Stumbling and Mumbling: How bonuses backfire

September 19, 2011

How bonuses backfire

There’s growing evidence that high-powered financial incentives such as big bonuses can backfire. This can be because they crowd out intrinsic motivations (pdf) and creativity; or because they encourage free-riding; or because they lead to choking; or because people fear their work will be only imperfectly monitored and so won’t get a payoff even if they work hard.
There might, though, be another possible reason for bonuses to fail, as a new paper points out.
Bonuses, the researchers say, have an ambiguous effect. On the one hand, there’s the standard effect (subject to the above caveats) of inducing more effort. On the other hand, though, there’s an informational effect. If the boss knows more than workers about the job, a big bonus will be interpreted as a signal that the job is very difficult. And this can, the researchers show, have big effects in reducing effort, as workers figure that there’s no point busting a gut in a losing cause.
What I wonder, though, is how applicable this mechanism is to the real world. I suspect it might not be. One reason for this is that the criteria that trigger bonuses might not be tightly defined. Instead, bonuses might be just a loose form of profit-sharing, in which case their signal is diluted.
Another reason, though, lies in selection effects.
Although rational people might be deterred from taking on a job with a big bonus, overconfident ones might not be. They’ll figure: “This is a tough job, but I’ve got the skills to do it.” This gives us another way in which some firms might actually select for overconfidence.
Also, this paper draws the information asymmetry very sharply; principals have information, agents don’t. In practice, though, this might not always be the case. Agents might instead find ways of cooking the books in order to appear to hit their targets. In this way, bonuses might select for unethical workers; I don‘t know if this happened in the case of Kweku Adoboli, but he fits the story.
Whatever. The point here is simply that the notion that bonuses have unambiguously good incentive effects is, surely, plain wrong. Sometimes, they work and sometimes they don‘t. And this means that a common justification for inequality is greatly flawed.

September 19, 2011 | Permalink

Comments

I'm an outsourced support worker in a small but growing investment bank. I get paid around £16 an hour and I'm discouraged to work beyond my shift hours as I am effectively paid overtime (due to my temporary contract being paid by the hour). I work an 8-hour day, five days a week. The analysts here, particularly the 'junior' ones, regularly work 12+ hour days, often 6 days a week. In yearly salary terms (excluding bonuses), they get paid more than me (probably more than twice as much). But if you translate that to a per-hour rate, I get paid far more than they do—and I get to have my evenings and weekends free.
However my job is in decline as the size of the teams I work for has shrunk quite markedly in the past 10 years. At larger banks, a lot of the work I do has been semi-successfully offshored. But analysts have also been passing us less work than before and are encouraged to do it themselves.
As a third-party (i.e., outsourced) worker, I get no yearly bonus. If I was directly employed by the bank, I would be unlikely to receive more than £1000—and that only if the bank has a 'successful' year. Could it be possible that many—perhaps most—banks are using bonuses for bankers to ensure that they work the increasingly long hours that allow for lower headcounts and the ability to phase out costly, non-wealth generating support services?
Of course, if the Government were to bring in French-style 35 hour weeks, ban bonuses and force banks to pay analysts a representative hourly rate, that would generate both jobs and goodwill. But that's a debate for another day…

Posted by: Cheesy Monkey | September 19, 2011 at 06:38 PM