Skip to main content Accessibility help

We use cookies to distinguish you from other users and to provide you with a better experience on our websites. Close this message to accept cookies or find out how to manage your cookie settings.

Close cookie message
×
Hostname: page-component-669899f699-b58lm Total loading time: 0 Render date: 2025-04-28T23:08:43.179Z Has data issue: false hasContentIssue false

20 - Does pay for performance really motivate employees?

Published online by Cambridge University Press:  22 September 2009

By
Margit Osterloh  and
Bruno Frey
Edited by
Andy Neely
Margit Osterloh
Affiliation:
Professor for Business Management Institute for Organisation and Administrative Science at University of Zurich, Switzerland
Bruno Frey
Affiliation:
Research Director Center for Research in Economics at University of Zurich, Switzerland
Andy Neely
Affiliation:
Cranfield University, UK
Get access

Summary

Introduction

Variable pay for performance may undermine employees' efforts, as rewards crowd out intrinsic motivation under identified conditions. A bonus system then makes employees lose interest in the immediate goal. Moreover, monetary incentives in complex and novel tasks tend to produce stereotyped repetition, and measurement is often dysfunctional. Therefore, intrinsic motivation is crucial for these tasks. However, for some work extrinsic incentives are sufficient. We offer a framework for how managers can achieve the right balance between intrinsic and extrinsic motivation.

Variable pay for performance and motivation

Variable pay for performance has become a fashionable proposal over the last few years, in private companies as well as in the public sector. Many firms have given up fixed salaries and have moved to pay their employees in a variable way. Firms try to match payment to objectively evaluated performance. It is reflected in such popular concepts as stock options for managers and various types of bonuses. In the public sector, efforts to raise productivity in the wake of new public management have also resulted in attempts to adjust variably the compensation of public employees for their performance. This means that firms and public administrations increasingly rely on price incentives – i.e. on extrinsic motivations.

We argue in this chapter that variable pay for performance under certain conditions has severe limitations. In situations of incomplete contracts – and these dominate work relationships – an incentive system based only on monetary compensation for work is insufficient to bring forth the performance required.

Type
Chapter
Information
Business Performance Measurement
Unifying Theory and Integrating Practice
 , pp. 433 - 448
Publisher: Cambridge University Press
Print publication year: 2007

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Book purchase

Temporarily unavailable

References

Adams, J. S. (1963). Towards an understanding of inequity. Journal of Abnormal and Social Psychology, 67, 422–36.CrossRefGoogle Scholar
Akerlof, G. A. (1982). Labor contracts as partial gift exchange. Quarterly Journal of Economics, 84, 488–500.CrossRefGoogle Scholar
Akerlof, G. A., and Yellen, J. L. (1986). Efficiency Wage Models of the Labor Market. Cambridge: Cambridge University Press.CrossRefGoogle Scholar
Amabile, T. M. (1996). Creativity in Context: Update to the Social Psychology of Creativity. Boulder, CO: Westview Press.Google Scholar
Amabile, T. M. (1998). How to kill creativity. Harvard Business Review, 76(5), 77–87.Google ScholarPubMed
Argyris, C. (1964). Integrating the Individual and the Organization. New York: John Wiley.Google Scholar
Argyris, C. (1998). Empowerment: the emperor's new clothes. Harvard Business Review, 76(3), 98–105.Google ScholarPubMed
Arrow, K. J. (1974). The Limits of Organizations. New York: Norton.Google Scholar
Austin, R. D. (1996). Measuring and Managing Performance in Organizations. New York: Dorset House.Google Scholar
Barkema, H. G. (1995). Do job executives work harder when they are monitored?Kyklos, 48, 19–42.CrossRefGoogle Scholar
Barkema, H. G., and Gomez-Mejia, L. R. (1998). Managerial compensation and firm performance: a general research framework. Academy of Management Journal, 41, 135–45.Google Scholar
Baker, G. P., Jensen, M. C., and Murphy, K. J. (1988). Compensation and incentives: practice versus theory. Journal of Finance, 43, 593–616.CrossRefGoogle Scholar
Becker, G. S. (1976). The Economic Approach to Human Behavior. Chicago: University of Chicago Press.Google Scholar
Blinder, A. S. (ed.) (1990). Paying for Productivity: A Look at the Evidence. Washington, DC: Brookings.Google Scholar
Bohnet, I., and Frey, B. S. (1999a). The sound of silence in prisoner's dilemma and dictator games. Journal of Economic Behaviour and Organization, 38, 43–57.CrossRefGoogle Scholar
Bohnet, I., and Frey, B. S. (1999b). Social distance and other-regarding behavior in dictator games: comment. American Economic Review, 89(1), 335–9.CrossRefGoogle Scholar
Brennan, G., and Buchanan, J. M. (1985). The Reason of Rules: Constitutional Political Economy. Cambridge: Cambridge University Press.Google Scholar
Buchholtz, A. K., Schulze, W. S., and Dino, R. N. (1996). Breaking the Psychological Contract: A Social Exchange Theory Perspective of Performance-based Managerial Pay, working paper. Storrs: University of Connecticut, School of Business Administration.Google Scholar
Calder, B. J., and Staw, B. M. (1975). The self-perception of intrinsic and extrinsic motivation. Journal of Personality and Social Psychology, 31, 599–605.CrossRefGoogle ScholarPubMed
Csikszentmihalyi, M. (1975). Beyond Boredom and Anxiety: Experiencing Flow in Work and Play. San Francisco: Jossey-Bass.Google Scholar
Dawes, R. M. (1988). Rational Choice in an Uncertain World. San Diego: Harcourt, Brace, Jovanovich.Google Scholar
Dawes, R. M., Kragt, A. J. C., and Orbell, J. M. (1988). Not me or thee but we: the importance of group identity in eliciting cooperation in dilemma situations – experimental manipulations. Acta Psychologica, 68, 83–97.CrossRefGoogle Scholar
Charms, R. (1968). Personal Causation: The Internal Affective Determinants of Behavior. New York: Academic Press.Google Scholar
Deci, E. L. (1971). Effects of externally mediated rewards on intrinsic motivation. Journal of Personality and Social Psychology, 18, 105–15.CrossRefGoogle Scholar
Deci, E. L. (1975). Intrinsic Motivation. New York: Plenum Press.CrossRefGoogle Scholar
Deci, E. L., and Flaste, R. (1995). Why We Do what We Do: The Dynamics of Personal Autonomy. New York: Putnam.Google Scholar
Deci, E. L., Koestner, R., and Ryan, R. M. (1999). A meta-analytic review of experiments examining the effects of extrinsic rewards on intrinsic motivation. Psychological Bulletin, 125(6), 627–68.CrossRefGoogle ScholarPubMed
Deci, E. L., and Ryan, R. M. (1980). The empirical exploration of intrinsic motivational processes. Advances in Experimental Social Psychology, 10, 39–80.CrossRefGoogle Scholar
Deci, E. L., and Ryan, R. M. (1985). Intrinsic Motivation and Self-determination in Human Behavior. New York: Plenum Press.CrossRefGoogle Scholar
Donaldson, L. (1995). American Anti-management Theories of Organization: A Critique of Paradigm Proliferation. Cambridge: Cambridge University Press.Google Scholar
Eisenberger, R., and Cameron, J. (1996). Detrimental effects of reward: reality or myth?American Psychologist, 51, 1153–66.CrossRefGoogle ScholarPubMed
Enzle, M. E., and Anderson, S. (1993). Surveillant intentions and intrinsic motivation. Journal of Psychology and Social Psychology, 30, 257–66.Google Scholar
Fehr, E., Gächter, S., and Kirchsteiger, G. (1997). Reciprocity as a contract enforcement device: experimental evidence. Econometrica, 65, 833–60.CrossRefGoogle Scholar
Frank, R. H. (1992). Melding sociology and economics: James Coleman's foundations of social theory. Journal of Economic Literature, 30, 147–70.Google Scholar
Frey, B. S. (1992). Economics as a Science of Human Behaviour. Dordrecht: Kluwer.CrossRefGoogle Scholar
Frey, B. S. (1997). Not Just for the Money: An Economic Theory of Personal Motivation. Cheltenham: Edward Elgar.Google Scholar
Frey, B. S., and Bohnet, I. (1995). Institutions affect fairness: experimental investigations. Journal of Institutional and Theoretical Economics, 151(2), 286–303.Google Scholar
Frey, B. S., and Oberholzer-Gee, F. (1997). The cost of price incentives: an empirical analysis of motivation crowding-out. American Economic Review, 87(4), 746–55.Google Scholar
Ghoshal, S., and Moran, P. (1996). Bad for practice: a critique of the transaction cost theory. Academy of Management Review, 21(1), 13–47.CrossRefGoogle Scholar
Gibbons, R. (1998). Incentives in organizations. Journal of Economic Perspectives, 12(4), 115–32.CrossRefGoogle Scholar
Güth, W. (1995). Shirking versus managerial incentives of chief executive officers (CEOs): a note on a possible misunderstanding of principal–agency theory. Journal of Institutional and Theoretical Economics, 151(4), 693–8.Google Scholar
Hackman, R. J., and Oldham, G. R. (1980). Work Redesign. Reading, MA: Addison-Wesley.Google Scholar
Heckhausen, H. (1991). Motivation and Action. New York: Springer.CrossRefGoogle Scholar
Hodgson, G. M. (1998). Competence and contract in the theory of the firm. Journal of Economic Behavior and Organization, 35, 179–201.CrossRefGoogle Scholar
Holmström, B., and Milgrom, P. (1991). Multitask principal–agent analyses: incentive contracts, asset ownership and job design. Journal of Law, Economics and Organization, 7(Special issue), 24–52.CrossRefGoogle Scholar
Jensen, M. C., and Murphy, K. J. (1990). Performance pay and top-management incentives. Journal of Political Economy, 98, 225–64.CrossRefGoogle Scholar
Kaplan, R. S., and Norton, D. P. (1996). Translating Strategy into Action: The Balanced Scorecard. Boston: Harvard Business School Press.Google Scholar
Kim, W. C., and Mauborgne, R. A. (1991). Implementing global strategies: the role of procedural justice. Strategic Manangement Journal, 12, 125–43.CrossRefGoogle Scholar
Kim, W. C., and Mauborgne, R. A. (1998). Procedural justice, strategic decision making, and the knowledge economy. Strategic Management Journal, 19, 323–38.Google Scholar
Kohn, A. (1993). Punished by Reward: The Trouble with Gold Stars, Incentive Plans, A's, Praise, and Other Bribes. Boston: Houghton Mifflin.Google Scholar
Kruglanski, A. W. (1975). The endogenous–exogenous partition in attribution theory. Psychological Review, 82, 387–406.CrossRefGoogle Scholar
Lane, R. E. (1991). The Market Experience. Cambridge: Cambridge University Press.CrossRefGoogle Scholar
Lawler, E. E., III (1990). Strategic Pay: Aligning Organizational Strategies and Pay Systems. San Francisco: Jossey-Bass.Google Scholar
Lazear, E. P. (1996). Performance Pay and Productivity, Working Paper no. 5672. Cambridge, MA: National Bureau of Economic Research.CrossRef
Lepper, M. R., and Greene, D. (eds.) (1978). The Hidden Costs of Reward: New Perspectives on the Psychology of Human Motivation. Hillsdale, NY: Erlbaum.Google Scholar
Likert, R. (1961). The New Patterns of Management. New York: McGraw-Hill.Google Scholar
Loewenstein, G. (1999). Because it is there: the challenge of mountaineering … for utility theory. Kyklos, 52(3), 315–43.Google Scholar
March, J. M. (1999). The Pursuit of Organizational Intelligence. Oxford: Blackwell.Google Scholar
McGregor, D. (1960). The Human Side of Enterprise. New York: McGraw-Hill.Google Scholar
Milgrom, P. R., and Roberts, J. (1992). Economics, Organization and Management. Englewood Cliffs, NJ: Prentice Hall.Google Scholar
Morrison, E. W., and Robinson, S. L. (1997). When employees feel betrayed: a model of how psychological contract violation develops. Academy of Management Review, 22(1), 226–56.CrossRefGoogle Scholar
Osterloh, M., and Frey, B. S. (2000). Motivation, knowledge transfer and organizational forms. Organization Science, 11(5), 538–50.CrossRefGoogle Scholar
Pfeffer, J. (1995a). Competitive Advantage through People. Boston: Harvard Business School Press.Google Scholar
Pfeffer, J. (1995b). Incentives in organizations: the importance of social relations. In Williamson, O. E. (ed.), Organization Theory: From Chester Barnard to the Present and Beyond, 72–97. Oxford: Oxford University Press.Google Scholar
Pfeffer, J. (1997). New Directions for Organization Theory. Oxford: Oxford University Press.Google Scholar
Pittman, T. S., and Heller, J. F. (1987). Social motivation. Annual Review of Psychology, 38, 461–89.CrossRefGoogle Scholar
Prendergast, C. (1999). The provision of incentives in firms. Journal of Economic Literature, 37(1), 7–63.CrossRefGoogle Scholar
Robinson, S. L., Kraatz, M. S., and Rousseau, D. M. (1994). Changing obligations and the psychological contract: a longitudinal study. Academy of Management Journal, 37(1), 137–52.Google Scholar
Rotter, J. B. (1966). Generalized expectancies for internal versus external control of reinforcement. Psychological Monographs, 80(1), 1–28.CrossRefGoogle Scholar
Rousseau, D. M. (1995). Psychological Contracts in Organizations: Understanding Written and Unwritten Agreements. Thousand Oaks, CA: Sage.Google Scholar
Rousseau, D. M., and McLean Parks, J. (1993). The contracts of individuals and organizations. Research in Organizational Behavior, 15, 1–43.Google Scholar
Schein, E. (1965). Organizational Psychology. Englewood Cliffs, NJ: Prentice-Hall.Google Scholar
Schwartz, B. (1990). The creation and destruction of value. American Psychologist, 45, 7–15.CrossRefGoogle Scholar
Simon, H. A. (1951). A formal theory of the employment relationship. Econometrica, 19, 293–305.CrossRefGoogle Scholar
Stigler, G. J., and Becker, G. S. (1977). De gustibus non est disputandum. American Economic Review, 67(2), 76–90.Google Scholar
Tang, S. H., and Hall, V. C. (1995). The overjustification effect: a meta-analysis. Applied Cognitive Psychology, 9, 365–404.CrossRefGoogle Scholar
Thaler, R. H. (1992). The Winner's Curse: Paradoxes and Anomalies of Economic Life. New York: Free Press.Google Scholar
Titmuss, R. M. (1970). The Gift Relationship: From Human Blood to Social Policy. London: Allen and Unwin.Google Scholar
Tyler, T. R. (1990). Why People Obey the Law. New Haven, CT: Yale University Press.Google Scholar
Upton, W. (1973). Altruism, attribution and intrinsic motivation in the recruitment of blood donors. In Selected Readings in Donor Motivation and Recruitment, vol. II, 7–38. Washington, DC: American Red Cross.Google Scholar
Wiersma, U. J. (1992). The effects of extrinsic rewards on intrinsic motivation: a meta-analysis. Journal of Occupational and Organizational Psychology, 65, 101–14.CrossRefGoogle Scholar
Williamson, O. E. (1975). Markets and Hierarchies: Analysis and Antitrust Implications: A Study in the Economics of Internal Organization. New York: Free Press.Google Scholar
Williamson, O. E. (1985). The Economic Institutions of Capitalism: Firms, Markets, Relational Contradicting. New York: Free Press.Google Scholar
Williamson, O. E. (1996). Economic organization: the case for candor. Academy of Management Review, 21, 48–57.CrossRefGoogle Scholar

Save book to Kindle

To save this book to your Kindle, first ensure [email protected] is added to your Approved Personal Document E-mail List under your Personal Document Settings on the Manage Your Content and Devices page of your Amazon account. Then enter the ‘name’ part of your Kindle email address below. Find out more about saving to your Kindle.

Note you can select to save to either the @free.kindle.com or @kindle.com variations. ‘@free.kindle.com’ emails are free but can only be saved to your device when it is connected to wi-fi. ‘@kindle.com’ emails can be delivered even when you are not connected to wi-fi, but note that service fees apply.

Find out more about the Kindle Personal Document Service.

  • Does pay for performance really motivate employees?
    • By Margit Osterloh, Professor for Business Management Institute for Organisation and Administrative Science at University of Zurich, Switzerland, Bruno Frey, Research Director Center for Research in Economics at University of Zurich, Switzerland
  • Edited by Andy Neely, Cranfield University, UK
  • Book: Business Performance Measurement
  • Online publication: 22 September 2009
  • Chapter DOI: https://doi.org/10.1017/CBO9780511488481.026
Available formats
×

Save book to Dropbox

To save content items to your account, please confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. Find out more about saving content to Dropbox.

  • Does pay for performance really motivate employees?
    • By Margit Osterloh, Professor for Business Management Institute for Organisation and Administrative Science at University of Zurich, Switzerland, Bruno Frey, Research Director Center for Research in Economics at University of Zurich, Switzerland
  • Edited by Andy Neely, Cranfield University, UK
  • Book: Business Performance Measurement
  • Online publication: 22 September 2009
  • Chapter DOI: https://doi.org/10.1017/CBO9780511488481.026
Available formats
×

Save book to Google Drive

To save content items to your account, please confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. Find out more about saving content to Google Drive.

  • Does pay for performance really motivate employees?
    • By Margit Osterloh, Professor for Business Management Institute for Organisation and Administrative Science at University of Zurich, Switzerland, Bruno Frey, Research Director Center for Research in Economics at University of Zurich, Switzerland
  • Edited by Andy Neely, Cranfield University, UK
  • Book: Business Performance Measurement
  • Online publication: 22 September 2009
  • Chapter DOI: https://doi.org/10.1017/CBO9780511488481.026
Available formats
×