get more things done because the prospect of the reward makes their effort seem worthwhile.

In Ariely’s words:

“Financial rewards are a double-edged sword. They provide motivation to work well, but they also cause stress and preoccupation with the reward that can actually hurt performance. If our tests mimic the real world, then higher bonuses may hinder executives from working to the best of their ability.”

“The assumption that more money leads to better performance is not true–at least not all the time. If it was, wouldn’t we expect that those who got tens of millions in annual bonuses would be optimal performers? Maybe even perfect? The fact that these high earners failed so miserably should add to the evidence against a direct link between higher rewards and better performances.”

In his second book, “The Upside of Irrationality,” Ariely writes about his experiments related to incentives and individual performance in greater detail. Here are some excerpts from his blog post:

“I tried another approach and asked for a volunteer from the audience to describe how the work atmosphere at his firm changes at the end of the year. “During November and December,” the fellow said, “very little work gets done. People mostly think about their bonuses and about what they will be able to afford.” In response, I asked the audience to try on the idea that the focus on their upcoming bonuses might have a negative effect on their performance, but they refused to see my point. Maybe it was the alcohol, but I suspect that those folks simply didn’t want to acknowledge the possibility that their bonuses were vastly oversized.”

To counteract the downside of bonus, he suggests:

“Could all this mean that sometimes we might actually behave less rationally when we try harder? If that’s so, what is the correct way to pay people without overstressing them? One simple solution is to keep bonuses low—something those bankers I met with might not appreciate. Another approach might be to pay employees on a straight salary basis. Though it would eliminate the consequences of over- motivation, it would also eradicate some of the benefits of performance-based payment. A better approach might be to keep the motivating element of performance-based payment but eliminate some of the nonproductive stress it creates. To achieve this, we could, for example, offer employees smaller and more frequent bonuses. Another approach might be to offer employees a performance-based payment that is averaged over time—say, the previous five years, rather than only the last year. This way, employees in their fifth year would know 80 percent of their bonus in advance (based on the previous four years), and the immediate effect of the present year’s performance would matter less.”