Incentive schemes are sometimes constructed in which rewards to the individual depend on achieving certain hurdle levels of performance. That is, compensation depends discontinuous on the achievement of some numerical goal. For example, a salesman bonus may depend on whether he surpasses some level of sales, and/or his average commission percentage may jump discontinuous as certain sales figures are exceeded. When effort is spread over time, such schemes can fail to achieve the desired ends. For example, a worker whose performance near the end of the evaluation period is far from the next hurdle will have little incentive to work hard. In contrast, employees who are close to a hurdle will have strong reasons to want to kill themselves (or others!) trying to make it, even at the cost of hurting performance in the future or undertaking dysfunctional actions, such as bilking a valued customer in order to make a quick sale. The salesperson far from the next hurdle may “bank” sales for the next period, while the salesperson close to the next hurdle may try to accelerate sales.
This can be particularly true of comparative schemes, where a prize is given, say, to the best cumulative performer over some period out of a set of employees. In such cases, if one employee builds up a substantial lead over the others, then all may decrease their efforts; those who are behind slow down because there is little chance that they can catch up, and the leader slacks off because those behind have slowed down. In general, the worker’s ability to shift the level and nature of effort as time passes makes schemes that evaluate performance over a period of time somewhat tricky.
Linear incentive schemes, such as giving a salesman a fixed commission based on sales, are remarkably prevalent in the real world. Doubtless this reflects, in part, the simplicity of such schemes and their ability to motivate employees robustly (i.e., they work for all sorts of employees, in all sorts of situations). But, in addition, a strong theoretical case has been made for linear incentive schemes, based on the sort of dynamic considerations mentioned here. Roughly, when the outcomes of employee efforts are time separable (the value added in each week depends only on efforts expended in that week), to keep the pressure of incentives steady over a longer accounting period, the firm will want to keep a steady rate of reward for marginal contributions, translating into linear incentive schemes.
There are a number of reasons why firms wish to decrease voluntary turnover. Hence, an important aspect of motivation can be encouraging the employee to remain. A method for increasing retention of more senior workers is to have compensation rise with seniority; if an employee is promised a valuable reward – such as disproportionately high wages, access to stock options, or a pension – if he remains for ten or twenty years with his current employer, he will be decreasing inclined to quit the closer he gets to that reward.
The economic theory of incentives is built up from the standard economic model of human behavior. Roughly but fairly accurately put, employees within economic models are greedy, slothful, and concerned entirely with ends and not means:
– Employees will evaluate compensation systems and their own compensation in terms of the fairness of the outcomes and the process by which their performance was evaluated and rewarded; distributive and procedural justice will be considered.
– They will engage in social comparisons; it won’t necessarily matter how well each did on an absolute scale, but rather how each did relative to his peers. (We recall an eminent labor economist who, while doing his stint as chair of his economics department-one of the best in the world-remarked in somewhat mystified fashion that his best-paid colleagues seemed particularly concerned not with how their annual raises compared with inflation, but instead how they stacked up with the raises earned by their other highly paid colleagues.)
– Compensation should be consistent with and even reinforce social status.
– Enterprises, compensation that doesn’t correlate strongly with position in the organizational hierarchy can be problematic.
– Compensation should be consistent with the organization’s culture. For instance, incentive compensation leading to enormous cross-sectional or temporal variation in wages might be entirely acceptable in organizations with a “market-like” culture, as long as those who get more are viewed as having earned what they get. The same compensation systems may be woefully inappropriate, however, for an enterprise that otherwise promotes a familial culture.
– In addition to external motivators-compensation, promotion, power and perks, retention, the esteem of peers, and positive social relations with peers-intrinsic motivation can play a powerful role. And extrinsic incentives can dull intrinsic motivation, when employees attribute their efforts to the pursuit of extrinsic rewards instead of inner satisfaction.
The force of these social processes can be ambiguous. Perhaps most importantly, the force of distributive justice is not always clear. Compensation is distributive just, by and large, if it conforms to the norm of equity-individuals should be paid according to how much they contribute. But what is “contribution?” Is it effort exerted or profits generated? Perceptions on this vary according to circumstances and, in given circumstances, can vary among observers.
To illustrate how non-economic forces can complicate “economically simple” questions about pay for performance, and because it is important in its own right, we turn next to a simple question: If you are going to reward employees based on performance, should the rewards take the form of a bonus (paid immediately) or a raise in base pay?
If the definition of pay for performance is stretched to include systems in which employees’ raises reflect past performance, then pay for performance is much more prevalent than one might initially think. The idea that one gets raises for a job well done is fairly common because of its ties to promotion: Workers are promoted for having done well, and promotions to new jobs usually entail higher wages.