Pay For Performance: Innovation Killer?

 -  7/23/13

While pay for performance can induce higher levels of productivity, a new study suggests it may be a barrier to creativity and innovation.

As pay for performance — linking employee compensation to effort or productivity — is increasingly accepted as a way to ensure employees are maximizing output amid a competitive economy, one study reveals the model is actually detrimental to another highly sought-after organizational goal: innovation.

Pay for performance is effective for employees in operational roles, such as a painter painting houses or a salesman hitting quotas. But when it comes to employees responsible for finding creative solutions to problems, the model is ineffective, said Gustavo Manso, co-author of a 2012 study published in the July issue of Management Science.

This is because a straight pay-for-performance model does not have a tolerance for early failure, a component essential to innovation, said Manso, an associate professor of finance at the University of California at Berkeley. Innovation is a “trial and error process,” Manso said. “You have to try things that you don’t know if they’re going to work.”

Manso and the study’s co-author, Florian Ederer of the University of California at Los Angeles, argue that the perfect compensation structure for innovation is one that provides security of early failures while rewarding for long-term success.

To prove this, the authors used a lab environment with the premise of managers conceiving a lemonade stand. The study tasked three groups with coming up with all the strategic components of setting up a stand — price, location, mix of sugar and lemon. Each group was compensated under separate models: The first group would receive a fixed wage, the second group a pay-for-performance model, and the third group a hybrid “exploration” model.

The authors’ hypothesis: The group operating under the hybrid model would explore more and be more likely to find superior strategy than the subjects in the two other compensation models.

The results proved just that. The subjects in the hybrid, exploration compensation model ended the experiment with the best location for the lemonade stand 80 percent of the time. Meanwhile, the subjects in the fixed wage and pay-for-performance model ended up in the best location 60 percent and 40 percent of the time, respectively.

Article Keywords:   productivity   innovation   compensation  


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