Big Incentives Can Hinder, Rather Than Help

by Melissa Korn
May 15th, 2012

Financial incentives can spur us to success—up to a point.

When the stakes get too high, performance can suffer, according to a new paper from researchers at California Institute of Technology. By studying brain-scan data of volunteers performing a basic motor task (controlling an object on a screen) for money, the Caltech team found that once the incentive for successfully completing the task hit a certain threshold, the brain’s reward center began to shut down, a response tied to loss aversion.

Previous studies have suggested that success rates decline with high incentives because people can be too motivated, but the newest research suggests otherwise, finding positive responses in the reward-response area only when the incentive was first introduced. In other words, participants responded well to the initial incentive but grew distracted once the task was under way.

To read the full article on the Wall Street Journal, please click here.

The original paper was published in Cell Neuron and is available here.  A little more about the paper:

Title: Neural Mechanisms Underlying Paradoxical Performance for Monetary Incentives Are Driven by Loss Aversion

Vikram S. Chib^1,2, Benedetto De Martino^3,4, Shinsuke Shimojo^1,2, John P. O’Doherty^1,2

¹ Division of Biology, California Institute of Technology, Pasadena, CA 91125, USA
² Computation and Neural Systems, California Institute of Technology, Pasadena, CA 91125, USA
³ Division of Humanities and Social Sciences, California Institute of Technology, Pasadena, CA 91125, USA
⁴ Psychology and Language Sciences, University College of London, London WC1H 0AP, UK
Accepted 27 February 2012. Available online 9 May 2012. Published: May 9, 2012.

Abstract: Employers often make payment contingent on performance in order to motivate workers. We used fMRI with a novel incentivized skill task to examine the neural processes underlying behavioral responses to performance-based pay. We found that individuals’ performance increased with increasing incentives; however, very high incentive levels led to the paradoxical consequence of worse performance. Between initial incentive presentation and task execution, striatal activity rapidly switched between activation and deactivation in response to increasing incentives. Critically, decrements in performance and striatal deactivations were directly predicted by an independent measure of behavioral loss aversion. These results suggest that incentives associated with successful task performance are initially encoded as a potential gain; however, when actually performing a task, individuals encode the potential loss that would arise from failure.

A great video adopted from Dan Pink’s talk.  Must watch.

Our summary: while this article is several months old, it discusses how the HR market is heating up as companies are upgrading their Talent Management infrastructure.  We are in the right market.

The Sleepy Little HR Software Market Is On Fire

by Josh Bersin
Originally Published on 2/09/2012

There is a sleepy old enterprise software market for HR systems which is on fire. Within the last 60 days, SAP acquired SuccessFactors for $3.4 billion (nearly 10X revenues) and Oracle just acquired Taleo (leading software provider for corporate recruiting) for $1.9 billion (around 5.3X revenues).

There are three huge trends taking place.First, corporate software is now moving to the cloud. The $15 billion+ marketplace for core human resources, payroll, and talent management software is being totally revamped. Companies are starting to replace all this core infrastructure software (much of which is 10-20 years old) with new cloud products – and the big players (Oracle and SAP) are buying their way into this market.

Second, the market for integrated talent management software has matured. Over the last ten years most companies purchased a wide variety of tools to help with recruiting, performance management, training management, compensation management, and workforce planning.

Source: http://www.nbrii.com/blog/infographic/

Scenario

At the end of every year, the management team would lock themselves up in a cabin in the woods and managers would fight for their employees to get them into the top-performer percentile.  The company had rank-and-yank workflow/structure, which was anything but transparent.  Almost all employees felt deeply dissatisfied with their bonuses and quickly burned out causing significant churn in the company.

Deployment

• 10% of gross profits allocated towards bonus compensation (no change from previous size)
• 360 FairImpact monthly expectation-based performance evaluation
• Vesting: 2 years
• Divesting: 6 months

Impact

• Improved Employee Retention: while the size of bonuses did not improve, transparency and mathematical rigor lead to employees feeling that bonus calculation was fair.
• Less Management: regular 360 evaluations reduced management load allowing for mid-level managers to get more involved in front-line operations.
• Light Touch Performance: before performance management involved a “score card” and was done every 6 months.  Switching to monthly single-question evaluations forced improved communication of expectations.  Some started doing bi-weekly evaluations to ensure constant feedback between management and front-line employees.
• Early Problem Detection: transparency of missed expectations lead to management becoming aware of potential problems early thus giving them a chance to assist before minor issues develop into crises.
• Improved Morale: because everyone had a voice and felt that management was trying to be transparently fair, culture significantly improved.

• perception of control leads to happiness
• existence of expectations reduces anxiety
• ROI without analysis of perception is incomplete
• classical economics is preoccupied with reality

“Everyone knows my example with Eurostar.  6 billion pounds spent to reduce the journey time between Paris and London by about 40 minutes. For 0.01% of this money, you could have put wifi on the trains, which wouldn’t have reduced the duration of the journey, but would have improved its enjoyment and its usefulness far more.  For may be 10% of the money you could have paid all of the worlds top male and female supermodels to walk up and down the trains handing out free Chateoux Petruce to all the passengers.  You’d still have 5 billion pounds in change and people would have asked for the trains to be slowed down.”

Another almost-as-important a bit: the recurring theme is that perception of being in control makes something tolerable, possibly even desirable. Money alone is insufficient to understand outcome – tying into individual emotions is of paramount importance.

FairSetup offers numerous advantages over existing models:

• Salary/Hourly pay for time, not impact.
• A high salary doesn’t always translate into productivity.
• Paying hourly creates an incentive to spend more time.
• FairSetup: people accept a lower salary and participate in the upside.  This “skin in the game” results in employees caring deeply about the outcome.
• Stock Options/Equity are a bad short-term incentive.
  
• Hard to evaluate actual worth.
• Require significant effort to deploy.
• Equity is hard to take away – there is no divesting.
• Dilution is not a good solution for large dynamic teams.
• Stock options generally expire after an individual leaves.
• Stock options can have reverse vesting, but it’s rare.
• Tax issues…
• FairSetup: impact-based compensation can be paid out as part of salary and an individual automatically divests over time after departure.
• Bonuses – are not an effective way to manage people unless very carefully used.
• Small bonuses – people are upset because they don’t make enough.
• Large bonuses – people are upset because then the boss must make an even larger undisclosed amount.
• FairSetup: the compensation is transparently connected to profits.

While money is the central component of any business, money is generally not the primary motivator.  When do people work best?  When they feel that they are treated fairly – when they feel that, if they put in a lot of effort, they are adequately rewarded for their impact.  Until now, this sort of mindset was reserved for startups.  FairSetup is a new type of compensation: one where a motivated company culture is achieved for by creating a system that fairly rewards all participants for their impact.

What makes people feel like their are being treated fairly?  The ultimate form of fairness is a feeling of ownership.

What is ownership?  It is 1) the ability to make decisions and 2) ownership of future profits. Most, especially late-stage commodity-type, employees are not interested in making strategic-level decisions.  At the same time, they do want to profit from their impact on the company and are willing to take a risk to participate in the upside.

FairShare, the most advanced form of deployment of FairSetup, offers exactly that – if you are an employee who works hard and the company does well, you own some of that tasty future profit.  The goal of FairShare is to give employees a sense of ownership so that they work hard and profit when the company does well and share in company’s plight when it doesn’t.

FairShare is an easy-to-understand transparent profit-sharing model.  Hiring additional people to grow your team becomes easier – no need to dilute, dilution happens naturally as more people become members in the compensation pool.

What’s even better is that FairShare helps address the necessary transience of high quality employees.  For example: let’s say that you need a high quality programmer when building a large system.  After the system is built, their involvement is no longer necessary.  Under FairShare, the programmer will want to build the system as quickly as possible and then move on to other interesting projects, because most compensation comes from success of the system, not the act of building it.

All in all, FairShare brings entrepreneurship into organizations of any size.