There is hardly a company today that does not have an incentive program for managers. For CEOs and senior managers bonuses are hefty. Large bonuses are especially pernicious. In spite of overwhelming evidence that monetary rewards do not work, the practice continues unabated.

The most significant aspect of senior managers’ work concerns the future. It involves making judgement with insufficient information amid uncertainty. A wide range of factors – internal and external – affect the firm’s future performance. Many of these forces are hard to foresee and account for. Luck plays a large role.

Random chance….pretty much 

Daniel Kahneman asserts that in spite of the CEO’s remarkable vision and outstanding ability the likelihood of a company performing well in the long term is not much better than the flip of a coin.

The correlation between top management’s competence and short-term performance may be better, but it is well short of consistently predictable.

Incentive schemes do not account for luck as a material variable. With the significant effect of chance in the mix, it really does not matter whether bonuses are paid in cash or as stock options.

What motivates us 

Pay-for-performance programmes make two assumptions. One, effort and output are directly correlated. Two: money motivates, more money motivates even more.

What motivates us, encourages us to commit ourselves to work, expend more effort smartly are things that come from within – intrinsic motivators. A large body of research has conclusively established that money, an extrinsic reward, actually undermines cognitive performance.

A large body of research has conclusively established that money, an extrinsic reward, actually undermines cognitive performance. 

Money undermines cognitive performance 

In an experiment carried out in India, Dan Ariely and his collaborators measured performance of tasks that required some thinking and judgement. Three groups of subjects were offered different levels of rewards: small, medium, and large. They found that subjects given medium and large incentives performed worse than those offered small amounts of money. Those with the most to gain performed worst of all. Other experiments in laboratories and in the field have thrown up similar results. Still managers continue to ignore the negative effects of performance incentives.

Instead of spurring people to do more, financial rewards trigger loss aversion. They distort managers’ response and behaviour. When the going is good and targets are being achieved employees expect their bonuses are assured. To avert loss of what appears to be high probability gain, they become risk averse. They stop exploring new ways of doing things. Problem solving and innovation takes a hit. Worse, they also throttle back on effort.

When business conditions are difficult and performance is weak they experience a sense of loss. To avoid what looks like sure loss, managers tend to take undue risks. Feeling of loss spurs them to put in more but rarely smart work. On occasion it can even lead to unethical conduct.

Psychologists have long pointed out that intrinsic rewards drive motivation effectively, in a sustained manner. 

The factor of intrinsic motivation 

Psychologists have long pointed out that intrinsic rewards drive motivation effectively, in a sustained manner. We want to do interesting and challenging work. We gain satisfaction from solving problems and contributing to the organisation. Reward curbs this tendency. People may work as long as they can earn it. Yes, managers need to be paid adequately, fairly. But large pay or bonuses do not motivate meaningfully. Extrinsic incentives encourage employees to compete with each other. They inhibit collaboration and affect morale.

Incentives, bonuses, pay-for-performance are, Alfie Kohn says, a kind of bribe: “Do this and you will get that”. They not only do not work, they diminish performance. Worse, they can corrupt an organisation’s culture and morality.

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