6.2Unintended effects of monetary incentives: chocking under pressure and dysfunctional behavioral responses to incentives

Stronger incentives does not always lead to better performance

The performance-improving effect of incentive pay rests on the assumptions that

• it will increase motivation and effort, and

• the increase in motivation and effort will materialize in performance gains

However, higher effort may fail to result in performance increase because of

• “choking under pressure", i.e. drastic decline in performance in any high stress situation

• strong incentives may result in dysfunctional behavioural responses (e.g., fraud) when performance measures for the workers are not sufficiently aligned with the relevant performance indicators for the firm (see chapter on performance measurement).

• Today: empirical studies for choking under pressure and dysfunctional response

Implications:

• Stronger incentives do not necessarily lead to better performance.

• Performance decreases as a result of overly strong incentives especially when tasks require cognitive effort. There are many such tasks.

• People are not necessarily aware of their individual motivation threshold, and may not be able to optimize their effort taking choking under pressure into account.

—>Paying flat wages might be optimal, especially for doing cognitively difficult tasks, which are many in a modern economy.

The dark side of incentives

Chris Cancialosi for Forbes (2014)

U.S. companies spend an estimated 38 billion USD on bonuses and incentives, but there's been debate in the business community about how effective they really are.

When designed properly and intentionally, incentive programs can increase performance and drive organizational success. They can be used to shape people's behavior by highlighting what's important to an organization and providing positive reinforcement to those who display the desired behaviors.

Unfortunately, when designed poorly, incentives can put a company's sustainability at risk by paying out too much, incentivizing the wrong behaviors, or possibly driving people to game the system to meet their targets.

Incentives that may appear completely rational to leaders can have the unintended consequence of rewarding bad behavior. However, that doesn't mean you should completely abandon incentive programs

Experimental evidence on sabotage under incentives

Charness, G., Masclet, D., and Villeval, M. C. (2013). The dark side of competition for status. Management Science, 60(1), 38-55.

An experiment with four treatments:

1. Baseline: groups of three participants do a task under fixed wage and no performance feedback.

2. Ranking: the same as baseline except each participant is informed about their relative performance.

3. Sabotage: the same as ranking except the possibility to pay to reduce the output of teammates.

4. Redemption: the same as ranking except the possibility to pay to artificially increase own output.

• Choking under pressure, especially in cognitively difficult tasks.

• Fraud, especially with complicated ownership structure.

• Incentives may induce “wrong" behavior.

• These consequences of incentives are “unintended", but anticipated by firms. Yet another reason why not all firms practice incentives