Does Financial Bonus Increase Job Performance?

Studies have shown that performance-based financial incentives work. They work when they are carefully designed. They increase the performance of the employees, though they may have side effects.

A study of technical employees in the private sector in Sri Lanka showed that the incentive factors that impact performance are the type of incentive, payout frequency, and employee participation in setting goals.

Another study of Navy recruiters showed that incentives primarily work when the payout time approaches. But performance can drop dramatically after the payout, especially if the next one is far in the future. So think carefully about your yearly bonus plans.

Yet another study showed that performance could not only increase ahead of the expected payout of the incentive but also reactively as a response to a reward already paid. Researchers found that periodic incentive payments lead to a temporary boost of unincentivized behaviors. Employees become more loyal and willing to do more than just the incentivized tasks if it helps the organization.

“Incentives spread uniformly throughout the year can lead to more consistent performance. Don’t rely just on a yearly bonus.”

The implication is that various incentives spread uniformly throughout the year can lead to more consistent performance. You shouldn’t rely just on a yearly bonus as that would have only a very localized effect.

When financial incentives work

A study of 11,939 employees over five years showed that merit and bonus pay positively impact employee performance. Bonus pay may have an even stronger effect than merit pay, but they can substitute each other. More importantly, the pay-for-performance effect differs between job types, over time, and with the employee’s tenure.

Report funded by Novartis, a global pharmaceutical company, summarized the current scientific evidence in the field of financial incentives, and the conclusion was clear. Financial incentives work. But they work better in some situations than others.

They are especially effective at increasing the performance of tedious and non-interesting tasks and may slightly negatively affect employees performing tasks they are interested in and excited about.

“Team-based incentives have a bigger impact on overall team performance than individual incentives, but they are less effective the bigger the team gets.”

It is worthwhile to note that team-based incentives have a bigger impact on overall team performance than individual incentives, but they are less effective the bigger the team gets. Curiously enough, the positive effect of financial incentives is bigger for more complex tasks than for less complex.

Side effects

However, financial incentives can have a negative influence when they are based on performance without clarifying the performance standards and also have other side effects.

Performance incentives can increase gender bias, decrease ethical behavior, increase the perceived value of money, and decrease intrinsic motivation. The incentives system you put in place will drive behavior, so make sure you consider the implications. Research showed that performance incentives lead to employees spending more time with coworkers and less with friends and family. The reason is simple, incentives make it look like work, and work relationships are more important than life outside of work. You get no incentives there.

“Performance incentives lead to employees spending more time with coworkers and less with friends and family, as they make it look like work is more important than life outside of work.”

No one would argue that having positive relationships is critical for psychological well-being. The most important and rewarding relationships are those with friends and family. Yet most working adults prioritize their work relationships, and the culprit seems to be performance incentive systems.

Bonus pools

And then you have the bonus pools. Bonus pools, a way most companies would do employee bonuses, are tricky. Research has shown that it can even backfire when the bonuses are too small or diluted by the overall group performance. For example, if you have a group of ten employees and each can expect a 5% bonus depending on their performance as well as group or company performance, and then a couple of the employees exceed their goals and therefore will get a bigger share, the rest of the team can be dramatically demotivated.

Let’s say each employee would be eligible for $100 if they give 100% performance and the team also gives 100% performance. Five of them attain 150% performance, and the rest their 100%. However, the company as a whole achieves only 80% of its financial goal and funds the bonus pool at 80%. So instead of the $1,000 in the bonus pool (10 people times $100), there is only $800. This means 100% performance leads only to $800. Moreover, because five people exceeded the expectations, they get more ($100 * let’s say 125% to reward individual performance * 0.8 bonus pool funding), which leads to $100 for top performers, this then leaves only $300 to be spread over the five employees who did their job at 100%, $60 each. They have met their performance criteria at 100% yet get a 60% bonus. How motivating is that?

Equity

The researchers assert that the use of equity, like stock options, creates a social exchange relationship between the employer and employees, leading to higher individual job performance in the future. Job performance is higher when the employee receives higher profits from their stock options. Unfortunately, in most companies, equity awards are not tied to performance but rather to a position in a hierarchy. It is a pity and a missed opportunity. Even a small performance-based equity award can go a long way to improve both the performance and loyalty of the employees.

What about intrinsic motivation?

Evidence suggests that financial incentives indeed work and don’t have a negative impact on intrinsic motivation as long as employees see them as fair and not exploitable.

Performance-related pay is generally associated with increased satisfaction with pay, job security, and worked hours. However, it is negatively associated with satisfaction with work itself. Pay for performance feels good because it seems fair, but it takes the fun out of work.

Fairness is the key. Financial incentives only work when there is a perception of procedural justice. Employees must trust the performance management and reward system are fair. Then financial incentives, combined with a clearly articulated meaning of one’s work, can increase even intrinsic motivation. This requires a decision-making process that is unbiased, consistent, and generally fair.

More on the topic of Leadership and Management:

8 Things To Avoid When Leading A New Team

Lead With Ruthless Compassion Instead Of Anger

How To Have More Women In Leadership Roles

Performance Management And The Paradox Of Meritocracy

Culture Is Not Created By What You Preach, But What You Tolerate

Great Leaders Turn Strengths Into Results

Employees Don’t Care About Perks, They Care About Respect

People Don’t Want Feedback, They Want Attention And Support

People Join Companies But Leave Teams

Hire Motivated People And Teach Them

What is your take on the topic? Do you believe financial incentives work to boost performance? What works for you personally? What do you believe is the best way to incentivize employees?

Originally posted on my blog about management, leadership, communication, coaching, introversion, software development, and career The Geeky Leader or follow me on Facebook and Twitter: @GeekyLeader

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