There is a wealth of research indicating that employees and managers will alter their behavior based on the incentive system in place for that behavior. Self-evident, no? We do what we need to do to get rewarded. Very recent research by Shawn Cole, Martin Kanz and Leora Klapper, however, indicates that this is not as easily understood as it first seems. Not only do we alter our behavior to fit the incentive, we apparently alter our view of performance based on the type of incentive we receive!
In a study of loan officers, Cole and his colleagues found that origination incentives (simply receiving a bonus for originating a loan) resulted in a 16 percent increase in lending compared with a high-powered incentive (bonus based on loan performance) and reduced profitability of 5 percent. On the other hand, when the incentive was tied to loan performance, the detection of bad loans increased by 11 percent, boosting profitability by 3 percent.
Here’s the real dilemma. Timing of incentives also impacts effort, e.g. if the incentive is paid relatively immediately, people will put more effort into the process than when the incentive is delayed. We tend to overvalue incentives today versus 90 days from now which means that basing incentives on longterm performance may have an upside in quality of work, but only to the extent that the downside of delayed gratification doesn’t get in the way.
What does this mean to you? First, look at the structure of your incentive program and see if you are incentivizing the low end (origination) or the high end (long term performance). If your incentives are based entirely on the origination side (sign-ups, enrollments, clicks), then it is likely that your people are over-estimating the value of each origination. If your incentives are based on the higher end, then you need to make sure that the incentive itself is worth waiting for. Keeping the incentive the same, but changing the payout to later versus now, will not work. The incentive down the road has to be worth the extra effort.