By Ian J. Cook, CHRP 

The goal of any good incentive scheme is to reward performance. The whole practice is based on the notion that the right rewards aligned to the right actions will bring about superior performance. In simple terms, people will respond positively to having the right type of carrot dangled in front of them and this will support an increase in organizational outcomes.

Our tight economic climate has made the focus on incentives even more important. In the past, base salary may have increased but many organizations are trying to stay competitive on pay by shifting the focus to an increased level of incentive pay. Given that money is tight it is only logical to try and pay out once the money has come in.

A recent piece of research, described in The Economist, highlights that it may be as important to focus on the approach taken to awarding incentives as well as the structure of goals and amounts paid out. The research comes from an area of economic study that is called behavioural economics. For many years economists assumed that all people behaved rationally aligned to their self interest. This has proved not to be an accurate or sufficiently detailed assumption, and so the study of behavioural economics has developed to explain economic activity linked to human psychology.

What the researchers found is that a group of workers were actually more motivated by the fear of loss than the opportunity of gain. The experiment they undertook was as follows:

Using two different work groups they provided the same goals and same level of incentive but they worded the allocation of that incentive differently. For one group, the incentive was a carrot. This group had the opportunity to earn more through attaining certain goals above and beyond their normal level. This would be a typical way of presenting an incentive. The second group was told that they had already been allocated the bonus amount, however should they not meet the performance criteria set they would forfeit this award. For this group the incentive was presented as more of a stick.

Through repeated application of this test the groups who were presented with the risk of losing their bonus outperformed the group who were presented with the opportunity to gain. The conclusion is that given well-structured incentives there is more likelihood of them being effective if they are presented in a way that suggests they could be lost than if they are presented as an opportunity to gain. This view runs counter to how most incentive schemes are presented and on the surface looks to provide a cost-free and psychologically-robust approach to enhancing your use of incentives.

The information presented was clear and credible. It provides some great food for thought when it comes to enhancing the design and application of incentive schemes.  There are a couple of important caveats to be considered before any substantial changes are made. The first is the financial structure underpinning incentives. Often the reason for making an incentive an opportunity is because the organization does not want to promise money it does not have. It will take some careful explanation to show that an incentive scheme that is based on a confirmed award that can be lost is, from a financial perspective, materially the same as an incentive scheme which pays out once the money has come in. The other is that the experiment was run in a manufacturing environment with clear measurable outcomes and it was only run for a period of a week at a time. The tangibility of the goals means that there is no need to factor in managerial competence to the award of the bonus. The award of the bonus is not dependent on the performance management abilities and diligence of any managerial member of staff.

If your performance goals are less tangible then you are increasing the financial and legal risk to your organization by making the award confirmed, as the proof of whether or not people have hit their goals is more ambiguous and open to interpretation and therefore more susceptible to managerial competence. By confirming the award you are more likely to end up paying out, not through improved performance but through poor performance management. Managerial competence does also impact incentives that are presented as the opportunity to gain however the financial and legal risks are increased if the award is confirmed.

The core principle that people are more motivated by a fear of loss (stick) than by an opportunity to gain (carrot) is a valuable finding. This reality of human behavior should shape your thinking around incentive design and how you position your various incentives. Before you make any whole sale changes it will be important to consider whether your organization is financially sophisticated enough and managerially competent enough to draw the best from your new approach to incentives.
 

Ian J. Cook, CHRP, is the director of research and learning at BC HRMA. Ian is using his global HR consulting experience and business knowledge to grow a function which delivers informative, relevant and timely comment.