Is Paying for Performance Such a Hot Idea?

Pay for performance has become virtually a religion in America. As a result, evidence that it doesn’t work as advertised is seldom heard in polite company.

Most of the caveats raised about bonuses in the business media relate to the design of particular pay arrangements rather than the general concept. These awards often reward short-term risk-taking or just dumb luck, and may be excessive relative to an individual’s real value added (as in they attribute too little value to the existing franchise and firm resources).

An article in New Scientist (hat tip reader Kevin S) raises more fundamental issues. It explains how performance-linked bonuses can be demotivating and lead employees to game the system rather than do their best work.

Using money or other rewards is useful when the task at hand in tedious. But perversely, these inducements are demotivating when the task is inherently interesting:

But the work of [psychologist Edward] Deci and others suggests the problem with bonuses runs far deeper than poor scheme design or cheating. In 1971, he asked students to solve puzzles, with some receiving cash prizes for doing well and others getting nothing. Deci found those offered cash were less likely to keep working on puzzles after they had done enough to get paid.

Two years later, a team led by Mark Lepper of Stanford University, California, asked children aged between 3 and 5 years old to draw with felt-tip pens. Some were told they would receive a special ribbon as a prize for doing so, and duly received it. These children were less likely to choose to draw with felt-tip pens when they were later given a free choice of activities. No such effect was seen with children who were not offered a reward, whether they subsequently received an unexpected one or not (Journal of Personality and Social Psychology, vol 28, p 129).

These studies suggest that offering rewards can stop people doing things for the sheer joy of it, an idea known as the overjustification effect. This was the basis for a series of books by [Alfie] Kohn in which he argues that rewarding children, students and workers with grades, incentives and other “bribes” leads to inferior work in the long run.

Those who believe in the power of bonuses fail to distinguish between intrinsic and extrinsic motivation – wanting to do something because you like it in its own right versus doing something because you want the reward, Kohn says. “It’s not just that these two are different, it’s that they are often inversely related. The more you reward people for doing something, the more their intrinsic motivation tends to decline.”….

What’s more, the studies suggest that the greater surveillance, evaluation and competition that tend to accompany performance-related rewards further undermine intrinsic motivation, and that offering rewards can also stop people taking responsibility.

Other studies have found that when offered varying levels of rewards for performing intellectual tasks, the groups offered the richest incentives performed less well that those offered low or medium-sized rewards. And studies of real-word efforts to improve results on readily-measured metrics often find the programs had little impact:

Brian Serumaga of the University of Nottingham and colleagues looked at the effect on 470,000 hypertension patients diagnosed in the four years before and three years after the introduction of the scheme. They found the financial incentives had no effect on the proportion of patients who had their blood pressure under control, who were being monitored and treated, and who suffered adverse outcomes such as heart attacks, stroke and renal failure. Neither did they have any impact on how patients’ actual blood pressure changed over time (BMJ, DOI: 10.1136/bmj.d108).

“Having spent three years looking at the evidence of payment-for-performance, I am astonished at how weak the evidence is,” Serumaga says.

Doctors are arguably less motivated by money than other professionals. However, another problem with performance measurement is that for most jobs, bosses make a largely-to-entirely subjective assessment of their subordinates. As we noted in a 2007 article for the Conference Board’s magazine:

Other factors can thwart an organization’s meritocratic efforts (many of these observations derive from a 1992 paper by Patrick D. Larkey and Jonathan P. Caulkin, “All Above Average and Other Unintended Consequences of Performance Appraisal Systems”). Many people, for instance, run up against conflicts between individual and organizational interests. Implicitly, any employee’s job is to serve his boss, when his check is actually being cut by the company. If the employee views his role as being different than his boss sees it, the boss’s view prevails, whether or not it is correct. In an extreme case, if the boss wants the employee to run personal errands, and the employee refuses, he runs the risk of getting a negative review….

And then there are difficulties in ranking employees across organizational units. Even though organizations want consistent ratings firmwide, it’s a practical impossibility. There are considerable barriers to a manager giving his staff member honest and useful feedback that lead to inflated ratings. They have an ongoing relationship; and thus both sides do not want the review process to create friction. Yet most employees have an inflated view of their achievements, which predisposes them to doubt, perhaps even resent, a truthful appraisal. And since the assessment of a job of any complexity is largely subjective, it’s difficult for the boss to defend a rating that is at odds with the employee’s self-assessment. In addition, managers consider themselves at least partly responsible for their subordinate’s performance. Thus a low rating reflects badly on them.

The odds are high that a lot of readers will reject this argument. Why? Most people, particularly successful people, need to believe that that their success was fairly won, and not the result of manager bias or luck. Wall Street denizens in particular see their outsized compensation as a badge of honor. Given how badly they’ve done in performing role of the financial intermediaries, that of allocating capital efficiently and effectively to real economy opportunities, the more questions raised about the logic of their pay, the better served the rest of us will be.

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  1. Neil Wilson

    Money is not and never has been a motivator – its a hygiene factor. Once you have ‘enough’ it is no longer intrinsically motivational in anything other than plodding roles.

    Then it some professions it becomes a scorecard – acting and finace spring to mind.

    But for most people interesting work and challenges are what motivate.

    There is a reason open source software exists and why people still climb dangerous mountains.

  2. Hans

    My father in law (a psychoanalist) used to hand out a gift to those of his kids that performed badly at school because he thought the ones with good grades were already awarded enough.

    1. KFritz

      Now that’s innovation! Anecdotally of course, do you remember if it produced any results?

  3. Middle Seaman

    The main problem with pay performance is the difficulty to arrive at accurate measure of performance. After all paying requires a way to compare performances. The post points to the fact that even profits are not simple to compare. Adhering to the black magic of “performance” should not the way to go.

  4. ScottW

    I personally witnessed compensation obsessed executives run a company into the ground. The product became irrelevant with most time and energy of the “top brass” consumed by creating gold plated compensation and pension plans. As their wealth increased, their personalities transformed into bitter, self-interested executives who hated each other.

    On the other hand, the studies mentioned in this article are often used as an excuse for not paying teachers, or others involved in more altruistic work. While increasing salaries may not motivate better performance, failing to pay workers a living wage does not produce superior, sustainable performance.

    In the end, all too many workers find their jobs boring and intrinsically unrewarding because frankly, what they do, is just mind numbingly boring and unrewarding. They see no social purpose behind what they do, and the only motivator is the paycheck. The difficulty is finding work that requires creativity, contributes to society, and allows a workers to lose themselves in daily activity, rather than counting the hours until departure.

  5. Michael Wasserman

    After reading this article, I thought about putting some money in your tip jar, but then reconsidered, as I do not want in any way to diminish the outstanding job you do!

  6. jake chase

    Executive compensation schemes are simple looting. Those in control of corporate machinery enjoy power to loot because the legal fiction of “independent directors” permits the executives to hire stooges to rubber stamp their compensation demands. Once upon a time directors had a fiduciary duty to stockholders, and stockholders could sue derivatively to enforce it. Such suits are now simple blackmail routines winked at by judges who have washed their hands of the whole matter. State regulation of corporations has produced a race to the bottom and located the bottom in Delaware, where anything goes. All this could be changed quite simply by requiring publicly held corporations to have federal charters, but of course that would require a Congress not itself entirely in the pocket of the executive crowd. How much is a corporate executive really worth? No more than an average shortstop, and for the same reason. The woods are full of them.

  7. anonym

    Do you really think there intrinsicly motivating jobs in finance ? and if yes, what %.. maximum 5… so all other people have to be paid to do the boring part.

    1. ScottS

      I imagine running a charity trust would be hugely satisfying. Also, it would be fascinating to run a major construction/development trust. I would also love to run a tech VC company, though there is already plenty of money there. It would still be fun to see what the smartest people are interested in, and help bring it to fruition.

      But does anyone stoke subprime mortgage markets then short them for the satisfaction of a job well-done? Gods, I hope not.

    2. Lucy Honeychurch

      Yes, it would certainly be personally satisfying to actually contribute to the multiplier effect, and thereby, the greater good.

  8. anonym

    What is also missing in the studies is the relative factor.. all studies are on the effect of compensation on individual or groups in isolation. But if you run the same studies with many groups and account for peer-group (ie, jêalousy) effect, I suspect your results will be very different..

  9. Lilguy

    Agree with the article & most of the statements here.

    As a retired federal employee, I can tell you that P4P was used in various departments to pay MOST employees LESS to the benefit of the few (too often for the wrong reasons, like political views). This largely true because, on an overall basis, employee salaries/benefits are capped within a dept/agency. The result is just a re-distribution of the pie.

    1. ScottS

      The last company I worked at started you with average salary, then subtracted 10% and gave it back to you as an “incentive plan.” It’s like the 401(k) scam, where they can simply hold it back when management fails to plan for emergencies, or makes bone-headed decisions.

  10. dave

    Have any of you ever worked in a large corporate? If anything there is a clear lack of pay for performance. Most everyone gets around the same mediocre merit raise every year and most promotions are around 10% jumps every 5-10 years. You know what happens to people when they get paid basically the same whether they try hard or not? They stop really caring. If your a programmer and your twice as productive at coding then someone else but you get paid the same you basically stop caring after awhile. You shift from trying to do more to trying to minimize work and getting out of the office sooner or slacking on the internet.

    1. ScottS

      Yes and no. A different study I saw showed that people respond most to recognition, either positive or negative. In the large corporate dynamic you describe, pay is just a special case of recognition. It’s easy to talk about pay since it’s quantifiable.

      Pay incentivizes people to do tedious tasks. Programming more tedious than designing.

      So how about a pay cut for architects, pay raise for those on the frontlines? I think it’s less absurd than it sounds.

      But this is somewhat tangential to the topic, which is the opposite extreme of paying bonuses way out of proportion with employee contribution. Consider that Transocean paid out 66% of the total “safety” bonus to it’s execs for their performance last year. Really? Worst oil disaster ever, and these guys get more than half of their safety-related bonus? This doesn’t seem to be rewarding anything constructive.

  11. Dan Duncan

    Yves Smith as an Evangelical. Whoda thunk it?!

    The debate of “Pay for Performance” has been played out between Evangelcal Protestants and Catholics for centuries.

    Arguing against Pay for Performance, the Protestants state that all one has to do is believe in Jesus Christ. Good deeds do not curry favor; rather good deeds are simply the result of divine grace.

    On the flip side, Catholics state that performance through good deeds does matter…since good deeds aren’t simply the result of divine grace, but rather they result from free will and the choice of good over evil.

    The Protestant ethos, of course, came as a protest against Catholic corruption. Much of Yves’ sentiment also comes from the same place…a protest against indulgences conferred upon the Bishops of Wall Street. And her protest is understandable.

    But in the end, it’s a question of Faith; because if it’s not a matter of “Pay for Performance”, then it’s “Pay for ____” what?

    “Pay for the Divine Grace conferred upon those baptized in the Holy Waters of State Sponsored Employment?”

    Fuck that. There’s neither faith nor logic in that enterprise…just a barren, uninspiring State-ism.

    Today, Yves is channeling her inner Rock’n’Rollen, Rainbow Man persona as she stands over this here blog with “John 3:16!” written in large letters on a giant poster.

    “For God so loved the world that he gave his only Son, so that everyone who believes in him might not perish but might have eternal life.”

    Only, her God is the State.

    Keep the debate about “Pay for Performance” where it belongs– in the arena of Catholics v. Protestants. At the worst, it’ll be a “Lie to me please–I promise to believe!” exchange that will get many desperate souls through the night.

    As for the workplace, Pay for Performance may not be perfect, but it’s better than the alternative.

  12. Chris M.

    I absolutely believe it is not a good idea to pay for performance. And I used to benefit from it. I agree with most of what Kohn has to say about it. But it’s not just a radical fringe idea. Mainstream management gurus like Demming and others didn’t believe it was such a great idea. But try saying that in a firm that does compensation consulting (among other things). You get stunned disbelief. It’s inconceivable to most people in corporate America that pay for performance is often counterproductive. (I also agree that it’s been a handy way for executives at places like GE and other hyper pay-for-perf companies to boost their pay in relation to avg worker pay.)

  13. Paul

    I have found it profoundly demotivating to work alongside others who are better compensated despite doing very little work. I don’t know what the ideal compensation plan looks like, but it won’t much resemble the Soviet system.

  14. krb


    I completely disagree with your view. As a former small business owner whose success or failure depended on the performance of many others, I found pay for performance extremely successful. But like anything else, the success is in the details.

    There is not space enough to fully describe here what we found to work. But some key components…..

    Accept the fact that all of us are fundamentally self-interested….”How does this affect me?” is the conscious or unconscious question whenever any of us hear new ideas or proposals. So to motivate people get their personal interests ALIGNED with company interests…..few companies do.

    Keep pay for performance programs or formulas simple and transparent. If some pay is determined by company performance or profit employEEs deserve to know exactly how that performance is determined, what impacts its, etc. They need to be able to trust that the employER won’t or can’t manipulate the criteria should the employEEs achieve the company objectives.

    Ditto for personal performance…..the job description, performance expectations and measures, etc. also need to be outlined, communicated and transparent… the story doesn’t change at year end when time to pay for performance arrives.

    There needs to be a plan component for cross performance of jobs…..will an employEE be rewarded if they step in for another to get a job done, catch mistakes, etc. for the benefit of the company?….getting the same work done with fewer people should help everyone, not just the company.

    There is much more, but you get the idea. Bottom line, we wanted to create an environment where the employEEs thought like owners, like it was their name on the front of the building…….and they did! In 100% of the cases I have heard about in other workplaces where “it didn’t work”, the programs were somehow flawed in the major components above.

    Unfortunately, we live in an era where employERs don’t want to go to the trouble, and employEEs don’t want the responsibility, for making such programs work. The fact you would take this view is consistent with your naive support for “collective bargaining”. The “need” for collective bargaining reflects a failure of both sides, employer AND employee….criticizing the one while enabling the other is cynical and narrow minded. I prefer employers aspiring to create organizations where collective bargaining isn’t even necessary, and any potential employee so cynical to believe it is necessary is unqualified to work there. Thanks, krb

  15. craazyman

    I did an experiment where I paid a bunch of chimpanzees to eat bananas and I found that they just threw the money around like it was confetti.

    The pay actually obstructed the banana eating and made a big mess.

    It reminded me of Wall Street. Now I’m looking for Grant Money to expand my study and live in an absinthe bar. All I need is a million dollars and I’ll never be seen again. But that won’t be pay for performance, it will just go toward what I view as bananas.

  16. rdoug

    After all the back dated options scandals there should be no argument that executive performance bonuses are just looting. Throw in the recent bonus awards for safety after the BP disaster and that is about all you need to know about the business corruption involved in management bonuses.

  17. ChrisCD

    Is being paid minimum wage while the owner(s) rake in the dough from your efforts a better idea?

    The problem is not the system, but the people. Good P4P programs work for good employees and they grow the business for the employer.

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