Bonuses in the financial industry hurt employees’ intrinsic motivation and well-being

Author: Marco Vario.

Bonuses do more harm than good. In the financial industry, variable compensation, or more commonly known as bonus, is common practice. In research, we refer to Performance for Pay (PfP), which describes the awarding of a tangible reward to employees based on their performance at work. PfP takes its origins in the 1970s, when many researchers in economics argued that it would motivate employees to perform better. Today, companies use PfP to motivate their employees to deliver high performance and to encourage them to adopt appropriate behaviors.

However, key findings of recent research in the field of psychological economics and self-determination theory have shown that PfP undermines people’s intrinsic motivation and well-being, which may also affect the firm’s overall performance.

Indeed, Performance for Pay (PfP) causes a cognitive shift. On one hand, it reinforces extrinsic motivation (price effect) and, on the other hand, weakens intrinsic motivation (crowding out effect). Depending on the strength of these two opposing effects, PfP either harms or promotes personal effort.

Intrinsic motivation is important in the workplace. When people are intrinsically motivated, they tend to display high-quality performance and well-being. Moreover, intrinsic motivation has proven to be a better predictor for performance than extrinsic motivation in two cases:

First, the complexity of the job matters. For complex tasks, research has shown that PfP undermines intrinsic motivation. These jobs are perceived as interesting, challenging, enjoyable and purposeful, which are thought to be intrinsically rewarding. The use of PfP for this type of job will increase extrinsic motivation, while destroying a much greater amount of intrinsic motivation. Considering that intrinsic motivation leads to better performance for complex jobs, employees’ overall performance will deteriorate because of PfP. In contrast, for tasks that are characterized as simple, research has demonstrated that extrinsic incentives lead to better performance. Since the nature of these tasks is not intrinsically rewarding, PfP, in this case, will improve performance through extrinsic motivation.

Secondly, another aspect to consider is that rewards, which are directly depending on the actual outcomes of the tasks, undermine intrinsic motivation. Indeed, research has shown that the reward exerts pressure on employees to think or act in a certain way. This affects their need for autonomy, resulting in a loss of intrinsic motivation.

What should companies do?

Nowadays, people are looking for jobs that are meaningful and want to make an impact in their daily activities. At the same time, many jobs require employees to be innovative and creative. Therefore, managers should focus on creating an organizational culture that fosters intrinsic motivation. More importantly, since current performance measurement and compensation processes have a negative impact on intrinsic motivation, companies should adapt them accordingly. A work environment in which managers acknowledge employees’ points of view, encourage personal initiative, provide meaningful feedback and assign tasks that are optimally challenging will lead to both high-quality performance and well-being.

Instead of bonuses, companies should consider increasing the base salary. Base salary does not depend on the employees’ objectives. No matter how they perform at work, they will be paid the same amount. Unlike the bonus, which will significantly reduce intrinsic motivation, research has suggested that a higher base salary is likely to have a positive influence on intrinsic motivation. Indeed, with a higher base salary, employees feel recognized by the company.

Finally, decisions and processes related to compensation are not always clear and transparent. Intrinsic motivation will be compromised if employees do not perceive the way in which the reward or level of pay has been determined to be fair and right (procedural justice). Therefore, companies should improve the clarity and transparency of compensation decisions and processes.

How should companies compensate their employees? What do you think about this topic? Are you looking for more research insights? We look forward to hearing from you! Please contact Marco at marco.vario@unisg.ch

Sources and interesting readings:

Cerasoli CP, Nicklin JM, FordMT. 2014. Intrinsic motivation and extrinsic incentives jointly predict performance: a 40-year meta-analysis. Psychol. Bull. 140(4):980–1008

Edward L. Deci, Anja H. Olafsen, Richard M. Ryan 2017. Self-Determination Theory in Work Organizations: The State of a Science. Annual Review of Organizational Psychology and Organizational Behavior 2017 4:1, 19-43

Olafsen AH, Halvari H, Forest J, Deci EL. 2015. Show them the money? The role of pay, managerial need support, and justice in a self-determination theory model of intrinsic work motivation. Scand. J. Psychol. 56(4):447–57

Weibel A, Rost K, Osterloh M. 2010. Pay for performance in the public sector—benefits and (hidden) costs. J. Public Admin. Res. Theory 20(2):387–412