Can bonus schemes have a negative effect on your company?

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Are performance-related bonus schemes actually effective or should businesses give the same salary to all individuals performing the same task in order to generate improved performance? Brice Corgnet finds out

Originally published 29 August 2019.

The idea that all work deserves some form of monetary reward is something that is ingrained in our working culture. Typically, in any organisation, it has become expected that managers will reward their employees with a bonus based on their performance.

By acknowledging the hard work and commitment of the people developing your business, bonus schemes are thought by many to be an excellent way to create a culture of hard work throughout your company by giving your people a share of the company’s profits.

Indeed, employee bonus schemes have long been thought to be a positive strategy within organisations. Their main purpose is to provide motivation and to encourage employees to work harder. As well as the incentive aspect, performance-related rewards have also been thought to increase employees’ identification with a company and align them with its operational objectives and ethos.

But are performance-related bonus schemes actually effective? Or should you give the same, consistent salary to all individuals performing the same task in order to generate improved performance?

Any financial-based incentive scheme needs to be designed carefully and tailored to align with an organisation’s business needs. The success of all bonus schemes depends on how effectively performance is defined, managed and observed, requiring effective communication and engagement on the part of both employees and line managers; however, this is where the problem is.

While it is assumed that money will have a positive impact on employee behaviour, conversely it may actually encourage negative activities. In order to reward an employee according to their actual contribution, managers require precise information about individual achievements which is often not readily accessible. Managers must therefore partly rely on an employee’s own reports of their personal contribution, which are likely to be biased.

When employees present themselves in a positive light and give the impression that they are key contributors, this generally brings financial benefits. Therefore, when monetary rewards feature in an organisation, employees will exaggerate their accomplishments, falsify documents, and blatantly manipulate their managers opinions in order to create a deceptively favourable perception of themselves for their own financial gain.

Organisations are negatively affected by these manipulation activities, as they can damage the company culture within an organisation, and can create an unhealthy working environment for employees. A successful organisational culture brings together the people at your company and keeps them aligned. If an organisation is based upon employees wanting to appear ‘better’ than their colleagues, it can create a culture of competition and disloyalty, and will have an impact on how well they collectively perform and function as a team.

Furthermore, these activities also reduce the quality of information available to managers, which ultimately weakens the correlation between compensation and performance measures. Ironically, this behaviour also induces time wasting, and distorts the incentive programs designed to encourage productivity.

But what is an effective alternative that could limit these manipulation activities and ultimately encourage productivity?  

It has been proven that when managers have less of an influence on financial rewards within companies, and opportunities for employees to exaggerate their achievements are not available, employee work levels were more in line with their pay. Therefore, if organisations limit managers’ discretionary power over decisions affecting the distribution of resources, this may result in increased productivity in the company.

Additionally,it could be argued that the widespread use of equal pay could be used as an alternative to performance-related bonus schemes, because, contrary to popular belief, productivity has been proven to be much higher when equal pay systems are in place. This is the case as long as the equal pay system is based on some measure of performance which are defined at the level of the team rather than at the individual level. In this team-pay system, employees will get a share of the profits generated by the whole team so that even though all workers in the team are paid equally they still have strong incentives to work hard and sustain group performance.

Deceiving behaviour and manipulation activities are also less likely with an equal pay system as opposed to performance-related bonus schemes, as there isn’t the opportunity for employees to take advantage of the system by giving the impression that they are key contributors when they aren’t.

Therefore, by paying team employees equally – yet above-average salaries – employees will understand that their work is valued fairly and consistently. As well as this, team-pay will also effectively reduce the extent of performance manipulation activities, and will instead create a culture of equality and cooperation, ultimately making the company more efficient.

More money is often thought to be the answer to everything, and organisations rely on the idea that individuals will work harder to demonstrate that they deserve monetary rewards. However, this is not always the case, and consistent, team-pay systems have been proven to reduce deceiving behaviour, and contrary to popular belief, encourage productivity. Senior management teams who want to avoid wasteful performance manipulation activities should weaken incentives and limit managerial discretion, as well as implement a financially sufficient team-pay system in order to benefit their company in the long term.

Brice Corgnet is professor of finance at Emlyon Business School, and a behavioural scientist who studies both market and non-market institutions. Professor Corgnet focuses on market design, financial literacy, market efficiency and behavioural finance.

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