Bonus structures and their organizational impact

¶ … performance bonuses at companies. There are four subjects. The first is about the use of bonuses -- would I make use of them? Then there is the question of evaluating people based on specific performance measures. Then there is the question of group bonuses and whether or not those are a good idea. Lastly I explain why I wouldn't institute a bonus program.

The role of the human resources department is to structure and implement the human resources strategy in such a way as to help the company to achieve its strategic objectives. There are a number of different ways that this can be achieved. One such way is through performance bonuses, which help to orient employees to specific types of behavior. This paper will analyze the issue of employee bonuses, taking a lot at some of the relevant data on the subject.

Use of Bonuses

Personally, as a manager, I would not make extensive use of performance bonuses. In principle, I should not have to bribe people to do their jobs. Furthermore, there are moral hazards involved with performance bonuses. The stronger the link between task and bonus, the worse these moral hazards become. In sales, it has been noted that a commission system -- the strongest form of performance bonus -- leads to enhanced neglect of nonincentivized tasks -- the salespeople only performed those tasks that lead directly to commission, with all other tasks going by the wayside (Kishore et al., 2013).

In addition, other studies have shown that while bonuses incentivize effort in certain areas they do not necessarily result in superior performance. In other words, workers might try harder where specific bonus incentives exist, but this does not mean they will be any better at the task and there is no evidence to suggest that performance outcomes are superior just because the effort is improved (Grinstein & Hribar, 2003).

Another argument in favor of bonuses is that they create a better atmosphere on the job -- that people appreciate receiving a bonus for a job well-done. They do -- people will always say good things about receiving extra money -- but beyond the talk bonuses have very little correlation with lower turnover and other employment measures. There is a small effect for white women, but no effect for other groups measured in a study that looked at how people respond to bonuses. In essence, people make decisions about their employment-based other factors. They like bonuses, but the presence of bonuses will not make up for deficiencies in other areas, and they are likely not necessary if there are no such deficiencies (Woodbury & Spiegelman, 1987). What all of this means is that the cases people make for bonuses do not usually hold up under scrutiny -- they are not nearly as effective as people think they are.

Evaluations

In my experience, it is definitely true that when your compensation is specifically tied to certain activities, you focus on those activities to the detriment of all else. I have lived through the classic one, the balance between sales and customer service. You are paid for each sale, and while management tells you that giving great customer service is good for sales in the long run, you are only thinking about the next pay period, and so you are oriented towards those short-term results. After all, in this case you don't own the business so you do not have much incentive to worry about the long turn. Churning customers is perfectly okay as long as there are always more. Thus, you become strictly focused on sales. Service, paperwork and being nice to other human beings ceases to be important.

Group Bonuses

There are pros and cons to group bonuses. The biggest pro-is that it promotes teamwork more, because you know that the group is the unit that is being evaluated. This should get people on the same page, and using their different skills to achieve the group's objectives. The con lies with a specific precondition -- that the group members actually trust in each other. If one person feels that the group is not good in general, that person is likely to lose interest in working hard for the betterment of the group. Social loafing is a big risk as well, and just as destructive. A further issue that that even when the bonuses are group-based, eventually you will be evaluated on your own contributions, and that might create incentive to work for yourself anyway -- the group bonus is somewhat transparent in that regard. If the group is too large -- say the entire company -- then one individual may not see enough link between his/her activities and the group outcome, eliminating any motivation that might accrue from the group bonus. However evidence has shown that group-based programs do generate higher performance, and this might be because of peer pressure to perform at a higher level -- when everyone is incentivized it is harder to get away with social loafing (Cooke, 1994).

Bonus/Reward Program

I wouldn't design a bonus/reward program. I already noted that I don't believe it them. The evidence suggests that they are largely ineffective, come with moral hazard and simply are not worth the effort. Fundamentally, you should not hire people whom you have to bribe to do their jobs well. If that is who you are hiring, you are doing it wrong.

What I would do is al little smarter. First, you hire good people who actually believe in hard work. They have pride in themselves and do not need to be bribed to do their best. You attract these people by paying a wage that is competitive -- top of the normal range, but nothing beyond that. You also need to create a strong employer brand, built on treating people well, giving them input into the company and their jobs. Respect is a more powerful motivator than cash. Look at a company like Costco -- that's my sort of benchmark. Their turnover is very low, and their staff is very productive. It's not performance bonuses, it's getting the right people and giving them the right direction.