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.