The myth of pay-for-performance

Wednesday, 8 January 2014 00:00 -     - {{hitsCtrl.values.hits}}

Following are excerpts based on the presentation made by Prof. Uditha Liyanage, Professor of Management of the Postgraduate Institute of Management (PIM), at the awards ceremony held to mark the completion of the Public Policy for Business Leaders Program at PIM Pay-for-performance and similar “if then” rewards are effective only in a few, limited situations. In other situations, they are dangerous, and very often, counter-productive. Indeed, it seems that business does not know what science knows! The puzzle Over the years, I have witnessed the effects of incentive schemes offered to employees at different levels in specific contexts. For instance, many sales people typically work on a low fixed income and a relatively higher variable income based on their level of performance. I have observed in many organisations that when salespeople are offered incentives on the achievement of sales targets, they, typically achieve the set targets but rarely go beyond them. Conversely, when the performance of salespeople forms the basis of a competition to select, say, the organisation’s best salespeople of the year, they, go well beyond the set targets. This has puzzled me. "The research is clear and compelling. Extrinsic, “if then”, carrot and stick, pay-for- performance rewards work when the task at hand is mechanical, sequential, rule-based and algorithmic. But when it comes to heuristic, creative and cognitive tasks, extrinsic motivators are terrible. In fact, they can backfire" There is an interesting distinction to be noted here. In the former case, goals and sales targets are set by others, and in the latter case, goals and targets are set by the salespeople themselves. This vital distinction will be revisited later in this paper. The larger question is about the nature and effectiveness of the “carrot and stick” reward schemes which are widely employed in many organisations, over the years and across industries and nations. “Carrot and stick” rewards are essentially “if-then” rewards. If you do this, then you will get that, is the principle here. Monetary rewards are typically associated with “if then” incentive schemes. They are classified in the literature as extrinsic motivators. The critical question that is addressed in this paper is the effectiveness of extrinsic, “if then” motivators and the contexts in which they are effective and those that render such rewards ineffective and, on occasion, counter-productive. Importantly, it should be noted that as one moves up the organisational ladder and hold jobs of greater authority and responsibility, the place for cognitive skills will become more important than tasks that are mechanical and rule-based. Hence, in the light of the available evidence, the effectiveness of “if then” reward schemes for senior management is indeed doubtful. "Intrinsic motivators, particularly, Autonomy, Mastery and Purpose, work best when the task at hand demands cognitive skills. The research from multiple sources confirms these facts. Indeed, we can ignore them at our peril. It is necessary that business comes to know what science knows!" Rewards and behaviour Pay-for-performance rewards schemes are considered by many as a cure-all for performance related problems in organisations. Achieve a desired and pre-determined level of performance and then you receive a pay, a monetary reward for the performance achieved. This is a typical “if then”, “carrot and stick” reward. The rationale here is that if you want more of a desirable behaviour, then reward that behaviour. Conversely, if you want less of an undesirable behaviour or none of it, then punish that behaviour. It has also been argued that human beings are hard-wired to respond to “carrot and stick” reward mechanisms. It is reckoned to be a function of our old-brain, conditioned over millennia. Importantly, recent research from behavioural economics and psycho-sociology is compelling. The findings of such research projects reveal the surprising truth about what motivates us. The evidence seems compelling, and directly challenges our deep-seated notions and assumptions about extrinsic motivators – the “if then,” or “carrot and stick” rewards. Organisations that claim the effectiveness of their “if then”, pay-for-performance reward schemes should re-examine whether the apparent effectiveness of the rewards is due to extraneous factors rather than the rewards themselves .The Hawthorne Effect may well have been at work! Evidence is compelling A quartet of economists from leading universities in the USA and North America set up shop in Madurai, India, to gauge the effects of extrinsic incentives on performance. Because the cost of living in India is much lower than in North America, the researchers could offer large and attractive rewards. They recruited 87 participants and asked them to play several games – for example, tossing tennis balls at a target, unscrambling anagrams, recalling a string of digits that required motor skills, and creativity. To test the power of incentives, the researchers offered three types of rewards for reaching certain performance levels. One-third of the participants could earn a small reward – Rs. 4 for reaching their (low) level of performance targets. One-third could earn a medium reward of Rs. 40 for reaching their (medium) level of performance and one-third could earn a very large reward of Rs. 400 for their (high) level of performance (Pink, 2009). What happened? Did the size of the reward predict the quality of the performance? Yes, but not in the way one might expect. As it turned out, the people who were offered the medium-sized rewards, did not perform any better than those who were offered the small one. And those in Rs. 400 super-incentivised group? They fared worst of all! By nearly every measure, they lagged behind both the low-reward and medium-reward participants. The researchers concluded, “In eight of the nine tasks we examined across the three experiments, higher incentives led to worse performance.” Four economists-two from MIT, one from Carnegie Mellon, and one from the University of Chicago who undertook extensive research for the Federal Reserve System-instead of affirming the widely accepted simple business principle of higher rewards lead to higher performance, in fact refuted it. Importantly, in 2009, scholars of the London School of Economics analysed 51 studies of corporate pay-for-performance plans and concluded: “We find that financial incentives… can result in a negative impact on overall performance” (Pink, 2009). Ariely et. al. (2008) wrote after extensive research that “our results suggest that one cannot assume that introducing or raising incentives always improve performance… Indeed, in many instances, contingent incentives that cornerstone of how business attempts to motivate employees may be a losing proposition.” “If then” rewards and creativity Again, research tells us that tasks that involve cognitive skills, such as creative and conceptual ability do not yield to “if then” rewards. Such rewards narrow people’s focus and blinker the wide view that is required to produce “out of the box” solutions. Pink (2009) reports that Teresa Amabile, the Harvard Business School professor and one of the world’s leading researchers on creativity, has frequently tested the effects of “if then” or contingent rewards on the creative process. In one study, she and two colleagues recruited 23 professional artists from the United States who had produced both commissioned and non-commissioned works of art. They asked the artists to randomly select 10 commissioned works and 10 non-commissioned works. Then Amabile and her team gave the works to a panel of accomplished artists and curators, who knew nothing about the study, and asked the expert panel to rate the work on creativity and technical skills. The researchers concluded: “Our results were quite startling. The commissioned works were rated as significantly less creative than non-commissioned works, yet they were not rated as different in technical quality.” When the artists were working for themselves, it was “play and joy”, whereas when the artists were working for someone else, it was “work and labour”. A study of the School of the Art Institute of Chicago produced very similar results. “If then” rewards and good behaviour Pink (2009) reports that Swedish economists decided to find out whether blood donors should be incentivised in order to promote their good intent and behaviour of donating blood. They found 153 women who were interested in giving blood. Then they divided the women into three groups. Researchers told the first group that blood donation was voluntary. The second group was told that if they gave blood, they would receive a small incentive (50 Swedish Kroner or about $ 7). The third group, a variation on the second offer: a 50 Kroner payment with an immediate option to donate the amount to a children’s cancer charity. Of the first group, 52% of the women decided to go ahead and donate blood. They were willing to donate blood in the absence of any compensation. The second group? “If then” extrinsic motivation would suggest that this group might be a bit more motivated to donate blood. However, only 30% of the women decided to give blood – the number decreased by nearly half! The third group responded much the same as the first group – 53% of blood donors. Interestingly, adding a monetary reward did not lead to more of the desired behaviour. In fact, it led to less. Pink (2009) argues that the monetary reward “crowded out” the intrinsic desire to do something good. It is clear that the gap between what science is learning and what business is doing is indeed, wide. When money works It must be noted that in the Swedish example of blood donors, the reward itself was not inherently destructive. It is not that all rewards at all times are bad. For instance, when the Italian government gave blood donors paid time off work, donations increased. The law removed an obstacle to altruism. It must be noted that extrinsic rewards work sometimes, and work very well. Research is clear and compelling that extrinsic rewards work well for mechanistic, algorithmic routine and rule-based tasks. What is also true is that mixing rewards with inherently (i) interesting, (ii) creative, and (iii) noble tasks – deploying them without understanding the peculiar science of motivation is dangerous. In these situations, “if then” rewards usually do more harm than good. Unintended effects of  “if then” rewards Research also suggests that when used in the wrong context, for the wrong task, extrinsic motivations can have unintended collateral consequences. Pink (2009) lists these consequences. They are, extrinsic motivators (i) tend to promote unethical behaviour. (ii) create addiction (you need more and more of them to work) and (iii) encourage short-term thinking. The research suggests that when goals are set by others, -sales/profit targets, quarterly returns and so on - extrinsic rewards offered to achieve them can have dangerous side effects. Like all extrinsic motivators, goals narrow our focus. That is also one reason why they can be effective in certain contexts and for certain tasks. They concentrate our minds. But the same motivators can, and usually, narrow and blinker the wide-ranging thinking necessary for cognitive tasks that entail innovative and creative skills. Conversely, goals that people set for themselves and are devoted to attaining mastery are usually healthy. The prescription is to be carefully noted: Goals may cause systemic problems for organisations due to narrowed focus, unethical behaviour, increased risk taking, decreased cooperation, and decreased intrinsic motivation. Exercise great care in applying goals in your organisations (Pink, 2009). Triple intrinsic motivators Beyond “if then”, carrot and stick extrinsic rewards which work well for certain tasks, we need to understand that intrinsic motivators work especially for tasks that are cognitive in nature-innovative, creative and conceptual tasks. Pink (2009) identifies three compelling intrinsic rewards. They are (i) Autonomy, (ii) Mastery and, (iii) Purpose. Autonomy is self-regulation. Employees appreciate freedom, and the possibility of self-regulating their actions. This, importantly, leads to employee engagement that modern organisations increasingly seek and value. But management, as it is often practised and, in fact, preached is about compliance, which is the very anti-thesis of self regulation and engagement. Mastery is an intrinsic motivator. Maslow (1954) identified many decades ago that self-actualisation, realising one’s innate potential and giving expression to it is a strong motivator. Mastery is this drive to perform and excel. Purpose is the organisation’s raison d’etre, which goes beyond making money. This is the larger, noble purpose for which the organisation was, perhaps, set up in the first place. Purpose is the anti-thesis of alignment. Goal setting and management-by-objectives are not only commonplace in organisations but are considered to be sacrosanct. To get to point B, you need to know where you are – point A – and then map out a direct path to get from A to B. Alignment at work! It is argued that goals are best achieved indirectly and here is a quote from Victor Frankel, (1959), the famous holocaust survivor, which exemplifies this principle of obliquity. “Don’t aim at success. The more you aim at it, and make it a target, the more you are going to miss it. Success, like happiness cannot be pursued. It must ensue, and it only does so as the unintended side-effect of one’s personal dedication to a task, greater than oneself.” The corporate mission and purpose of the Tata Corporation is illustrative of such a purpose: “We are committed to improving the quality of life of the communities we serve. Our practice of returning to society what we earn evokes trust among our customers, employees and other stakeholders. We are committed to protecting this heritage of leadership with trust through the manner in which we conduct our business.” These intrinsic motivators raise the perspective and performance of employees, leading them to be cooperative, engaged, and innovative. They go the extra mile and excel in their performance. They identify themselves with the organisation. They are deeply loyal to their organisations. Conclusion The research is clear and compelling. Extrinsic, “if then”, carrot and stick, pay-for- performance rewards work when the task at hand is mechanical, sequential, rule-based and algorithmic. But when it comes to heuristic, creative and cognitive tasks, extrinsic motivators are terrible. In fact, they can backfire. Extrinsic rewards also don’t work when the task to be performed is interesting, creative and noble. In fact, they become counter-productive. Intrinsic motivators, particularly, Autonomy, Mastery and Purpose, work best when the task at hand demands cognitive skills. The research from multiple sources confirms these facts. Indeed, we can ignore them at our peril. It is necessary that business comes to know what science knows! [The writer is a Senior Marketer, Professor of Management at the Postgraduate Institute of Management (PIM) and Adjunct Professor of the University of Canberra, Australia. He is on the Boards of Directors of a number of leading companies.] References:
  • Ariely et al (2008), “Large Stakes and big mistakes”, New York Times, USA.
  • Frankl Victor (1959), Man’s Search for Meaning, Simon and Schuster, New York.
  • Maslow, Abraham (1954), Motivation and Personality, Harper and Row, New York.
  • Pink Daniel (2009), Drive, The Surprising truth about what motivates us, Penguin Group, USA.