Pay for Performance Does Not Always Deliver the Intended Results

Questions about pay for performance have been raised repeatedly. The primary accusation is that the system can be gained by those whose performance it is intended to value. Recent research suggests there may be good reasons rooted in brain science and basic psychological research that underpin the on-going disappointments in the quest for compensation systems that reward good performance while not cheating those who are paying for it. From Yves Smith via New Scientist:

"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.