The Psychology Behind Performance-Based Bonuses is Total Bunk

Compensation is an arcane art. Everyone in business knows how a company determines compensation is extremely important to its health and culture, and yet nobody ever seems to be happy about it. Adding to this problem is the additional fact that nobody wants to sound like a jerk, and so there’s a strong tendency for companies to spout niceties and platitudes, regardless of empiricism, even though the evidence probably suggests they should get rid of their employees’ performance bonuses—not just to cut costs, but to make them happier and more productive.

Performance-based pay is an article of faith in the business world. GE’s Jack Welch, one of the most respected managers in the universe, became legendary among other things for his changes to performance pay in GE. To him, much of the art of management boiled down to giving employees the right goals (not too hard, not too easy) and then the right (financial) incentives to reach those goals.

To be fair, there’s been a rethinking of the idea in the wake of the 2008 financial crisis, when it was thought that the culture of fat bonuses led bankers to behave recklessly. More profoundly, if there’s one thing every manager knows, it’s that the certain thing about every incentive scheme is that it will get gamed. What managers actually want are intangibles: High quality, effective work. They try to figure out proxies for what they want, but those proxies never fully capture them. And, inevitably, you get the proxy instead of the real thing.

One workaround for that is to try to plug that into the incentive formula. This is a famous problem in sales, where incentive pay is typically such a big part of the package that salesmen become very good at gaming the incentive formula, sometimes at the expense of the company’s long-term health. The problem is that if you do this too much, the incentive system becomes incomprehensible. Since executives and managers don’t know what they get rewarded for, the whole point of incentive pay is defeated.

But there’s a more fundamental reason: the case for incentive pay is based on bunk psychology, which in turn is based on highly questionable metaphysical assumptions. The high-level concepts in management textbooks that we have now are still largely inherited from the very early days of business schools and “management science”: the industrial era of Frederick Taylor, Henry Ford and Alfred P. Sloan. In the late 1990s, the changes wrought about by the industrial revolution were so impressive that many thought that the entire world needed to be run “industrially”, that is, like a machine, and with maximum efficiency. (The reason why pupils in schools today have one class in one classroom and then move to the next classroom the education reformers of the late 19th century believed schools should be like a factory conveyor belt, with children the product and teachers like workers.) A human is a machine, and so the way to get the machine to produce the right outputs (work) is to give it the right inputs (incentives).

This quasi-religious belief dominated the field of psychology through the work of the notorious B.F. Skinner, a professor of psychology at Harvard and pioneer of the theory known as “behaviorism”, which holds that humans are like animals and that their behavior is completely determined by their incentives. This already isn’t true of many animals, and it certainly isn’t true of humans. While Skinner’s theory has largely been debunked, it was so popular in its day that it colored countless approaches to social organization (Skinner fancied himself a social philosopher, not just a scientist), including management.

As authors such as Alfie Kohn have noted, the scientific consensus today is much more in line with what we all know from our personal experience: while it’s certainly possible for humans to be externally motivated (i.e. by the prospect of a reward or fear of a punishment), not only is it possible for them to be internally motivated (i.e. they are motivated to pursue X simply because they have their own reasons to want to pursue X), but the overwhelming evidence is that internal motivation is much stronger than external motivation. But that’s not all: there is experimental evidence from countless fields that external motivation destroys internal motivation. In other words, if someone is internally motivated to do a thing, and then you tell them you will give them a bonus for doing that thing, they will lose their internal motivation to do the thing.

The culture of incentive pay still endures for a number of reasons. The first is the latent behaviorism that’s still in so many business school textbooks and curricula. The second is that external motivation really is effective—over the short term. Of course if you tell someone you will fire them if they don’t do X or they will get $50,000 if they do X, they will be highly motivated—at first. And we all have anecdotal experience of external motivation “working.”

But, I think incentive pay persists mostly because managers are lazy. If you want employees to have internal motivation, you need to figure out a way to make their job intrinsically interesting and rewarding. It can be done: Kohn delivers a case study of a garbage disposal company—the least intrinsically-rewarding job you might imagine—that boosted performance once it got rid of incentive pay and let garbage truck drivers design and choose their own routes. Not only did they do their job better, the new routes ended up being more efficient.

In other words, making work intrinsically motivating requires highly engaged, creative, and empathetic managers. Which is the biggest reason why your company should get rid of incentive pay: If your managers use it, they’re not doing their job. They are like someone sprinting at the start of a marathon: They might have great performance for a while, but they won’t get anywhere (and they’ll get themselves hurt in the process). The plus side, though, is that managing by figuring out ways to keep employees intrinsically motivated—that sounds like something intrinsically motivating.