Why Financial Employee Incentive Programs Can Reduce Motivation

Whether it be in the office or at school, people tend to think financial incentives would make them and their team work harder. If only they could get paid directly for putting in that extra effort, and perhaps their overall motivation and performance would improve as a result. And sometimes, especially when the reward is big enough, that is what happens. The opportunity to earn more money for improved performance presents itself, and thus, performance improves.

Happy motivated diverse office team giving high five together.

The plot twist, however, is due to the extrinsic nature of financial incentives. For example, if a manager handed out gift cards as rewards for good behavior, then the department will be largely motivated by something outside of themselves. Often, they become dependent on these incentives to do something that would otherwise be expected and completed using internal or intrinsic motivation


The Theory

Let’s take a look at an important theory behind employee motivation: motivation crowding theory.

Bruno S. Frey is an economist and researcher who wrote extensively on the topic of motivation crowding theory and specifically on the “crowding-out effect.” The concept describes a phenomenon where offering financial rewards leads to decreased motivation and reduced performance due to the “crowding-out” of intrinsic motivation by extrinsic motivating factors.

When this idea was first argued by Titmuss in his 1970 book The Gift Relationship, there was a general lack of empirical evidence backing up his theoretical yet quickly popular position. Since then, however, there have been a considerable number of studies looking at the crowding-out effect that demonstrate the actual impact of financial incentives on behavior modification.


The Evidence

Motivation crowding theory has a plethora of supporting evidence. 

Today, there is more empirical evidence gathered on motivation crowding theory and examples of crowding-out than can ever be discussed in a single article. The crowding-out of intrinsic motivation can be seen nearly everywhere, from academic achievements to volunteer work.

One study by Levitt, List, and Sadoff (2016) looked at motivation crowding in an academic context by paying high school freshman in Chicago for meeting a certain achievement standard based on grades, attendance, and need for disciplinary actions such as suspension. They had two research groups, one who received a $50 monthly reward for reaching the standard and another who was entered in a monthly lottery to win $500 (with a 10% chance of winning) if the standard was achieved. In both treatments, it was only the students on the border of success or failure who were significantly impacted by the financial incentive.

Though the short-term results show these students’ improved performance, by the time they reached their junior and senior years in high school, the motivation was no longer there. Therefore, graduation rates were unaffected. The payment program was only in place for the eight months making up the freshman year, and by the end of the sophomore year, any detectable performance improvements were gone. Ultimately, this demonstrates the short-term nature of extrinsic motivation from financial incentives, in particular once the incentive has been removed.

In an office context, the crowding-out effect could quickly become a company-wide issue. Financial rewards might seem to motivate some employees in the short term, but what happens when the HR budget changes or an employee who has gotten used to monetary rewards doesn’t meet the standards one month?

The expected result, based on research evidence, is the intrinsic motivation an employee has to work hard and meet company goals will have been crowded out by the extrinsic motivation provided by extra money. Very quickly, the lack of financial incentives can feel like a punishment. Employees might struggle to connect with the piece of themselves that makes going to work feel meaningful, contributing to their willingness to put in discretionary effort.


The Solution

Move away from financial employee incentive programs to promote intrinsic motivation and employee engagement.

As Levit, List, and Sadoff discuss in their paper, there’s no questioning the value of growing human capital, a fundamental part of any company’s continued success. The key, however, lies in the way organizational bodies like schools and businesses try to enhance human capital by molding behaviors and improving performance. Many organizations still hold on to financial incentives, hoping they will motivate employees and modify behaviors, thus adding economic value via human capital. But as the research demonstrates, these employee reward programs tend to backfire.

In their last sentence, the researchers argue “we believe interventions aimed at building human capital in ways that allow for individualization hold the greatest promise.” Because financial rewards are not the most effective employee incentive program, it’s time to push forward and implement ways to support an individual’s intrinsic motivation such as through employee appreciation.

From sharing encouraging recognitions to highlighting the company purpose, it’s more important than ever to focus on workplace relationships and making others feel appreciated so they can sustain motivation, happiness, and success throughout their career. 

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