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Apr 01
2011

Why executive compensation needs non-financial incentives

Posted by annearf in financial incentivescompensationcareer/management

annearf

How to design executive compensation that improves performance without encouraging unethical behavior?

According to Adam Grant and Jitendra Singh, two management professors at the Wharton School of Management, the answer is to include in the mix a hefty portion of non-financial incentives that have a powerful effect on behavior.

The professors, who presented their views in a Knowledge@Wharton article , aren't saying that financial incentives don't work. For example, they cite research showing that individual financial incentives increase employee performance and productivity by 42 percent to 49 percent.

But according to the authors, there are plenty of unintended consequences to pay based solely on reaching certain financial metrics.

--It often encourages employees to do whatever it takes to get the money-cheating, say, or shipping poor quality products.

--There's the matter of pay inequality. When employees receive different levels of compensation based on performance, it leads to resentment. Studies show that companies with higher pay inequality have more turnover, for example, and major league baseball teams with larger pay gaps lose more games. Other research has shown that tech firms with more pay inequality at the top have a lower average market-to-book value and shareholder returns. 

--Also, financial incentives can backfire in another way, by undermining employees' intrinsic motivation to work on challenging tasks.

So if financial incentives have mixed results, what should companies do? One approach is to pay more attention to the importance of intrinsic rewards, which can pack a powerful punch and provide surprisingly effective motivation for performance. To that end, say the authors, companies should focus on four particularly important areas:

--autonomy, meaning that people can control what they do, when, where and how to do it.

--mastery, that is, employees can develop skills and expertise.

--purpose-contributing to a meaningful cause

--connection, which involves the sense of belonging to a community and being valued.

The authors also recommend that financial incentives be used for tasks most employees don't want to do and be delivered in small sizes so as not to undermine intrinsic motivation.

What the authors don't discuss, however, is differences among industries. In financial services, for example, where the culture is all about making as much money as possible as quickly as possible, it's hard to imagine that even the most wonderful intrinsic incentives would do the trick.

Still in many industries, as long as people are earning a certain level of compensation, it's quite likely that intrinsic rewards could go a long way to creating engaged employees willing to stick around and not do something unethical to make their numbers.

 

 

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