Financial Incentives Can Create Bad Employee Behavior

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Offering financial incentives to motivate employees and executives has been a common management practice for decades. Car salesmen get higher commissions for selling more automobiles. Teachers get bonuses when their students score higher on standardized tests. Executives get generous stock options for boosting the company's stock price.

Professor Jeffrey Pfeffer of the Stanford Graduate School of Business warns that using monetary incentives can backfire, especially if they are offered mainly to influence behavior.

"Incentives should be used not to drive behavior but instead to provide recognition and to share the company's success with its employees," he wrote in an issue of The Conference Board Review. "There are, unfortunately, few shortcuts in leadership-and using financial incentives to fix companies isn't one of them."

Pfeffer writes that increasingly companies and organizations have been using individual incentive pay-including sales commissions-to inspire employees to be more productive or efficient.

He cites a report by Hewitt Associates, the compensation and human resources consultancy, which said the percentage of companies participating in its salary survey that offered at least one plan that tied pay to performance jumped from 51 percent in 1991 to 77 percent in 2003.

Pfeffer said organizations use incentive pay based on the belief "that if employees were just compensated appropriately, virtually every organizational and management problem could be solved."

However, that view can be misguided, he adds. Pfeffer cites his own experience in buying a car on the San Francisco Peninsula. When he and his wife told a salesman that they were not planning to make a purchase that afternoon, the representative-who was paid by commission-began ignoring them. Pfeffer and his wife ended up buying a car from another dealership where more attentive salespeople who "tried to build a customer-service culture and encourage dealer loyalty."

Pfeffer also cited the experience of the city of Albuquerque where officials, hoping to slash overtime costs in garbage collection, began paying truck crews for eight hours of work no matter how long it took them to complete their routes.

The city hoped the new policy would encourage the workers to finish the job quickly. Instead, some crews cut corners-missing pick-ups; speeding, which caused accidents; or driving to the dump with overloaded trucks, which led to fines.

The controversial practice of awarding stock option grants to top executives has also been problematic, Pfeffer writes. "There is evidence that the higher the option grants to senior executives, the more likely it is that their companies will have to subsequently restate their financial statements."

Corporations and organizations should not assume that their employees and members are motivated primarily by money, he writes. Financial incentives can play a role, but the key is still to build a supportive culture in an organization.

"You want rewards to be large enough to be noticed, and you want to use them to provide an occasion for celebration and recognition, to let the group come together and share successes and enjoy each other's companionship," Pfeffer writes. "But you certainly don't want to make the incentives so large that they begin to drive, and thereby distort, behavior."

However, Pfeffer laments that many corporations and organizations have come to rely too heavily on financial rewards.

"One can change a pay system or a set of financial rewards fairly quickly and easily," he writes. "It is much harder to change organizational culture, people's mindsets and beliefs, their knowledge and skills, and how effectively they work and communicate with each other. Thus, financial incentives offer the mirage of a quick fix-and contemporary management seems to be enamored of that idea."

Pfeffer is the Thomas D. Dee II Professor of Organizational Behavior with the Standford Graduate School of Business.

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