The Risks and Rewards of Employee Incentive Programs

Evil or genius? When you're talking about the value of broad-based corporate incentive plans, it depends on who's judging.

Many companies invest big dollars in employee incentives because they believe the programs improve engagement, retention and productivity. An industry has even sprung up to provide the little sister of cash incentives: rewards programs that provide products and services with monetary value.

But decades of academic research argue that the benefits can be illusory. And news headlines remind us of what happens when incentive plans spawn unethical or even illegal behavior.

As many employers still struggle to find talent, it's clear that incentive plans live on.

WorldatWork's 2021 Incentive Pay Practices Study found that 99 percent of publicly traded companies use short-term incentives, compared with 93 percent of privately held companies and 82 percent of nonprofit organizations.

"A well-designed, well-communicated incentive plan should be a win-win for the employee and the company," says Greg Stoskopf, managing director and national compensation strategies practice leader at Deloitte.

The upside for companies, Stoskopf says, is that incentive plans can offer more attractive packages to employees without overcommitting: Incentives can be linked to corporate financial results so that in lean years the company doesn't have to turn on the incentive tap. And by not building the extra compensation into base salaries, any salary percentage increase in future years won't balloon because of the incentives.

But Liz Supinski, SHRM-SCP, director of research and insights at WorldatWork, a global nonprofit that focuses on total rewards, warns that plans need to be "calibrated to a level that an organization can afford to spend in most years. Taking away or reducing an existing plan, other than in very rare economic circumstances, is very poorly received by employees."

Examining the Effectiveness of Employee Incentives

Many renowned management experts have found fault with employee incentives. The late management guru W. Edwards Deming, dubbed the "father of quality management," argued against management by objectives and numerical quotas. So did the late Peter R. Scholtes, author of The Leader's Handbook: Making Things Happen, Getting Things Done (McGraw Hill, 1997), who asserted that managers would do better to focus on removing obstacles that demotivate workers, rather than trying to motivate them, since workers can be inherently motivated by work.

Alfie Kohn, author of Punished by Rewards: The Trouble With Gold Stars, Incentive Plans, A's, Praise, and Other Bribes, Twenty-Fifth Anniversary Edition (HarperOne, 2018), argues that carefully designed incentives may improve productivity, but those types of extrinsic awards also can backfire and kill interest in the work. On his website, Kohn writes that "not a single controlled study has shown a long-term improvement in the quality of work as a result of any reward system. That would be an astonishing fact were it not for the existence of scores of studies—conducted with adults as well as children, in real workplaces among other venues—that have demonstrated how rewards tend to be not merely ineffective, but powerfully counterproductive."

"If I'm always trying to motivate people with incentives, I turn the relationship into a transaction ... It's all about the money." - Kelly Allan

Kelly Allan, a management consultant in Columbus, Ohio, recalls a client that acquired many companies in the medical industry. The client found that the companies using incentives and command-and-control style management had much higher turnover than those without those approaches.

"If I'm always trying to motivate people with incentives, I turn the relationship into a transaction ... It's all about the money," says Allan, owner of Kelly Allan Associates, who teaches Deming management principles.

For Millennials and younger Generation Xers, work is a transactional experience, and they focus on their "genuine life" outside the office, Allan says. But Generation Z is different: Many want to share a value system with the organization they work for, so incentives are a less-effective tool for shaping their behavior, he says.

"They want to have work that has inherent meaning in it, and they don't have to be bribed with incentives," Allan says.

A 2018 Gallup report, How to Align Your Employee Compensation and Talent Management Strategies, found that the effectiveness of incentives is based on the type of job. Extrinsic motivations such as cash rewards work with jobs that are repetitive or involve constant physical exertion. But jobs that require creativity and innovation can be stifled by incentives that might encourage workers not to take risks. Gallup also said intrinsic and extrinsic motivation can be used together because the former impacts quality while the later influences quantity.

"Research suggests that intrinsic motivation tends to be more powerful than extrinsic motivation, partly because it is experienced every day, and partly because people tend to value intrinsic motivators that boost personal value, such as purpose, meaningful work, a feeling of competence and a sense of accomplishment, even more than they value money," the Gallup report stated.

The Unintended Consequences of Incentive Schemes

Wells Fargo could be considered the poster child of unintended consequences for incentives. In 2020, the financial giant agreed to pay $3 billion to settle federal civil and criminal investigations, admitting that employees had opened as many as 2 million fake accounts without customer authorization over a five-year period.

The scandal was created by a incentive system based on the volume of new accounts opened coupled with management pressure to meet tough quotas.

A company's culture can have a big influence on whether people are lured into unethical behavior. It's up to executives to communicate ethical standards, lead by example and punish wrongdoers so others know what's not acceptable, says Tae-Youn Park, director of the Research Institute for Compensation Studies at Cornell University's Industrial and Labor Relations School.

Another unintended consequence of incentive plans, Kelly Allan says, is that teamwork may suffer. Employees become so focused on collecting their individual rewards that they decline to help colleagues.

"Incentives are powerful because our brains like numbers," Allan says. "Numbers to the brain are like mainlining heroin. We create incentive junkies."

Incentives create barriers between people and departments that prevent them from collaborating, he says.

Pritchard says he read about one bakery company that offered incentives to quality inspectors for finding problems in the products. But that ended up motivating the inspectors to bring foreign materials into the plant, insert them into the snacks the company was making and then get rewarded for finding the "problem."

"The stronger the incentives, the more likely it's going to happen—like putting twigs and dead mice into the flour," Pritchard says of such cheating.

One of Allan's clients in the IT industry gave salespeople incentives for meeting monthly quotas. But managers ended up giving all the best leads to the top sellers, who didn't pursue them if they had already met their quotas. Nor did they share leads, or anything else, with other salespeople who might be a better fit for a particular client, because the top sellers saw colleagues as competitors for the incentive dollars. The company thus left big money on the table, Allan says.

The Gallup report said removing incentives might actually lead to better outcomes in some situations.

"When employees are incentivized to sell fast and in volume, they are less likely to spend the right amount of time identifying what's best for their customers, solving their problems and earning repeat business," the report stated.

Pritchard says one safeguard against cheating is to have an audit trail or other system where manipulation will eventually show up. That could mean polling customers periodically, for instance, to make sure quality of service hasn't suffered amid a rush for quantity.

When it comes to aligning employee efforts with company goals, organizations have an arsenal of options at their disposal aside from salary. Short-term incentives. These are one-time awards usually based on whether specific goals are reached. Bonuses based solely on the company's bottom line are becoming less popular, while the upward trend is in incentives tied at least partly to employees meeting specific goals, says Greg Stoskopf, managing director and national compensation strategies practice leader at Deloitte. Bonuses also can be doled out based on more subjective factors. Commissions are a form of short-term incentive that are not as broad-based, such as when salespeople are given a percentage of what they bring in. Long-term incentives. These include stock options and often are restricted to executives or other higher-level workers. They tend to be organized in three- to five-year plans. Rewards and recognition. When these are substantial, such as a new car or a luxury vacation, they function similarly to short-term cash incentives. But rewards can also be as simple as a thank-you note or a spot award of cash, gift cards or swag. These rewards often are given to recognize events such as anniversaries with the company or particularly admirable work. They can be awarded soon after a worker's accomplishment since they aren't tied to a fiscal year. They are often more subjective than broad incentive plans that spell out in advance what numeric goals need to be met to get compensated. —T.L.

Crafting Incentive Programs for Positive Impact

Still, well-designed incentive programs can be beneficial, says Lori Wisper, managing director, Work and Rewards at Willis Towers Watson PLC, which helps companies design incentive programs.

"At their core, incentive plans are a communication vehicle that lets employees know what's important for that performance period," Wisper says. "They provide focus. For that reason alone, they're valuable."

With many employers still struggling to fill positions, particularly front-line workers, incentive plans are becoming more common for hourly workers, Wisper says.

However, thorough research and careful planning are required to ensure a company's incentive plan achieves the desired results.

"Financial incentives are extremely difficult to do well," warns Bob Pritchard, a psychologist and professor emeritus at the University of Central Florida in Orlando, whose research has focused on organizational performance and work motivation.

Factors that go into designing incentive plans include:

• Who is eligible?
• Will employees be rewarded based on their individual performance, their team's achievement or the company's overall performance?
• How will performance be measured?
• How do the employee goals align with the company's priorities?
• How much will be offered?
• How will the money be distributed?
• How will the plan be communicated to workers?

The plan should be simple so that employees understand how the incentive is calculated. Workers need enough information to determine what they must do to earn a payout. Wisper recommends using between three and five goals for each employee. More than that, she says, and "instead of focus, you create confusion."

Communication is also important to let managers know the company values they should reward.

"This is helping people digest what the values mean in action. It's taking values off the wall and putting them into action," says David Burke, senior director and head of talent acquisition and employer brand at Framingham, Mass.-based Workhuman, which runs rewards programs for companies.

The information that is communicated should be more than just a bottom-line score. It should include a breakdown with details on what success looks like based on the various measurements in the plan, Pritchard says.

The problem with most incentive plans is that employees come to expect them and may become disengaged if they don't receive cash incentives at some point. The "secret ingredient" is pairing monetary rewards with recognition, Burke says.

His company creates programs for employers to give workers points based on milestones and superior work. The reward, which can be worth $20 or much more, can be given based on manager or co-worker nominations. The workers can cash in their points immediately or stockpile them for something bigger on Workhuman's shopping platform.

When Burke looks down at his watch, which he received through the program, he remembers the positive vibe of being recognized.

"This is helping people be seen," he says. And in an era of remote work, "the onus is on leaders to make sure everyone is visible."

Tamara Lytle is a freelance writer in the Washington, D.C., area.

Explore Further

SHRM provides resources and information to help leaders create employee reward and recognition programs that help improve retention.