Bonus payments

In this article, my friend Mike Meldrum discuss the use of bonuses and pay raises as motivators for employees. He shares research that suggests that simply offering a higher pay rate or raise does not have an effect on effort.  Instead, he suggests offering money as a one off extra has a significantly better motivational impact and discusses the implications of institutionalising bonus payments.

To bonus, or not to bonus?

For busy Managing Directors running a business the question of pay rates, motivation and the use of bonuses is a regular conundrum. Most people know that money by itself is a poor motivator but want to incentivise people to work harder and to reward those that have worked hard. 

Research from Harvard throws some light on this and it appears that ‘it’s not what you do but the way that you do it’ that really counts.

Based on experimental research, Duncan Gilchrist, Michael Luca, and Deepak Malhotra conclude that just simply offering a higher rate or raise engendered very little extra effort but that if money was offered as a gift, it had a significant motivational impact. Thus, paying above-market wages, per se, does not have an effect on effort, but something that is presented as discretionary does.

The explanation is that an initial high offer is seen as ‘the market rate’ and therefore to be expected. Giving a raise after someone has been employed gives rise to thoughts that they were underpaid before and that the raise is merely getting back to the market rate. But, if money is offered after someone has been employed on the basis that, say, the budget is larger than expected so the surplus is being shared, employees reciprocate with greater effort.

The principal at play here is one of reciprocity. Marketers and good sales people have known for some time that offering something that is clearly ‘above and beyond’ will encourage people to be more generous in their turn. However, if the ‘gift’ is seen as part of the package or deal, it becomes expected and has little impact on price or willingness to buy.

The new MD of a family property business I have worked with caused great consternation amongst staff when the Christmas bonus was reduced in line with profits. Previously, the bonus had been paid regularly and without explanation, and had become regarded as a reward for being part of the firm. The discovery that it was a) discretionary and b) dependent on profits came as a shock and created resentment when employees felt that they were being denied something that they had received by right.

The implications of this are many and need to be considered in the context of specific businesses. However, the research does suggest that institutionalising bonus payments will not induce higher efforts but merely be accepted as the norm – part of what people are owed for turning up at work. Similarly, giving a rise on an annual basis may simply be seen as recompense for a ‘cost-of-living’ rise and therefore ‘only fair’ rather than something that recognises effort or skill development.

Interestingly, the research also found no difference in impact if the extra money was given as a one-off without expectation that it would be repeated and if it was given with the expectation that it might be repeated at some point in the future. For most people, this is counter-intuitive but suggests that we don’t have to promise more down the road to get the improved motivation sought.

If individual businesses decide use this idea they will have to work look at how they currently present increases and bonuses and how they can migrate to a more discretionary basis for awarding rewards. However, the two key principles to work on seem to be:

Article courtesy of my friend and experienced mentor Mike Meldrum

My own footnote is that this is very consistent with one of my favourite and highly recommended business books:

Drive: The Surprising Truth about What Motivates Us by Daniel Pink