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Bigger bonus, worse performance
Games with big rewards
The study was run by Dan Ariely and three colleagues, with MIT students playing games that tested creativity, motor skills, and concentration. When a task needed only mechanical skill, bonuses worked as expected: the higher the pay, the better the performance.
To check for cultural bias, the team repeated the experiment in Madurai, India, where the standard of living is lower and a reward that is modest by North American standards is more meaningful. People offered the medium reward did no better than people offered the small one, and people offered the highest reward did the worst of all. Across three experiments, higher incentives led to worse performance in eight of the nine tasks examined.
The researchers came from MIT, Carnegie Mellon, and the University of Chicago, and the Federal Reserve Bank of the United States sponsored the work.
Pay plans at companies
Economists at the London School of Economics later looked at 51 studies of pay-for-performance plans inside companies. They found that financial incentives can have a negative impact on overall performance.
Why would a huge bonus lower performance?
One explanation is choking under pressure. Psychologist Sian Beilock found in her research at the University of Chicago that worrying about a result can occupy the working memory a task needs. A very large reward raises the stakes on every move, which gives that worry more to feed on. Tasks that need only effort suffer less, because they draw little on working memory.
Why do economists expect pay to raise effort?
Standard economic models treat a worker's effort as something an employer can buy with the right incentive. Michael Jensen and William Meckling's 1976 paper on agency costs helped set out the logic, in which owners tie pay to results so that employees' interests line up with their own. That reasoning lies behind sales commissions, stock options, and performance bonuses. The model works well when more effort translates directly into more output.
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