Pay and incentives

Survey and register data indicate that many employees prefer a socially responsible employer and will accept a lower wage to achieve this. Laboratory experiments support the hypothesis that socially responsible groups are more productive than others, partly because they attract cooperative types, partly because initial cooperation is reinforced by group dynamics. Overall, the findings indicate corporate social responsibility may have cost advantages for firms.

The keys to effective teamwork in firms are (1) carefully designed team-formation policies that take into account what level of diversity of skills, knowledge, and demographics is desirable and (2) balanced team-based incentives. Employers need to choose policies that maximize the gains from teamwork through task coordination, problem solving, peer monitoring, and peer learning. Unions and labor market regulations may facilitate or hinder firms’ attempts at introducing teams and team-based incentives.

How do firms motivate their employees to be productive? The conventional wisdom is that workers respond to monetary incentives—“Pay them more and they will work harder.” However, a large and growing body of empirical evidence from laboratory and field experiments, surveys, and observational data, as well as neuroeconomic research, suggests that workers’ perceptions of fairness and trust are also key drivers of their work effort. Treating employees with respect is not only ethically warranted, it can create positive economic outcomes for both the worker and the firm.

Concerns about poor student performance have led schools to diverge from traditional teacher compensation and base a portion of pay on student outcomes. In the US, the number of school districts adopting such performance-based financial incentives has increased by more than 40% since 2004. Evidence on individual incentives in developed countries is mixed, with some positive and some negligible impacts. There is less evidence for developing countries, but several studies indicate that incentives can be highly effective and far cheaper to implement. Innovative incentive mechanisms such as incentives based on relative student performance show promise.

A wide range of high involvement management practices, such as self-managed teams, incentive pay schemes, and employer-provided training have been shown to boost firms’ productivity and financial performance. However, less is known about whether these practices, which give employees more discretion and autonomy, also benefit employees. Recent empirical research that aims to account for employee self-selection into firms that apply these practices finds generally positive effects on employee health and other important aspects of well-being at work. However, the effects can differ in different institutional settings.

Employers want motivated and productive employees. Are there ways to increase employee motivation without relying solely on monetary incentives, such as pay-for-performance schemes? One tool that has shown promise in recent decades for improving worker performance is setting goals, whether they are assigned by management or self-chosen. Goals are powerful motivators for workers, with the potential for boosting productivity in an organization. However, if not chosen carefully or if used in unsuitable situations, goals can have undesired and harmful consequences. Goals are a powerful tool that needs to be applied with caution.

Economists typically predict that people are inherently selfish; however, experimental evidence suggests that this is often not the case. In particular, delegating a choice (such as a wage) to the performing party may imbue this party with a sense of responsibility, leading to improved outcomes for both the delegating entity and the performing party. This strategy can be risky, as some people will still choose to act in a selfish manner, causing adverse consequences for productivity and earnings. An important issue to consider is therefore how to encourage a sense of responsibility in the performing party.

Profit sharing can lead to higher productivity and thus to higher firm profitability and employee wages. It may also enhance employment stability by enabling firms to adjust wages during downturns rather than lay off workers. While adoption of profit sharing increases earnings fluctuations, it also increases earnings growth in the longer term. As with any group incentive plan, profit sharing may result in some workers benefiting from the effort of others without themselves exerting greater effort (“free-rider problem”). However, there is evidence that in team-based production workplaces, profit sharing may reduce shirking and thus contribute to productivity growth.

Allowing workers to control their work hours (working-time autonomy) is a controversial policy for worker empowerment, with concerns that range from increased shirking to excessive intensification of work. Empirical evidence, however, supports neither view. Recent studies find that working-time autonomy improves individual and firm performance without promoting overload or exhaustion from work. However, if working-time autonomy is incorporated into a system of family-friendly workplace practices, firms may benefit from the trade-off between (more) fringe benefits and (lower) wages but not from increased productivity.

Firms regularly use incentives to motivate their employees to be more productive. However, often little attention is paid to the language used in employment contracts to describe these incentives. It may be more effective to present incentives as entitlements that can be lost by failing to reach a performance target, rather than as additional rewards that can be gained by reaching that target. However, emphasizing the potential losses incurred as a result of failure may entail hidden costs for the employer, as it may damage the trust relationship between a firm and its employees.