A customer support centre for a telecoms provider introduces a monthly bonus. Agents who close an average of more than twelve tickets an hour receive an extra 8% of salary. In the first month, tickets closed per hour rise by a fifth. The operations director circulates a chart.
By the third month the chart looks even better and everything else looks worse. Repeat contacts have risen, because agents are closing tickets before problems are solved. Complex cases are being transferred between queues, since nobody wants a forty-minute call. Two experienced agents who used to coach newer colleagues have stopped. A customer complaint that reaches the regulator turns out to have been “closed” five times. The agents are not lazy or dishonest. They are doing, with great efficiency, exactly what the company announced it would pay for.
Few ideas in management are as intuitive as paying people more for doing more. And few have such a mixed record. Incentives do change behaviour, which is the problem as often as it is the point: people respond to what is measured and rewarded, and that is seldom the whole of what the employer wants.
This guide sets out what psychology and economics have found about bonuses: where they work, the main ways they fail and how to design them with the failure modes in mind.
Incentives work, on what is measured.
Simple bonuses raise output for individual, countable tasks and distort multi-dimensional ones.
Rewards can crowd out interest.
Controlling rewards for work people find engaging can reduce their own motivation to do it.
Design against gaming.
Pair quantity with quality, avoid cliff-edge targets and pilot first.
Do bonuses work at all?
Yes, for the right kind of work. The clearest case is a study of a car windscreen installer.
When Safelite Glass moved its installers from hourly pay to pay per windscreen fitted, output per worker rose by about 44%. Roughly half the gain came from existing workers producing more; the rest came from more productive workers joining and less productive ones leaving.
The conditions were ideal. The task was done by one person. The output was easy to count. Quality was checkable, and the company made installers redo faulty work unpaid. When those conditions hold, piece rates and simple bonuses raise output substantially.
The trouble is that the conditions rarely hold in modern jobs. Most work is done in teams, has several dimensions, and has results that are partly luck and only visible months later. Take a simple bonus into that setting and the side effects begin.
What is the multitasking problem?
Economists Bengt Holmström and Paul Milgrom showed formally in 1991 what the support centre discovered in practice. When a job has several dimensions and only some can be measured, rewarding the measurable ones pulls effort away from the others. Pay teachers for test scores and they teach to the test. Pay agents for tickets closed and they close tickets.
A social scientist, Donald Campbell, put the general point memorably: the more a quantitative indicator is used for decisions, the more it will be subject to corruption pressures and the more it will distort the process it was meant to monitor. A related maxim, Goodhart’s law, says that a measure which becomes a target ceases to be a good measure.
People are ingenious at hitting numbers. If the number and the purpose can come apart, a strong enough incentive will pull them apart. This is not a character flaw in employees. It is a predictable response to the system.
The best-known corporate example is Wells Fargo, where aggressive sales targets for the number of products per customer were followed by the opening of millions of accounts without customers’ authorisation, a scandal that became public in 2016 and cost the bank billions in penalties.
Can rewards reduce motivation?
For tasks people find interesting, they can. This is one of the most studied and most argued-over findings in psychology.
In early experiments, students paid to solve puzzles spent less free time on them afterwards than students who had not been paid. A later meta-analysis of 128 experiments concluded that tangible rewards made contingent on doing or completing a task reliably reduced subsequent intrinsic motivation, while unexpected rewards and positive feedback did not.
The explanation offered by self-determination theory is that people have a need to feel that their actions are their own. A reward that feels controlling shifts the reason for doing the work from “I want to” to “I’m paid to”, and when the payment stops, so does the effort. Psychologists call this the overjustification or crowding-out effect.
Economists have found similar patterns outside the laboratory.
In one study, students collecting charity donations who were paid a small commission collected less than those paid nothing. In another, day-care centres that introduced a fine for late pick-ups saw lateness increase: the fine converted a moral obligation into a price that parents were willing to pay.
The lesson is not that money demotivates. It is that introducing a price changes the meaning of an activity, and small or clumsy incentives can displace better motives without supplying enough of their own. The authors’ summary was to pay enough or not pay at all.
Do big bonuses improve performance on complex work?
Not reliably. High stakes can impair performance on tasks that need thought. In experiments run in rural India by Dan Ariely and colleagues, where the researchers could afford to offer bonuses worth months of income, participants offered the largest rewards generally performed worse on tasks requiring concentration and creativity. The pattern is familiar from sport: pressure narrows attention and makes skilled people clumsy.
Large bonuses also change what people attend to. A year dominated by a personal target is a year spent on the target, sometimes at the expense of colleagues, long-term projects and candour about risk.
What about goals attached to bonuses?
Goal-setting is among the best-supported techniques in work psychology. Decades of research by Edwin Locke and Gary Latham show that specific, difficult goals produce higher performance than vague ones. Tie a large payment to hitting a goal, however, and new problems appear.
| Side effect | What happens | Example |
|---|---|---|
| Narrow focus | Anything outside the goal is neglected | Quality, safety, helping colleagues |
| Sandbagging | People negotiate easy targets or hold back results | Deals pushed into next quarter |
| Threshold effects | Effort drops once the target is hit or clearly out of reach | The “coasting” December |
| Misreporting | Figures are stretched when the target is narrowly missed | Channel stuffing, premature closure |
| Risk-taking | People take long shots to reach an all-or-nothing payout | Mis-selling |
A widely cited paper, “Goals Gone Wild” by Lisa Ordóñez and colleagues, argued that these side effects are systematic and under-appreciated. Locke and Latham replied that the answer is better goal design, not fewer goals. Both camps agree on the practical point: a cliff-edge bonus for a single number is the riskiest design.
How does loss aversion affect bonuses?
Because people feel losses more than equivalent gains, a bonus framed as something to lose can be more powerful than the same bonus framed as something to win. In a field experiment with teachers in Chicago Heights, Roland Fryer and colleagues found that teachers given a bonus in advance, to be repaid if their students missed targets, produced larger gains in student results than teachers promised the same bonus at the end of the year.
The same mechanism works against employers. A bonus paid for several years stops being a bonus in the recipient’s mind. It becomes part of pay, and a year without it is experienced as a pay cut. Morale after a missed bonus is often worse than if the scheme had never existed. This entitlement effect is one reason to be cautious about making variable pay a large share of the total for roles where results swing with the market.
“Clawback” or loss-framed bonuses can raise effort, but they also raise anxiety and the temptation to cheat, and in many jurisdictions deductions from pay are tightly regulated. Take legal advice before copying the experiment.
Individual, team or company bonuses?
Each solves one problem and creates another.
| Type | Strength | Weakness |
|---|---|---|
| Individual | Clear line from effort to reward | Undermines cooperation; invites gaming |
| Team | Rewards helping and shared goals | Free-riding; strong performers feel they carry others |
| Company-wide (profit share) | Aligns everyone with overall results; low conflict | Weak link to any one person’s effort |
Studies of profit-sharing and employee ownership generally find modest positive effects on productivity, which seems surprising given how little any individual can affect company profit. The likely explanation is social: when everyone shares the result, colleagues monitor and encourage one another, and the scheme signals that the firm shares its success.
For interdependent work, the usual advice is to lean toward team and company schemes, keep individual variable pay modest and rely on promotion and base pay to recognise sustained individual contribution.
How should a bonus scheme be designed?
With its failure modes written down in advance.
Pair every quantity measure with a quality measure. Tickets closed and repeat-contact rate. Sales and cancellations.
Avoid cliffs. A payout that rises smoothly with results removes the incentive to manipulate around a threshold.
Keep it simple enough to explain. If people cannot work out what they will earn, the scheme cannot motivate them.
Leave room for judgment. A discretionary element lets managers adjust for luck and for behaviour the metrics miss. It requires managers whom people trust to be fair, which is the subject of our guide to organisational justice.
Use recognition as well as cash. Unexpected, specific appreciation does not carry the crowding-out risk and costs little.
Before launching a scheme, ask the team: “If you wanted to maximise this bonus and did not care about anything else, what would you do?” They will tell you within five minutes what would otherwise take three months of data to reveal.
The support centre replaced its bonus with one based on tickets resolved without a repeat contact within seven days, measured for the team, with a smaller individual element for customer ratings. Tickets closed per hour fell back by a tenth. Repeat contacts fell by a third, and the two experienced agents started coaching again. As with pay rises, the money mattered less than what it told people the company valued.
Frequently asked questions
Do bonuses actually motivate employees?
They reliably increase effort on whatever is rewarded. For simple, individually measurable work this raises performance. For complex or collaborative work, they can shift effort away from unmeasured parts of the job, encourage gaming and reduce cooperation.
Why do bonuses sometimes reduce motivation?
Experiments show that rewards perceived as controlling can undermine people’s intrinsic interest in a task, so that effort falls when the reward is removed. Small payments can also replace social or moral motives with a weak financial one.
Are team bonuses better than individual bonuses?
For work that depends on cooperation, team or company-wide schemes usually cause fewer problems, though they risk free-riding. Many organisations combine a team or company element with a small individual element and use base pay and promotion to reward individual contribution.
What is the biggest mistake in bonus design?
Tying a large, all-or-nothing payout to a single number. It concentrates effort on that number, creates pressure to manipulate results near the threshold and ignores everything the number does not capture.
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