Big bonuses for bosses can have adverse effects upon productivity. A new paper by Jorg Oechssler, Anwar Shah and Nikos Nikiforakis concludes:
Managerial bonuses have the potential of generating conflict between managers and their subordinates. Managerial bonuses can be a disincentive for subordinates...firms should exercise caution when using high-powered incentives for managers. The benefits from managers’ increased motivation need to be weighed carefully against the adverse effects for other employees.
This is based upon laboratory experiments in which a manager and subordinate cooperate on a project: they found that when the manager is offered a big bonus, subordinates' effort levels drop.
This might well have external validity, given that in the real world managerial oversight of subordinates is less tight than it was in the lab. As HSBC's CEO Stuart Gulliver said, “Can I know what every one of 257,000 people is doing? Clearly I can’t.”
But of course, this is but one of several pieces of evidence that big individual bonuses can have adverse effects. Experiments (pdf) by Uri Gneezy and colleagues have shown that they can reduce performance because people can be over-motivated and so crack under pressure. Other experiments have found that bonuses for traders can encourage asset price bubbles, or that collective bonuses can reduce effort by encouraging free-riding. It's also possible that bonuses can crowd out intrinsic (pdf) motivations (pdf) and encourage short-termism and earnings manipulation. And Nobel laureate jean Tirole has argued that bonuses can cause "signifi cant efficiency losses" by over-incentivizing some roles and under-incentivizing others: traders tend to get big bonuses, risk managers not so much - so guess what happens?
I suspect that the main justification for bonuses is not so much that they elicit effort but rather that they are a form (pdf) of efficiency wage: bosses and CEOs who cannot be effectively monitored must be bribed handsomely not to steal the firm's assets.
Subject to this caveat, all this implies that bonuses can be inefficient. Insofar as they contribute to inequality, this in turn is more evidence that inequality might reduce productivity. How lucky it is for the rich, therefore, that our politicians don't care about productivity.
Another thing: if bonuses do reduce productivity, it's not obvious that the solution is to tax them more heavily; it could be that it's pre-tax bonuses that matter, to the extent that these are associated with individuals' sense of self-worth and intra-firm perceptions of fairness.
"And Nobel laureate Jean Tirole has argued that bonuses can cause "significant efficiency losses" by over-incentivizing some roles and under-incentivizing others"
This supports the Hayekian argument that bosses simply lack the knowledge to run their firm effectively. There may be a great deal of tacit knowledge about important roles and staff members that aren't available to them.
Posted by: Steven Clarke | April 23, 2015 at 06:13 PM
Bollocks. If the authors are so sure that big bonuses reduce productivity, they should be starting a company with lower bonuses, higher base salary, and making a killing, not writing papers.
If this is true, supposedly very greedy shareholders and senior managers are foregoing extra money.
It may well be true in some circumstances. Probably those we don't observe bonuses. I highly doubt that very competitive labour markets are systematically and largely wrong about productivity incentives.
Also, who are the experiment participants? Likely there are during selection effects - those who are motivated by bonuses sell them out, while those who are discouraged do not.
Posted by: Matt Moore | April 23, 2015 at 06:59 PM
Two of the papers by the Nobel Prize winning Economist, Jean Tirole, ‘Intrinsic and Extrinsic Motivation’ and ‘Competitive Pay, Screening & Multi-tasking’, co-authored by Roland Benabou, are replete with examples that point to the facts that incentives are not about performance, per se, but hinge on the alignment of objectives between the principal and the agent and that higher their extrinsic value, lower is their potential to succeed, while intrinsic factors remain more entrenched in the drive for achieving self-driven goals, which may or may not serve the purpose that a principal could be bent on. The biggest malaise is however the estrangement of cooperation when extrinsic factors act as impediments between individuals or groups; the great virtues of cooperation and vulnerability seem to be missing as extrinsic incentives come to play.
Posted by: Procyon Mukherjee | April 24, 2015 at 10:11 AM
It takes worker bees for the Queen & hive to survive, too many Queens and the hive breaks down.
Posted by: Larrydpowell | April 24, 2015 at 01:11 PM
"Very competitive labour markets" - where would those be then?
If labour markets were very competitive, we'd see constant innovation and new pools of labour being developed...
Posted by: Metatone | April 24, 2015 at 01:18 PM
Bollocks yourself, Matt. You're assuming that senior management remuneration depends on higher productivity, when it's far more plausible that -- like the Soviet ruling class or antebellum southern cotton planters -- they prefer a less efficient way of organizing production because it lets them skim more off the top.
They'd rather have a bigger slice of a smaller pie -- and their very act of taking a bigger slice reduces the size of the overall pie.
I can easily imagine someone in the 1850s saying "bollocks" to the assertion that slavery was inefficient, by arguing that if that were so some innovative cotton planter would be organizing their slaves into self-managed cooperatives.
Have you ever considered that capitalism has structural features that limit competition, so that large corporations don't HAVE to be efficient to survive?
Posted by: Kevin Carson | April 24, 2015 at 09:17 PM