The Pay-for-Performance Fallacy

In business, money is power. It buys influence and backs much-needed investments in things like infrastructure and technology — resources hardly any business could do without.

Money also attracts talent. In the global war for top talent, money is often the differentiating factor in getting someone to leave one company for another, along with other benefits and perks.

But once talent is in the door, there are a few things money cannot buy.

Despite the oft-cited belief that money is a tool for motivation, engagement, job satisfaction and performance, companies still find themselves scratching their heads when increased salaries or lucrative bonuses fall short on improving such matters.

In many instances, the people known to work the longest hours and who are most satisfied with their work-life balance — those who are self-employed — also earn, relatively speaking, the least amount of money.

What is more, evidence suggests that money may even damage performance. In a 2009 study from Review of Economic Studies commissioned by the Federal Reserve Bank of Boston, participants received the equivalent of one day’s, two weeks’ or five months’ worth of pay for completing a set of cognitive tasks. While there was no difference between participants’ performance in the first two groups, there were significantly fewer star performers among those who received the largest amount of pay.

As it turns out, chasing cash doesn’t always bode well for individuals or organizations.

The myth that businesses can pay for performance is pervasive because it’s perpetuated by employees and leaders themselves. In the largest study of the subject, University of Michigan researchers Betsey Stevenson and Justin Wolfers found that as income increases, life satisfaction rises. The wealthier we are, the happier we are. Therefore, the thinking goes, the way to become happier is to be paid more.

Individuals, by their human nature, demand more pay, so organizations use pay as a lever for performance. The problem for businesses and stakeholders alike is that, although employees may express an initial spike in happiness when paid more, the boost doesn’t necessarily increase performance in the long-term.

Instead, there are a host of psychological factors — backed up by reliable data from decades of research — showing how productivity, job satisfaction and performance can be increased without having to spend a penny.

Purpose: The first is a sense of purpose. People can view what they do as either a job (putting meals on the table), a career (climbing up the ladder) or a calling (delivering something that matters more than personal gain).

Across industries, about a third of people fall into each category. According to a 1997 study published in the Journal of Research in Personality, a surgeon is no more likely to view work as a calling than a janitor. Those who perceive their occupation as a calling are more satisfied and feel less need to alter their work-life balance. Therefore, businesses will gain a clear advantage in their effort to boost motivation and productivity if they’re able to provide a sense of purpose to their employees.

For example, consumer products company Unilever has an organizational goal to double its size while halving its environmental footprint, thus having a positive social impact. This means not only reducing the emissions it produces when it manufactures products, but also encouraging consumers to use less.

And when communicated consistently throughout the organization, even the most cynical manager can buy in and appreciate the greater good that his or her work is driving toward in protecting the environment — and, as a result, increase his or her engagement and feeling of purpose.

“We are making sustainable living a driver of everything we do at Unilever,” said Nick Pope, the company’s global learning director. “This deeper calling is one of the main reasons people choose to join and stay at Unilever.”

Stretch goals: The second lever is stretch goals. The oft-quoted study in this regard comes from Yale University. In 1953, as the story has often been told, researchers surveyed its graduating seniors to determine how many of them had specific, written goals for their future — only 3 percent had.

About 20 years later, the researchers polled the class of 1953 again and found that the 3 percent with written goals had accumulated more personal financial wealth than the other 97 percent combined. Though many dispute the truth of the story, it highlights the theme, and there is firm evidence elsewhere of the effect goals have on performance.

For instance, according to an example given in a 1974 study from the Journal of Applied Psychology by researchers Gary P. Latham and Sydney B. Kinne, the American Pulpwood Association increased the productivity of its loggers and truck loaders by measuring their progress against a challenging target, rather than simply telling them to “do their best.”

Moreover, more than 40 percent of strong financially performing businesses align managers’ goals with the company’s overall strategy, according to a 2007 study from research firm the Workforce Intelligence Institute, compared with less than 5 percent of weakly performing businesses.

And at Microsoft Corp., personal accomplishments are less important than managers’ ability to get the best from their team members. By cascading goals this way, managers are rewarded for developing their team, thus growing the business’ overall capability.

As these examples show, challenging goals rouse individuals’ competitiveness and provide a sense of accomplishment.

Appreciation: The third non-financial lever for performance is appreciation. Regular feedback — praise in particular — is the closest thing to a certainty when it comes to transforming behavior. In a field study published in the Journal of Applied Psychology that tracked workers in a manufacturing plant, periodical feedback resulted in near-perfect safety scores. When the feedback stopped, safety performance dropped to 80 percent, only to shoot up again when it was reinstated.

Additionally, research from the Corporate Leadership Council has shown that formal reviews that emphasize individuals’ strengths increase performance by 10 percent more than reviews that focus on weaknesses. Strengths-based informal feedback, meanwhile, boosts performance by 39 percent, compared to just 11 percent for informal feedback that highlights weaknesses.

Feedback also helps employees see the meaning in their work. In a 2012 Duke University study by professor of psychology and behavioral economics Dan Ariely, psychologists paid participants a diminishing amount for every Lego robot they built until they gave up. The robots were either displayed on the desk or taken apart and given back to participants to reassemble. The former group built on average 10.6 robots at a cost of $1.36 per figure; the latter gave up after 7.2 models costing $1.60 per unit.

As it turns out, the pointlessness of the task meant that individuals required greater financial rewards to carry on. In organizational settings, a well-placed word of praise can be the appreciation employees need to renew their efforts.

Coaching: The fourth way to increase performance without paying is coaching. In coaching, conversations swing between being directive and collaborative — managers balance asking targeted questions with sharing their own insights. The discussion focuses on what the ideal solution looks like and how to get there.

When managers at U.K. telecommunications firm O2 were taught how to coach, its branches’ ability to hit revenue targets increased by almost 30 percent, according to a case study by Mind Gym Inc., a performance management firm where the author works. What’s more, 55 percent of the branch managers whose performance had improved were coached by their manager.

Differentiation: The fifth and final lever is consistent differentiation. When performance ratings are scored around the mean — centrality bias — or bunched at the top — leniency bias — effort drops and so does performance, according to a 1983 study by Norbert L. Kerr and Steven E. Bruun published in Journal of Personality and Social Psychology.

If everyone scores four, there’s little point in being outstanding and no consequence to underperforming, the study showed. Even motivated employees ease off when they see lazier colleagues getting away with less — a phenomenon called social loafing.

Differentiation is being applied at Unilever. When CEO Paul Polman first arrived in January 2009, incentives were based around the average. “Everyone got the average, so the company was average,” he said. “Our new system has more differentiation, so there is a higher upside and higher downside.”

Changing the performance rating system can be cost-effective shock therapy for those who are happy coasting. But a forced distribution system — where a fixed proportion of people receive each rating — loses effectiveness after the first year. More successful is consistent differentiation, in which managers aim for broad variance and make decisions with the help of a formal inter-rating discussion. This ensures that individuals are treated equally based on what they’ve achieved.

In any case, the conversations between managers and direct reports are more important than the process by which they arrived at the score. Explaining in concrete terms why an individual scored three and what he or she has to do to reach four motivates that person to go the extra mile.

Purpose, stretch goals, appreciation, coaching and consistent differentiation are all proven to increase performance more than traditional financial incentives — and all are elements that increase employee engagement, perhaps the most powerful driver of productivity and bottom-line growth. In a 2012 Gallup survey of 1.4 million employees, units that scored in the top quartile for employee engagement outperformed those in the bottom quartile on a host of factors, including profitability, productivity, customer satisfaction, safety, retention and absenteeism.

Adding a few digits to an employee’s paycheck is a quick — albeit expensive — fix for those who believe that money motivates. But savvy companies are increasingly looking beyond cash to gain a competitive advantage.

Money might talk, but treating people well and having conversations that leave them feeling challenged, purposeful and appreciated — these are the things that make them sit up and listen.

Sebastian Bailey is president of Mind Gym Inc., a performance management firm. He can be reached at