Psychology of Incentives Part 3

Short Term Incentives (STI)

Short Term Incentives (STI)

Behavior psychology provides valuable insights into incentives and rewards and understanding this science, does enable us to better understand the drivers or motivators of incentives. It is axiomatic that HR practitioners must become behavioral psychologist Jedi’s in order become an incentive ninja’s.

However, when it comes to Short Term Incentives (STI) behavioral psychologists and economists are divided in their opinions.

Opinions against STI

At the outset one must acknowledge that a plethora of research and experiments, has been conducted examining the value of short-term incentives or rewards – and in concluding that rewards are counterproductive. Given this, the following is a brief overview of the work, and opinions, of some behavioral psychologists:
The University of Rochester’s Edward Deci and Richard Ryan studied the “free-choice paradigm”. Participants in an experiment were paid to draw. The compensation to draw was then taken away. Participants who were at first paid to draw, drew less when there was no payment. Paying people to draw changed how they viewed drawing, undercutting the intrinsic motivation that made it fun in the first place.
Alfie Kohn in his seminal article in the Harvard Business Review entitled “Why Incentive Plans Cannot Work” stated:
“One of the findings in psychology that has been shown over and over again [is that] the more you reward people for doing something, the more they tend to lose interest in whatever they had to do to get the reward”.
“Incentives, a version of what psychologist call extrinsic motivators, do not alter the attitudes that underlie our behaviors. They do not create an enduring commitment to any value or action. Rather, incentives merely – and temporarily – change what we do”.
“As for productivity, at least two dozen studies over the last three decades have conclusively shown that people who expect to receive a reward for completing a task or for not doing that task successfully, simply do not perform as well as those who expect no reward at all”.

Frederick Hertzberg famously stated that just because too little money can irritate and demotivate, it does not mean that much more money will result in satisfaction and increased motivation.

Given the foregoing opinions of eminent scholars, one could be excused for immediately scrapping any STI!!

Opinions for STI

Economists however disagree with the findings of these experiments. They postulate that the salient function of incentives should be to increase the productivity of the activity. The research does show that one should not introduce an incentive scheme and then change it or discontinue it. The initial plan design must be an adroit and well-designed plan which will stand the test of time and motivate employees to perform individually and collectively, to achieve the strategy of the company.

Jenkins when formulating his article “Financial Analysis” studied 28 previously published studies and found that 57% had in fact had a positive effect on performance but only when the performance measures were quantitative in nature, such as producing more of something and/or faster. The take-away from this is that STI performance targets must be quantitative – achieve an EBITDA of X. This design feature was also discussed in Part 2 where Agency Theory dictates that where the principal has information to verify agent behavior, the agent is more likely to behave in the interest of the principal.

We have been saying this for years – any goal, objective or performance condition should have a calculable ROI (return on investment) and be “self-liquidating”; where the cost of the incentive represents a percentage of value added for the company.

Hockenbury and Hockenbury state that “Incentive theories proposed that behavior is motivated by the “pull” of external goals, such as rewards, money, or recognition.”

Prendergast in his article entitled “The provision of incentives in firms” found that there was empirical evidence that the use of incentives improves performance.

Lazear in his article “Performance pay and productivity” examined the impact of a change from fixed salaries to piece-rate compensation in an auto-glass factory. Productivity soared and output per worker was increased by 44%.


In light of the conflicting opinions elucidated above, we feel that we need to declare our

We are firm advocates and promoters of STI

We contend that an appropriately designed scheme will support and reinforce a high-performance culture and encourage ethical behavior consistent with the company’s values. However, the risk-reward must be balanced where the scheme is structured in such a manner that it incentivises the employee to promote sustainable long-term growth, without encouraging excessive risk taking or a short-term parochial focus.

The scheme should be designed with a view of encouraging recognition and strengthening the psychological engagement with employees, while at the same time, providing top talent with an extrinsic monetary reward for their hard work and dedication.


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