Section 7: Incentives in Organizations
What are the important questions should we ask before we start to design organizational incentives? Which incentives work (and under what circumstances)? What types of incentives do not work? Are performance reviews (peer feedback) a good incentive to use?
Making Sense of Incentives
Levitt, S. (2005). Do This, Get That: Making Sense of Incentives. Associations Now.
Author: McCully, James I; Editor: Creedon Jr, John Thomas
The author’s underlying premise is that incentives are a vital tool for accomplishing objectives. He believes that “economics is, at root, the study of incentives: how people get what they want or need, especially when other people want or need the same thing.” Under the general public’s perception, incentives are associated with business. However, even in this context, the use of incentives is highly underutilized given the great reward. This is especially prominent in the nonprofit sector where incentives are seen as a corporate mechanism and frowned upon. Given the great reward that incentives bring in accomplishing objectives, true mastery of the incentive system is difficult. There is underlying issue with individuals gaming the system to their benefit while reaching the goals initially planned.
Three Incentive Programs
Incentive programs can be split into three types: economic, social, and moral. The most common incentive program would be financial and is the manner in which the general public views incentives but it is not necessarily always the most effective mechanism.
Social incentives focus on making individuals feel liked, respected, and appreciated. This can be done through special recognition for a job well done or through an employee-of-the-month program. On the flip side, by publicizing relative performances of individuals can stigmatize poor performances and act as a form of negative social incentive as well.
Moral incentives allow individuals to act upon an internalized moral code by presenting them with choices that could be right or wrong. An example would be to increase the number of organ donors, a moral incentive would be to let individuals know the value they would provide since organs would save lives. These types of incentives lends themselves well to the non-profit sector as many who work in this sector view themselves as driven towards a higher cause.
A question is presented as to whether all three incentives should be used together to maximize the benefits. The author argues that this strategy is not efficient as evidence points to financial incentives weaken both social and moral incentives and vice versa. An experiment showed that parents who were fined for coming late to pick up their children from day care did not reduce the number of parents who came late but rather increased the number. The experiments concluded that with no initial fine, parents were faced with a social or moral penalty for making the day care providers wait longer with the children. However, once a financial penalty was placed, which could be seen as a financial incentive to not be late to pick up their children, it took away from the moral or social penalty as parents did not feel as bad for being late since they had to pay for it. This experiment shows that it is very difficult to combine the three types of incentives.
The author discusses looking at both internal and external audits and comparing the best and worst individuals from both scenarios and what makes them so. Using this evaluation can then produce an incentive system that would fit better with the vision of how the organization should work. One particular focus is ensuring the right type of incentive is used to match with the desired result. This is not a simple task of asking the targeted group what would make them respond. The author believes that there is a great source of data that could be used to analyze these issues but it is not being used by organizations as much as it should be. One issue is that to draw relevant conclusions would require experimentation that may not be well received by clients and customers.
Testing Incentive Plans
Two methods: First, integrate incentives one at a time so each can be measured or aligned more easily than if it were offered as a batch. Second, implement a range of treatments for different groups. The best ways to evaluate incentive programs is through randomization and take the process like an experiment but care should be taken not to antagonize people.
Experimenting with different incentive programs is extremely useful and important but there are two reasons for caution. One, a slight change can lead to large changes, second, changes that you get are often unanticipated. Mistakes are going to be made but the challenge for association leaders will be ensuring that an incentives strategy inspires not only tremendous activity among their members and stakeholders but also drives the right activity. This could be the difference between energetically driving an organization to accomplish even the most grandiose goals or settle for mediocrity.
Performance Monitoring Systems
_Are Amazon’s Feedback Tactics Unusual? BBC, August 22, 2015. _
Author: Hamlin, Madeleine Rose; Editor: Whiting, Cal McCulley
In August 2015, the New York Times published an exposé about the work culture in Amazon’s white-collar Seattle headquarters. Despite the controversy that ensued, Peter Fleming argues that there is little new about Amazon’s management practices.
Amazon employees are subject to what is known as a ‘rank and yank’ performance review system: they are regularly reviewed and ranked, and the lowest-performing employees are fired. The system relies on a micro-performance management philosophy that is best reflected in the company’s “Anytime Feedback Tool.” Using this tool, workers can comment anonymously on their co-workers’ performance at any time. Employees are reviewed on nearly every action, including how long it took them to reply to an email. In this way, Amazon effectively “turn[s] the annual performance review into a daily event.”
However, Fleming argues that, despite relying on new tools enabled by ‘big data’ technology, the principles behind Amazon’s management system date back to Taylorism. Frederick Taylor (1856-1915) popularized the 'rank and yank' management system that emphasized the scientific measurement of every aspect of worker performance. He was famous for using a stopwatch to evaluate steel factory workers and their output. Amazon's use of 'big data' is an extension of Taylorism facilitated by the increased capacity and use of technology. Many major companies employ ‘rank and yank’ systems, including General Electric, Microsoft, and Accenture. The “Anytime Feedback Tool” is not so different from the “360 degree” appraisal method, which has been used since World War II.
While Amazon is not alone in its management practices, doubts remain about the efficacy of this system. Fleming argues that constant surveillance and evaluation discourages cooperation and breeds paranoia, mistrust, and anxiety, making it difficult for workers to perform.
Highest Paid CEOs are the Worst Performers
_Adams, S. The Highest Paid CEOs are the Worst Performers, New Study Says. Forbes, June 26, 2014. _
Author: Wohlenberg, Danielle Irene; Editor: Kim, Chung Myung
The Impact of Incentives for CEO’s
This article analyzes the success of companies when the CEO has a pay increase. According to Michael Cooper from the University of Utah’s David Eccles School of Business “the more CEO’s get paid, the worse their companies do over the next three years.” This then poses the question, is money an incentive for better performance? Or does it develop complacency and overconfidence?
A combined study by The University of Utah, Purdue, and the University of Cambridge researched 1500 companies over three year periods, from 1994-2013. The revenue generation of these companies was then compared to other companies in the same field. The research discovered a trend, that CEOs with higher pay have companies who do “worse”. More specifically the companies that were paid at the top 10% of the scale had the worst performance, returning 10% less than other companies in their field; and the top 5% of CEOs with the highest pay had companies that did 15% worse on average than their peers.
Michael Cooper theorizes that this trend is a result of overconfidence by the CEO and leads to overinvesting, and investing in bad projects. He suggests that claw-back provisions can be used as a way to incentivise the CEO to make better and wiser financial decisions. The claw-back provision can be included in the CEO's contract and would stipulate that if the firm perform poorly compared to its peers, then the CEO will lose a share of his or her compensation.
This research recommends to therefore increase proficiency of a corporation through negative incentives instead of positive incentives. According to Cooper most corporations however are unlikely to implement negative incentives.
What Field Experiments Have Taught Us About Managing Workers
_Levitt, S. D., & Neckermann, S. (2014). What field experiments have and have not taught us about managing workers. Oxford Review of Economic Policy,30(4), 639-657. _
Author: Legnetto, Deanna Marguerite; Editor: Hanson, Keely
Field Experiments: Where they are and where they should be
Levitt and Neckermann discuss the extent to which research is available on field experiments as useful tools to measure relationships between employees and their employers. While significant evidence is avaible indicating output responds positively to
financial incentives, there is mixed support in regard to the output response to employer generosity.
Their discussion highlights five commonly known main points to be made about these relationships, and also recommends that research be conducted by asking these questions to be asked concerning these relationships.
There are five conclusions to be made from field experiment research regarding employee incentives. According to Levitt and Neckermann, both monetary and non-monetary incentives will work. It is evident that when presented with general or competitive financial incentives, employees performing simple or straight-forward tasks will work harder. If employees are given a few gestures of appreciation, whether it be monetary through pay raise or gift or general consistent kindness, work output will tend to increase but not at the same rate. Providing employees with different types of recognition including awards and honors may correlate with increased levels of output, but will differ among organization type and culture. The social culture of the workplace that exhibits friendly professional relationships can have a positive effect on work effort. Lastly, the organization of the work itself, especially implementing group work, can effect employee performance.
Although employee responses to incentives is an interesting point to be made, Levitt and Neckermann believe field experiments have failed to assess three other areas that can be connected to the relationship between the employee and employer. Examining the recruiting process an employer exhibits may give valuable information on the relationship between employees and employers. Field experiments should analyze the reasoning behind promotions and assess their implications. Funding employee training is also another area that would benefit from further analysis. Little research and experiments have been done regarding recruiting, promotions, and training mainly because employers are not interested and have difficulty admitting there are issues in these areas. Aside from financial approaches to incentives, employers can add ‘meaning’ to mundane tasks and/or recognize their employees and also potentially see an increase in output. Thus, social relations are also important for employers to consider in how firms function and design their incentive structures.
Pentland, A. (2014). Social Physics: How Good Ideas Spread-The Lessons from a New Science. Penguin. CH 4: Engagement.
Author: Lancto, Katelyn N; Editor: Orlan, Samuel Lawrence
Engagement is the repeated cooperative interactions within a group. Collaboration is achieved by encouraging individuals of a group to adopt certain behaviors and norms that become harmonious. Working together requires compromising to adopt behaviors and develop habits that result in optimal cooperation. Many animals have developed techniques to facilitate group decision making, such as signaling mechanisms, vocalization, body posture and hand movements. Synchronization and uniformity of idea flow is critical within a group; when the majority of group members seem ready to adopt new ideas, the skeptics are convinced to go along.
Leaving the animal world, engagement is important in business as well. Research has shown that engagement can improve the social welfare of the group and promote positive behavior that is conducive for successful business practices. Microfinance banks are an example where strong social engagement is key to success. They have found that strong engagement increases the likelihood that loans will be repaid.
An experiment was done to see how Facebook users would respond to social pressure. Some users received a “get out and vote” message alone, some received the message along with seeing the faces of friends who already voted. The group that was shown pictures of their friends who had already voted, voted at a higher rate. Words themselves had very little effect without the social pressures. The manipulation of social ties was effective in pushing individuals toward a desired behavior. Seeing members of the group adopting new ideas or exhibiting certain behaviors provides motivation to follow suit. Social pressure works, especially in small groups, because the ability to punish or reward members helps promote cooperative behavior. This also tells us that standard economic incentives often miss the mark because they ignore the fact that people are social creatures influenced by social ties. Therefore, in order to change behavior, we need to aim incentives at social networks, rather than offering traditional economic incentives.
Another experiment was conducted to test the theory that the best way to motivate people was by using social network incentives. Citizens of Boston are much less likely to engage in physical activity during winter. The experiment sought to promote physical activity levels by assigning all participating members two “buddies” and the buddies were given cash rewards based on the behaviors of the “behavior-target person.” It turned out that this system increased physical activity almost four times as much as traditional individual incentives, and for those who had a close relationship with their buddies, the effect was almost eight times as high. The study found that the number of direct interactions that people had with their buddies was a good predictor of the level of behavior change. Additionally, the number of times people had direct interactions with each other gave an accurate preediction of the trust they expressed in each other.
This chapter also looked into “digital engagement.” Pentland looked at an experiment where individuals were not only rewarded for staying active, but they could see how their buddies were doing online. This added a competitive aspect that led to a doubling in the effectiveness compared to the financial incentive alone. Social media is often used within companies, especially those with global reach that span across time zones. A study of companies with digital networks found that when the digital social network grows in bursts of engagement, the network ends up being more effective than when it grows gradually. Additionally, it mattered who invited whom to join the network. The study found that if you receive three invitations from people who are close to you, you are virtually guaranteed to join. However, even if you received 12 invitations from people you are not regularly engaged with, you were not likely to change your behavior and join.
Adam Smith explained capitalism as the “social fabric created by the exchange of goods, ideas, gifts and favors”, which guides capitalism to create solutions that are good for the community. However, Adam Smith lived in a smaller world, where the poor were not considered and the lack of engagement between rich and poor removed the social constraints. When there is no engagement between social groups, there is more chance of “between-group violence” because the groups are poorly integrated. When there is a mismatch of this type, subjugation and persecution often follow. When there is not cooperation, but instead a distrust based on previous interactions, the majority of interactions are explosive, and each interaction would serve to further erode trust leading to increasingly negative engagements.
In summary, success at being part of a team depends on having continual engagement with the team network. The level of engagement is a strong predictor of team productivity and resilience across human activities. There are three key ideas about engagement, or in other words, the process in which the ongoing network of exchanges between people changes their behavior: (1) Engagement requires interaction because there needs to be network restraint, or repeated interactions between all members of the group. The number of direct interactions is a good measure of social pressure to adopt cooperative behavior, as well as an excellence predictor of how well people maintain new, more cooperative behaviors. (2) Engagement requires cooperation where each individual must be pushed towards joint ownership of the group project or goal. (3) Engagement requires building trust which enhances the expectation of future fair and cooperative exchanges.
Monetary vs. Non-Monetary Compensation
_Ariely, D. (2008). Predictably irrational (p. 20). New York: HarperCollins. CH 4: The Cost of Social Norms. _
Author: Sears, Kicia Kimberly; Editor: Farrior, Cheri Nicole
Ariely argues that we live in two worlds of exchange: a world of social norms and a world of market norms.
In the world of social norms, people are willing to help another person as a favor, without expecting anything in return. The pleasure of helping someone is worth the exchange of our efforts. In this world, the mention of money is gauche: We would be offended if someone offered to pay for a Thanksgiving meal we've just cooked for them, for example.
However, accepting gifts is perfectly ok in the world of social norms. Even though we know, intellectually, that gifts cost money, we feel that a small gesture is appropriate--though perhaps unnecessary--in exchange for our help.
In the world of market norms, however, money is expected. There are no "warm & fuzzy" feelings about our exchanges. We expect to be compensated at a value equivalent to our efforts and talents. The market world is not mean, per se, but it values "self-reliance, inventiveness, and individualism." In addition, in market norms, people expect to be paid on time and consumers get what they pay for.
Keeping these worlds separte is crucial. When we begin to mix them, social norms are the ones that get destroyed.
The author cites experiments done to explore this dual yet often unspoken understanding of how exchanges work. In one experiment that he completed with a partner, participants were asked to complete a mundane task on a computer: putting a circle from one side of a screen into a box on the other. One group was given $5 at the beginning of the experiement for 5 minutes work. The second group was given $.50 for the same amount of time. A third group was asked to do it without mention of any reward. The results were interesting: the first group ($5) dragged an average of 159 circles in 5 minutes; the second group ($.50) dragged an average of 101 circles, and the third group ($0) dragged 168 circles. Though the difference between the first and third group averages is small, the implication is clear: on average, people will work just as hard for a favor (free) as they will for an appropriate wage.
The same experiment was done with gifts: the first group was given a box of Godiva chocolates ($5 value), the second a Snickers bar ($.50 value) and the third was not promised a gift. The result was that all three groups worked equally hard on the task--the first group dragged 169 circles, and the second and third dragged 162 and 168, respectively.
These experiments show that a social exchange (gifts or simply favors) can compel people to work just as hard as they would for an appropriate wage ($5).
When the author and his partner blended the worlds--as they have advised against--the results were predictably worse: Before the experiment, they told the first and second groups the cost of the gift. "They reacted to the explicitly priced gift in exactly the way they reacted to cash, and the gift no longer invoked social norms--by the mention of its cost, the gift had passed into the realm of market norms." People will work hard for free or they will work heard for a reasonable wage, but if you offer them a small monetary payment then they will walk away. When offering a gift as compensation, do not mention the cost of the gift or it will loose its purpose.
The author argues that Market norms also create a strange set of behaviors with regard to how we interact with one another. As mentioned before, the market norms value individualism and self-reliance--two things that seem at odds with the "warm & fuzzy" feelings of social exchanges. The authors wanted to see if simply making people think about money was enough to invoke these norms and do away with social norms.
They gave two groups a set of scrambled sentences or phrases to unscramble. In one group, the sentences were neutral and did not invoke the market. In the other, the sentences were related to money (for example, "High-paying salary" versus "It's cold outside"). Once these puzzles were done, participants in each group were given a more difficult puzzle and told that they could ask for help if they needed it. The group given money-related sentences showed much more self-reliance and either didn't ask for help, or waited for longer before asking for help. This is seen as a positive effect.
However, the particpants in the group with money-related sentences were also less likely to assist others, including other participants who were struggling, an expirimenter who needed to enter a lot of data, or a "stranger" who "accidentally" spilled pencils.
The point of these experiments is to show that social norms and market norms really make people think and behave differently when it comes to the exchange of goods and services. When kept separate, things go smoothly. When mixed, the market norms tend to win out over social norms and damage personal relationships as well as productivity.
The author also discovered that mixing the worlds has even worse affects on social norms. A daycare in Israel imposed a fine on parents who picked up their children late in an attempt to discourage tardiness. What they discovered was that the social contract they had in place prior to the fine--guilt, mostly--was much more effective than the fine. People were picking up their children late even more frequently. Therefore, they removed the fine. However, the social norms had already been ruined by imposing the market norms (in the form of a fine), and tardy pickups became even more frequent. The point is that market norms are powerful: they have the ability to destroy social norms for a long time after they have come and gone.
Here, the author begins to make an argument regarding the proper places of social and market norms with regard to the business world. Companies have begun attempting to create a social connection between themselves and their customers and/or their employees. This is a good idea in theory, but has not been successful for more than a few companies. The author argues that this is because companies fundamentally don't understand social norms. They expect to "have it both ways" by asking customers for loyalty then turning around and imposing exhorbitant automatic fees on bank accounts, for example, or by asking employees to behave as friends doing favors by going above and beyond (staying late, being available out of office, etc.) but do not return the exchange with behavior or policies in kind (being unreasonable regarding sick leave, cutting health benefits, etc.)
The author argues that this problem is especially hurtful to employer/employee relationships. Companies want productivity and loyalty, but cut all kinds of benefits for employees that foster these behaviors far more than money. Ariely: "As companies tilt the board, and employeees slide from social norms to the realm of market norms, can we blame them for jumping ship when a better offer appears?"
Since social norms are just as powerful as market norms and foster a more desirable environment for both companies and their customers or employees, the author concludes that more needs to be done BY companies to foster an environment of social exchange. A company can't claim to be "family" and then turn around and treat its customers or employees poorly. Though the author understands that an entire world made up of only social norms of exchange would not be realistic or particualrly fun, more social norms need to be introduced--and properly upheld--to truly improve our lives.
People aren't willling to risk their lives ding their job when the pay isn't worth it or they don't feel that their job is valued high enough. However, this situation could be changed by elevating the social norm and making workers feel like the job they are doing is worth way more than the pay they receive for it.
In the educational setting, standardized testing and performance based salary are pushing schools further and further away from social norms and more into market norms. The focus should not be so much on test scores and salaries, but more so linking students education to social goals and making them feel a sense of pride and purpose in their education. It is important to get kids excited about their education the same way they get excited about other things that are important to them, such as sports.
Money can turn out to be a costly way to motivate people, whereas social norms are cheaper and have a larger effect.
Pay for Performance
_Lazear, E. P. (1996). Performance pay and productivity (No. w5672). National bureau of economic research. _
Author: Dieselman, Andrew; Editor: Washington, Layvon Q
"Pay Performance and Productivity"
In Edward P. Lazear's 1996 working paper, supported in part by the National Science Foundation and the National Bureau of Economic Research, he discusses the implications of performance pay and productivity. This case study examines Safelite Glass Co.'s switch from paying hourly wages to paying piece rates.
Lazear theorizes that paying workers based on performance, rather than traditional hourly wages, will increase their levels of output. In using data from the Safelite Glass Co., Lazear is able to conclude that (1) a switch from hourly to performance based wages had a "significant effect on the average levels of output." Lazear is also able to state that (2) there are two reasons for this increase: workers have more incentive to produce more; and, there is a reduction in turnover among the most productive workers coupled with an ability to hire the most productive workers.
This paper refutes claims that monetized incentives will reduce output. Lazear does not outright state that a piece rate wage system is better, only that his data supports the traditional economic theory. A firm must still weigh this information with the low monitoring cost and "perhaps higher quality output," which one gets through the hourly wage system, with the benefits from piece rate wages. It is important to note that Lazear's results found that by shifting from hourly pay to performance based pay, the productivity of the average worker increased by 36%, in one year after the new system was adopted (Lazear, p.36). Interestingly enough, this new system attracted empolyees who had better productivity than veteran employees.
Based on Lazear's article, some important questions that should be considered before designing organizational incentives includes the following: Does the benefits outweight the cost?; In what ways will veteran and incoming employees be effected?; How will the change from hourly to performance based wages impact the hierarchical structure of the organization, will there need to be more managerial position to monitor performance? The aforementioned will aid in determining if the shift from hourly wage to performance based wage will be the most effective method in improving productivity through incentives.