Incentive

In general, incentives are anything that persuade a person to alter their behaviour in the desired manner.[1] It is emphasised that incentives matter by the basic law of economists and the laws of behaviour, which state that higher incentives amount to greater levels of effort and therefore higher levels of performance.[2]

For other uses, see Incentive (disambiguation).
Protest sign displaying "Stop Climate Change" at climate strike in Melbourne, Australia. Climate movements may incentivize governments and industry to take collective action in the fight against climate change.

Divisions

Incentives can be broken down into two categories; intrinsic incentives and extrinsic incentives.[3] The motivation of people's behaviour comes from within. In activities, they are often motivated by the task itself or the internal reward rather than the external reward. There are many internal rewards, for example, participating in activities can satisfy people's sense of achievement and bring them positive emotions. An intrinsic incentive is when a person is motivated to act in a certain way for their own personal satisfaction.[4] This means that when a person is intrinsically incentivised, they perform a certain task to please themselves and are not seeking any external reward, nor facing any external pressure to perform the task.[4] On the other hand, an extrinsic incentive is when a person faces external pressure that compels them to act in a particular way.[5] The external pressure could include either a reward for completing the task or could be a form of punishment or consequence if the task is not completed.[5] When people have difficulty completing a task or lack interest in participating in an activity, extrinsic incentives can often be effective in helping people improve their motivation.

Intrinsic incentives and extrinsic incentives are both important and drive people's behaviour. However, people's intrinsic motivation tends to decrease when they are offered too many extrinsic rewards. In order to maintain the action, constant incentives have to be provided. This is known as the Overjustification Effect.

In the context of economics, incentives are most studied in the area of personnel economics where economic analysts, such as those who take part in human resources management practices, focus on how firms make employees more motivated, through pay and career concerns, compensation and performance evaluation, to motivate employees and best achieve the firms' desired performance outcomes.[6]

Overall, the standard "law of behaviour" suggests that more incentives will result in higher performance and higher effort.[1] People can take their performance to the next level by being rewarded for their efforts. As a result, extrinsic incentives are commonly used within the workforce by employers and managers.[1] This is because employers believe that the more they encourage their employees to act in a manner which is consistent with the interests of the firm, the more likely the firm is to reach its organisational goals.[1] However, there are some parties who oppose the benefits of using extrinsic incentives and believe that they cause more harm than good. These opponents believe that the constant use of extrinsic incentives can lead to crowding out of intrinsic incentives, which are also valuable performance motivators.[2] When people are constantly being incentivised by external pressures, they neglect their intrinsic motives which could consequently be detrimental to their work ethic.[7] Employees can become too comfortable with consistently gaining some reward for acting in a manner which is consistent with the interests of the firm. As a result, employees begin to believe that they deserve to earn rewards for doing certain things, not for the benefit of the firm but rather for their own benefit, which leads to them shirking if no extrinsic incentive is offered in return for high effort.[7] Nonetheless, incentives (both intrinsic and extrinsic) can be beneficial in altering a person's behaviour and can be effectively used and executed within many different areas of life including in the workforce, in education and within one's personal life.[1]

Classification

Classified by David Callahan, the types of incentives can be further broken down into three broad classes according to the different ways in which they motivate agents to take a particular course of actions:[8][9]

Class Definition
Remunerative incentives (or financial incentives) Exist where an agent can expect some form of a material reward like money in exchange for acting in a particular way.[9]
Moral incentives Exist where a particular choice is widely regarded as the right thing to do or is particularly admirable among others.[9] An agent acting on a moral incentive can expect a sense of positive self-esteem, and praise or admiration from their community. However, an agent acting against a moral incentive can expect a sense of guilt, condemnation or even ostracism from the community.[9]
Coercive incentives Exist where an agent can expect that the failure to act in a specific way will result in physical force being used against them by others – for example, by inflicting pain, or by imprisonment, or by confiscating or destroying their possessions.[9]

Monetary incentives

Monetary incentives are any form of financial good given to someone to incentivize their actions and align their incentives with those of the principal who provides the monetary incentive.[10] This is a type of extrinsic incentive and is commonly seen in the workplace. They can come in the forms of profit sharing, bonuses, stock options or even paid vacation time. Well-chosen monetary incentive programs can produce positive motivation and influence the productivity and output of individuals and firms.[11]

A common monetary incentive system used by firms is performance-based pay where incentives are paid based on employees' productivity or output over a particular period of time. Some methods are commission-based where the employee, for example a salesperson, receives a payment directly correlated to their output level. Firms also pay additional wages or rewards for employees who work overtime and for their additional work above firm expectations. Expectancy theory implies that, provided employees place sufficient value on the monetary incentive to justify their extra effort and perceive that greater effort will result in better performance, such incentives can motivate employees to maintain high levels of effort and discourage shirking. This in turn increases the individual productivity of workers and the overall productivity of the firm.[10]

Other monetary incentives are less direct, such as awarding periodic, discretionary bonuses to top performers, offering the possibility of a promotion to a higher-paying position or profit sharing for team projects.[12] Alternatively, firms can also incentivize their employees to perform by threatening to demote or terminate them for poor performance.[12] When employees feel that their careers are in jeopardy, they are more likely to increase their efforts.

The effect of monetary incentives can depend on the framing of the rewards. For example, in cadaveric organ donation, funeral aids are perceived to be more ethical (particularly in showing gratitude and honoring the deceased donor) and potentially increase donation willingness than direct cash payments of the same monetary value.[13][14]

Non-monetary incentives

A non-monetary incentive is an incentive which takes the form of a non-cash incentive. They are still used as forms of motivation but are much more cost effective in incentivizing employees who have performed highly. Some examples of these incentives include extra paid holidays, recognition, gifts, family benefits or even work-based perks such as more interesting projects or work. Rewards such as these tend to boost employees' job satisfaction as they feel more appreciated for their efforts. Firms with higher job satisfaction and morale have found to have better overall employee contribution and hence better productivity. Compared to monetary incentives, studies have shown that employees find non-monetary incentives more memorable as they are separated from normal pay and hence are more distinguishable. This can create more satisfaction in working environments.[15]

Effective use of non-monetary incentives can increase the morale of firms as well which has also been seen to increase productivity. This type of incentive has commonly been used to directly enhance job satisfaction of employees.[15] Studies have shown that non-monetary rewards, such as extra paid holidays and more responsibilities increase job satisfaction more than monetary incentives do. Non-monetary incentives also offer greater opportunities for skill development of workers, which can often result in higher wages in the long run as employees' skills improve and they become more qualified for higher roles. These non-monetary incentives are very important to firms and create better working environments for employees.

Incentives in the economic context

The economic analysis of incentives focuses on the systems that dictate the incentives needed for an agent to achieve a desired outcome which is dictated by the principal.[12] Incentives can help companies link employees' rewards to their productivity. When a firm wants their employees to produce a certain amount of output, it must be prepared to offer a compensation scheme such as a monetary bonus to persuade employees to reach the target output.[12] Compensation must achieve two goals. The first is to reduce employee turnover and retain the highest performing and most productive employees. Compensating employees can help attract workers to work harder and retain their ability. The second is to improve productivity. Compensation can not only stimulate the ability of workers to produce output, but also improve the enthusiasm of employees to work, thus promoting business development.[12] A rise in pay variance across the firm reflects an increased demand for highly productive workers, and therefore compensation has begun shifting towards pay-for-performance.[16] This helps employees recognize the direct relationship between their work output and their reward.

Misaligned incentives

Principals within a firm want their agents to work for the principals' best interests, but agents often have different goals than the principals.[17] Due to this problem of misaligned incentives, firms must design compensation plans to induce workers to act in the firm's best interest and generate a level of output that maximizes the firm's profits.[12]

The problem of asymmetric information means that the principal does not know exactly how to motivate its agents to act in the firm's best interests. Consequently, compensation plans are difficult for firms to design.[18] The principal-agent theory is used as the guiding framework when aligning incentives with the employee's effort to obtain the efficient level of output for the firm.[12] For example, a manager may want a certain level of output from an employee but does not know the capabilities of the employee in the presence of imperfect monitoring, and to achieve the best outcome, an optimal scheme of incentive may be set to motivate the worker to increase their productivity.[18]

The Tournament theory also provides a framework of compensation but at different levels of the firm's hierarchy.[6] The theory demonstrates that individuals are not promoted on the basis of their performance and output, instead on the relative position in the organization.[6] The theory also explains that the compensation does not necessarily motivate the employee currently working at that level but instead motivates the employees below that level whose aim is to be promoted.[6]

Self-selection effects of incentives

Potential employees know more about their own abilities, competitiveness and risk attitudes than potential employers. Due to this asymmetric information, firms design incentives not only to enhance employees’ motivation to act in the interests of the firm and maximize their output, but also to influence the type and quality of workers that they attract.[19] For example, empirical studies have shown that firms which implement pay-for-performance rather than fixed wage compensation schemes tend to attract more productive workers who are less risk averse.[20] Accordingly, firms use incentives as a method of filtering out low productivity workers.

Potential issues

Incentives are arguably beneficial in increasing productivity, however, they can also have an adverse effect on the firm.[12] This is evident through the ratchet effect. A firm may use its observation of an employee's output level when they are first employed as a guide to set performance standard and objectives for the future.[21] Knowing this, an employee may deliberately reduce their output level when first employed or hide their ability to produce at a higher output with the intent of exploiting being rewarded in the future when they strategically increase their output level.[21] Best performances of employees can be limited from it. Thus, the ratchet effect can significantly diminish production levels of a firm and planned economies.[22]

Additionally, since the 1970s psychologists begun exploring the role of motivators, whilst economist were simultaneously studying crowding out effects. This came as a result of Richard Titmus' 1970 publication 'The Gift Relationship', which explained how the constant use of extrinsic incentives can result in conflict with other motivators and lead to crowding out effects.[23] In his publication, Titmus argued that the use of monetary incentives was disrupting social norms around the idea of voluntary contribution and would ultimately have a crowing out effect. He acknowledged that if the incentives are large enough it is more likely to offset crowding out effects, but noted that making the incentives too large could also have an adverse effect and result in people not meeting expectations.[24] However, crowding out can still take place when incentives are removed over the long run. This is because the complete removal of incentives can result in employee effort levels being lower than when the incentives were offered thereby hindering motivation and performance.[25]

Incentives are not always effective at aligning employees' incentives with those of the firm.[26] For example, some corporate policies popular during the 1990s aimed to encourage productivity have led to failures as a result of unintended consequences.[27] Moreover, providing stock options was intended to boost CEO productivity through offering a remunerative incentive to align the CEOs' interests with those of the shareholders to improve company performance.[27] However, CEOs were found to either make good decisions which resulted in a reward of a long-term price increase of the stock, or were found to have fabricated the accounting information to give the illusion of economic success and to retain their incentive-based pay.[27] Furthermore, it has been found to be extremely costly for firms to incentivize CEOs with stock options. Nevertheless, firms are forced to pay substantial amounts of money to ensure that CEOs act in the best interest of the firms.[12]

Incentives can have a bipolar effect on the company. On the one hand, the company's incentives to employees may create a pay gap. For example, low-paid employees may reduce their production or contribution to the company. Low-paid employees and high-paid employees may not be able to communicate and cooperate effectively, causing low-paid employees to gradually lose their enthusiasm for work.[28] Firms should provide a fair amount of incentives for both low-paid and other employees, incentives for low-paid workers can be breaks rather than monetary incentives. Motivating employees with financial rewards may make a difference. That's because if the company is profitable in the first year, it may have plenty of bonuses to hand out to employees. However, if the company makes less money in the second year than it did in the first year, the company may not be able to give employees the same bonuses as in the first year even though they put in the same effort. This also reduces employees' motivation to work. Therefore, incentives may be counterproductive. Firm can provide other types of incentives rather than monetary incentives, such as promotion or vacation breaks for high-performing employees.

On the other hand, incentives have a positive effect on education. For example, students may underestimate their own learning ability. Incentives not only make teachers or parents pay more attention to students' abilities, but also encourage students to achieve good learning outcomes. However, it is worth noting that monetary incentives may not be positive. There may be bribery education in monetary incentives, and this monetary incentive is often contrary to morality.[25]

Teamwork is very important to the productivity of the company and will also serve as an incentive for the company. When firms encounter complex problems, the company effectively incentivizes employees' performance by establishing teams to communicate and collaborate with each other. In particular, when the abilities of employees form complementary forms, the company's incentive effect achieves a good performance. However, when companies reward individual achievement for work that is completed as part of a team, this creates conflict amongst team members and hinders their ability to cooperate productively in the future.[29]

Ultimately, there is always potential for conflicts to arise, both in the short and in the long run, during the application of incentives in different areas, as incentives that seek to change behaviours can cause crowding out on intrinsic motivators. Growing evidence suggests that economists must broaden their focus when exploring the effects of incentives as the effect they have is largely dependent on how they are designed and specifically how they interact with intrinsic and social motivators in the short run and the long run.[30]

See also

References
Look up incentive in Wiktionary, the free dictionary.
  1. Gneezy, Uri (2011). "When and Why Incentives (Don't) Work to Modify Behavior". Journal of Economic Perspectives. 25 (4): 191. doi:10.1257/jep.25.4.191.
  2. Gneezy, Uri; Meier, Stephan; Rey-Biel, Pedro (Fall 2011). "When and Why Incentives (Don't) Work to Modify Behavior". Journal of Economic Perspectives. 25 (4): 191. doi:10.1257/jep.25.4.191.
  3. Masterclass. "Understanding Incentives in Economics: 5 Common Types of Economic Incentives". Masterclass. Retrieved 2022-04-29.
  4. Li, Pamela (19 April 2019). "What is Intrinsic Motivation & How Does it Work?". Parenting for Brain. Retrieved 2022-04-29.
  5. Sennett, Phil (29 June 2021). "Understanding intrinsic and extrinsic motivation". University of Rochester. Retrieved 2022-04-29.
  6. Lazear, Edward. P; Shaw, Kathryn. L (2007). "Personnel Economics: The Economist's View of Human Resources" (PDF). Journal of Economic Perspectives. 21 (4): 91–114. doi:10.1257/jep.21.4.91.
  7. Behavioural Science Solutions. "Incentives". Behavioural Economics. Retrieved 2022-04-29.
  8. Callahan, David (2004). The cheating culture: Why more Americans are doing wrong to get ahead. Harcourt. ISBN 9780156030052.
  9. Dalkir, Kimiz (2011). Knowledge Management in Theory and Practice (Second ed.). The MIT Press. ISBN 9780262015080.
  10. Lazear, Edward P. (2018-08-01). "Compensation and Incentives in the Workplace". Journal of Economic Perspectives. 32 (3): 195–214. doi:10.1257/jep.32.3.195. ISSN 0895-3309. S2CID 158410132.
  11. Pokorny, Kathrin (2008-05-01). "Pay—but do not pay too much: An experimental study on the impact of incentives". Journal of Economic Behavior & Organization. 66 (2): 251–264. doi:10.1016/j.jebo.2006.03.007. ISSN 0167-2681.
  12. Neilson, William.S (2007). Personnel Economics. Pearson Education Inc. p. 11. ISBN 9780131488564.
  13. Arnold, R; Bartlett, S; Bernat, J; Colonna, J; Dafoe, D (2002). "Financial incentives for cadaver organ donation: an ethical reappraisal". Transplantation. 73 (8): 1361–1367. doi:10.1097/00007890-200204270-00034. PMID 11981440. S2CID 29823737.
  14. Pham, V (2021). "Cash, Funeral Benefits or Nothing at All: How to Incentivize Family Consent for Organ Donation" (PDF). Review of Behavioral Economics. 8 (2): 147–192. doi:10.1561/105.00000136. S2CID 237705443.
  15. Cassar, Lea; Meier, Stephan (2018-08-01). "Nonmonetary Incentives and the Implications of Work as a Source of Meaning". Journal of Economic Perspectives. 32 (3): 215–238. doi:10.1257/jep.32.3.215. ISSN 0895-3309. S2CID 52834710.
  16. Lazear, Edward P; Shaw, Kathryn L (2007). "Personnel Economics: The Economist's View of Human Resources" (PDF). The Journal of Economic Perspectives. American Economic Association. 21 (4): 91–114. doi:10.1257/jep.21.4.91. JSTOR 30033753.
  17. Prendergast, Canice (March 1999). "The Provision of Incentives in Firms". Journal of Economic Literature. 37 (1): 7.
  18. "LectAgent Problem" (PDF). Archived from the original (PDF) on 2015-11-23.
  19. Prendergast, Canice (March 1999). "The Provision of Incentives Within Firms". Journal of Economic Literature. 37 (1): 14–15.
  20. Bram Cadsby, C; Song, F; Tapon, F (April 2007). "Sorting and Incentive Effects of Pay for Performance: An Experimental Investigation". The Academy of Management Journal. 50 (2): 389–392.{{cite journal}}: CS1 maint: multiple names: authors list (link)
  21. Kanemoto, Yoshitsugu; MacLeod, W. Bentley (1992). "The Ratchet Effect and the Market for Secondhand Workers". Journal of Labor Economics. University of Chicago Press. 10 (1): 85–98. doi:10.1086/298279. JSTOR 2535130. S2CID 154244118.
  22. Cooper, David J.; Kagel, John H.; Lo, Wei; Gu, Qing Liang (1999). "Gaming against Managers in Incentive Systems: Experimental Results with Chinese Students and Chinese Managers" (PDF). The American Economic Review. 89 (4): 781–804. doi:10.1257/aer.89.4.781. ISSN 0002-8282. JSTOR 117159.
  23. Gneezy, Uri; Meier, Stephan; Rey-Biel, Pedro (Fall 2011). "When and Why Incentives (Don't) Work to Modify Behavior". Journal of Economic Perspectives. 25 (4): 192. doi:10.1257/jep.25.4.191.
  24. Ariely, Dan; Gneezy, Uri; Loewenstein, George; Mazar, Nina (2009). "Large Stakes and Big Mistakes" (PDF). The Review of Economic Studies. 76 (2): 451–469. doi:10.1111/j.1467-937X.2009.00534.x. Retrieved 3 May 2022.
  25. Gneezy, Uri; Meier, Stephan; Rey-Biel, Pedro (Fall 2011). "When and Why Incentives (Don't) Work to Modify Behavior". Journal of Economic Perspectives. 25 (4): 191–210. doi:10.1257/jep.25.4.191.
  26. Chiappori; Salanié (2003). M. Dewatripont; L. Hansen; S. Turnovsky (eds.). "Testing contract theory: a survey of some recent work" (PDF). Advances in Economics and Econometrics. Cambridge: Cambridge University Press. 1: 115–149. doi:10.1017/CBO9780511610240.005. ISBN 9780511610240. S2CID 3067063.
  27. Jain, Abha (2019). Sports Psychology. India: Friends Publications. p. 215. ISBN 978-93-88457-75-0.
  28. Breza, Emily; Kaur, Supreet; Shamdasani, Yogita (10 October 2017). "The Morale Effects of Pay Inequality*". The Quarterly Journal of Economics. 133 (2): 611–663. doi:10.1093/qje/qjx041.
  29. Lazear, Edward P; Shaw, Kathryn L (1 November 2007). "Personnel Economics: The Economist's View of Human Resources" (PDF). Journal of Economic Perspectives. 21 (4): 91–114. doi:10.1257/jep.21.4.91.
  30. Gneezy, Uri; Meier, Stephan; Rey-Biel, Pedro (Fall 2011). "When and Why Incentives (Don't) Work to Modify Behavior". Journal of Economic Perspectives. 25 (4): 206. doi:10.1257/jep.25.4.191.
This article is issued from Wikipedia. The text is licensed under Creative Commons - Attribution - Sharealike. Additional terms may apply for the media files.