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On The Popularity Of Pay-For-Performance And The Illusion Of Control…

August 30th, 2010 · 7 Comments
Behavioral Econ · Incentives · Press · The Simpsons

So I was quoted in Human Resource Executive Online:

Jodi Beggs, a researcher in the field of behavioral economics and incentives who focuses specifically on when, if and how incentive schemes work, says the jury is still out on whether pay-for-performance compensation plans will someday be the norm.

“The high-level summary of academic findings is that pay-for-performance can work in some contexts and with certain types of work, but can have unintended consequences and even lead to lower performance in others,” says Beggs, who is based in the Boston area.

To wit, the Kelly’s research notes that pay-for-performance plans are more prevalent in financial services, travel and leisure, retail and business services as opposed to other industries.

“I don’t necessarily disagree with the survey finding that some employees would be in favor of pay-for-performance systems in their workplaces,” she says, “but they certainly aren’t the silver bullets that they are sometimes made out to be.”

It’s true- I *am* based in the Boston area:

(My office is in the building with the clock above the door.) I found this article to be interesting because of the survey data that shows that people want pay-for-performance systems to be implemented in their companies. This is perplexing to me on a couple of levels:

  1. For the last few years, I have been reading about teachers’ unions who have been fighting tooth and nail to prevent pay-for-performance plans from being implemented in their districts. Now, I do understand that part of this pushback has to do with the fact that there’s not really a good way to measure teacher output (think for a second about the myriad problems inherent in paying teachers based on students’ test scores, for example), but isn’t that true of a lot of jobs? I suppose technically the article reports the attitude towards more of a profit-sharing setup then specific incentives for individual performance, so this could partly explain the difference. But it also brings me to my second point…
  2. Realistically speaking, how much control over company profitability does a single employee actually have? My company is, well, me (and sometimes an intern or research assistant), so I suppose I have a lot of control over the profitability of my company. If I were a CEO of a larger company, the same may be true, but these examples are the exception rather than the rule. If an employee doesn’t have a lot of direct control over company profitability, asking for compensation in the form of stock, stock options, profit-sharing bonuses, etc., is a bit like buying a lottery ticket. Employees are likely susceptible to the illusion of control in this way. It could also be the case that employees don’t see the tradeoff between performance-based and guaranteed compensation and think that the latter would be granted without them having to give up any of the basic salary in order to make this happen.

The illusion of control is a funny thing…literally:

The Illusion of Control, Simpsons Style

It’s important to realize what events we do and don’t have control over, since it’s easy to slip into bad choices otherwise. For example, I’m sure that all of you have been told at some point that diversification is important in an investment strategy, and yet the very same people who diligently heed this advice go and purchase or hold stock in the company that employs them. Think about it- if something goes down with the company, not only are you out of a job, but your savings is also pretty worthless. I’m sure the former employees of Enron would be more than happy to tell you why this not the safest plan. As an economist, I can’t help but think that I would want to take a hedging approach and buy stock in the competitors to my employer, but I’m guessing that would be frowned upon to some degree.

(UPDATE: You can find a version of this article over at the Huffington Post here.)

Tags: Behavioral Econ · Incentives · Press · The Simpsons

7 responses so far ↓

  • 1 Tristan T. // Aug 30, 2010 at 7:33 pm

    I think we’ve all learned how incentives can have negative effects on the company because employees are focused on themselves and bonuses. …Mortgages… *cough*

  • 2 Joao Pedro Afonso // Aug 31, 2010 at 10:23 am

    hmmm… to bet on the competitors would have the advantage that the employer wouldn’t have the need to do their best in his work. Actually, it could be in his best interests to work worse. Smart move. But funny, funny, would be if every employer of every company would have picked the same idea… How was called those cartoons from Hanna-Barbera? The Wacky Races?

  • 3 The Unqualified Economist // Aug 31, 2010 at 11:17 am

    Also, and maybe I’m missing something here which is highly possible, but likely wouldn’t pay-for-performance in a traditional office job likely have some cap and you’d only reach the top if you’re performing at 100% and there would be no incentive to go above and beyond that?

    Additionally, if there are incentives to go above and beyond, then you just move towards a commission/bonus based salary, which isn’t necessarily an accurate pay for performance. Say you start a job in a sales territory that has been neglected for years and you blow out your sales goals earning a large bonus. Then for the next few years it is likely going to be difficult for you to live up to that extreme growth that really had nothing to do with your performance.

  • 4 David Harper // Aug 31, 2010 at 2:37 pm

    Based on my eight consulting years designing/installing pay-for-performance plans (btw, that’s 7.9 years more than you want to spend in compensation), I think your skepticism is warranted.

    Pay turns out to be an intimate issue, with importance varying by demographic, industry; e.g., our Rewards of Work showed that pay system was an important recruitment issue, but less so in regard to motivation and retention where manager quality and advancement opportunities matter more. Other things too, it turns out to be easier when the company is in a crisis than when company is super profitable

    In theory, you can get alignment between pay and performance (re your point about company profitability: increasingly, people are okay to link to their group/division performance … it’s even a good “test” of job importance) but, among the various issues that I found, and where I agree with the “not a silver bullet” argument is: invariably a well-designed pay for performance plan ironically puts great stress on the culture and politics of a place. Strangely, this is true even if the plan is quanty with metrics and gives prospective clarity (ex ante rather than relative performance).

    What I mean is, most company cultures represent a low upper limit on plan design potential. A well-designed pay plan absolutely requires an strangely rare combination of elements (i) a good performance management, (ii) good performance reporting, (iii) managers trained to give feedback and coaching, to name a few…so my view on why most pay plans are bland bands is they already operate at their cultural limits. Add any more design than the culture allows, and get ready to itemize the issues

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