Does Incentive Pay Work?

The most obvious and common type are incentives for increased sales. In this arena, there’s no doubt that incentive pay works.

In a 2010 joint Harvard Business School and Yale School of Management study on whether bonuses boost sales productivity within the sales force of a large office supply company, researchers found that:

• Bonuses do increase productivity.
• Quarterly bonuses increase sales force productivity more than annual bonuses.
• Salespeople tend to give up when they’re far away from reaching a quota, but they don’t slow down once a quota is reached, especially if their firm offers commissions for overachievement.

For nonsales roles, the data is equally compelling. More companies are offering short-term incentives, according to a 2018 report by WorldatWork, which surveyed 325 companies, nonprofits and government organizations. The survey results showed that 96 percent of the responding companies had short-term incentive programs in 2017, up from 94 percent in 2015. Spending on short-term incentives rose to a median of 6 percent of operating profits, up from 5 percent in 2015. In addition, about 66 percent of nonexempt employees were eligible for annual incentives, up from 52 percent.

In the survey, 74 percent of respondents said their organization’s annual incentive plan was “moderate to effective” in achieving its objective. That rating, along with the increase in the use of incentives, shows that compensation professionals find them successful.

Incentive pay, which is a variable form of compensation, can benefit employers in other ways as well.

“During volatile economic times, the use of variable pay allows a company to reward individuals and teams based on current profits and productivity, without the promise or expectation that such rewards will be offered continuously,” according to a 2014 article in the International Journal of Human Resource Studies. 

For my company, Stiles Corp., dealing with the cycles inherent in the real estate and construction industry is challenging. By carefully managing the fixed cost of salaries and using incentive plans, we have been able to better weather economic downturns, including the Great Recession.

Yes, there are times when incentive plans don’t work, or even backfire. Witness the debacle with Wells Fargo, which has cost the company billions in fines, lost business and brand damage. Cases like these are most likely the result of poor plan design or administration. Another important requirement for incentive plans to be effective is organizational trust between employees and managers.

There are many more cases of incentive plans working than not. Group incentive plans can contribute to organizational collaboration and achievement of company goals. For best results, companies should emphasize the need for employees to track and communicate progress toward organizational goals and, most important, to share how the employees’ actions directly correlate to those goals, according to Bill Fotsch and John Case, writing in a 2018 Forbes article, “The Key to an Effective Incentive Plan.”

Incentive pay plans that are properly designed and administered within an organization that has a culture of trust can benefit both the employee and employer, motivating and rewarding workers. And, the practice will be around for a long time.

George Boué, SHRM-SCP, is vice president of human resources for Stiles Corp., a commercial real estate company in Fort Lauderdale, Fla., and a member of SHRM’s Special Expertise Panel on HR Disciplines.

One of the main arguments against incentive pay is that it can encourage employees to act in an improper, unethical and even illegal manner. If an employee falls short of his goals, he might be tempted to bend the rules to achieve his target so that he can receive a bonus. 

Wells Fargo’s experience is a highly visible example of incentive pay plans gone horribly wrong. Employees were paid incentives based on the number of bank accounts they opened. In 2016, Wells Fargo was fined $185 million after regulators found that employees were opening additional bank accounts for customers without customers’ permission.

Numerous studies have shown that paying employees financial incentives to meet their goals can lead employees to make poor decisions and engage in dishonest activity. 

Here are some other disadvantages of incentive pay: 

Over time, it can create a sense of entitlement, decreasing motivation and lowering performance. In the early 1990s, Hewlett-Packard managers implemented 13 different incentive pay programs at various sites. Initially, employees met their goals. In response, the managers raised the goals, which lowered incentive pay. Workers grew dissatisfied. Managers found that workers were less motivated, leading to large variances in team performance, according to a 2002 study. 

It can negatively affect employees’ job satisfaction. A study published in the Harvard Business Review in 2017 that surveyed more than 13,600 employees in the United Kingdom found that profit-related incentive pay resulted in lower job commitment and trust in managers. It also found that performance-related incentive pay made employees feel increased pressure at work.

It can create an overly competitive workforce not focused on quality. Incentive plans that reward only certain segments of an organization can make nonrecipients envious and can lead to increased turnover among consistent performers in other departments.

It can create tension among co-workers. Team bonuses can create animosity between high-performers and those who produce less. In addition, low-performers could feel pressured by others to perform at a level they can’t achieve.

It can increase pay inequality for women. A study by ADP Research Institute released last year has shown that women, on average, are paid 17 percent less in base salary than men. When incentive pay is added, the pay gap increases by 2 percentage points. Other research has shown that female executives receive less incentive pay than males. 

It can be expensive when things go wrong. As the Wells Fargo case shows, when incentive plans go awry, the cost to employers can far outweigh any benefit. A study published in Organization Science in 2016 found that an incentive pay plan aimed at boosting attendance in five factories decreased productivity by 1.4 percent because conscientious, internally motivated employees who were performing well before the program was implemented felt it was unfair. 

In light of these downsides, organizational leaders should proceed with caution in implementing an incentive pay program. 

They should consider both the intended—and unintended—consequences and should determine whether incentive pay is an ideal fit for their organization. 

If they ultimately decide to implement a program, they should monitor it closely to ensure that it’s achieving the desired goals.  

Danielle M. Corradino is human resources director at The Corradino Group, an engineering and urban planning company in Doral, Fla., and a member of SHRM’s Special Expertise Panel on Ethics/Corporate Social Responsibility & Sustainability.