Management of Organizations

Themes Session Topic

1 Introduction and Systems Thinking

Systems
2 Incentives and Motivation
3 Judgment and Decision Making
Skills and Self 4 Ethical Decision Making
Awareness 5 Leadership Dilemmas
6 Social Influence
7 Power and Managing Up
Challenges 8 Stereotyping in Organizations
9,10 Leading Change

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Session 2 Overview
Case Discussion
§ ICICI and other articles

The Economic Model

§ Pay for Performance

Alternatives to Contingent Rewards

§ Intrinsic Motivation

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Session 2 – Incentives and Motivation
LEFO – Kakkar
 Pay for Performance

Session 2 – Incentives and Motivation

LEFO – Kakkar
 The Economic Model
Two-part contract:

Compensation = a + bx

§ Fixed part: a = Salary

§ Variable part: b = Rate of Contingent Reward
§ E.g., piece rate, bonus, profit-sharing, options
§ Performance: x = f (effort)
§ Imperfectly correlated with effort
§ E.g., sales, stock price, manager’s evaluation

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Example Compensation Packages
90

CR only (a=0)
80
Compensation = a + bx
70
Compensation

60 Mixed

50

Salary only (b=0)

40

30

20

10

Poor Fair Good Great

Performance Outcome

Two key issues in evaluating compensation package:

Base pay and slope

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Fixed Pay vs. Contingent Reward
How much of a compensation package should
be contingent on performance?
Depends on the fundamental trade-off:
§ Motivation…
§ How much do extrinsic incentives increase effort?
§ …vs. Risk
§ What are the risk preferences of the principal and agent?
§ How much uncertainty is there in the system, and where
is it?

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Factors Influencing the Efficacy of CR
Observability Measurability
Can the organization Can the organization measure
observe the employee’s desired performance?
effort directly?

Firm Outcomes
Performance
Effort Profit
Measure
Compensation

Controllability Reliability
Do employees believe they can Do employees believe that there is
increase the output being a clear, consistent policy for
measured through their effort? translating measures into rewards?
Reduced by: Dependence on others, Reduced by: Discretionary rewards,
favoritism in evaluations, etc. changing formulas, etc.

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Contingent Reward Factors - Summary
Factor Rely more on CR if… Why
Observability of Employee CR is a substitute for
Effort is hard to observe
Effort direct monitoring
Measurability of Desired Desired output is Rewards are tied to what
Performance measurable you care about
Employees’ Perceptions of the
Effort translates directly
Controllability of what is Effort is less risky
into measures
being Measured
Employees’ Perceptions of the Compensation is tied
Effort is less risky
Firm’s Reliability directly to measurement

Additional Considerations: Rely less on CR if… Why

There are other reasons for Don’t need CR,
Intrinsic Motivation
working hard undermining
Employee is more risk
Risk Preferences Optimal risk sharing
averse than Management

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Compensation level affects selection
and retention
If not contingent (i.e., salary),
higher compensation increases
quality of applicant pool and
reduces rate of turnover (no
outside option)

Total Compensation
Poor Fair Good Great
Performance

Session 2 – Incentives and Motivation

LEFO – Kakkar
Compensation slope affects selection
and retention
Before performance, level is an
expected value (to the
employee) based on the
employee’s expected

Total Compensation
performance

Beliefs about control matter

(e.g., optimism, confidence)

Steepness of slope affects the

type (e.g., confident and/or
risk-tolerant) of employee Poor Fair Good Great
Performance
selected and retained

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Pay for Performance Summary
When does pay-for-performance work well
§ Individual’s Perspective
§ Strong link between effort, performance, & compensation
v Relative independence
v Stability of rates
v Transparent and egalitarian culture
§ Organization’s Perspective
§ Strong link between performance and outcomes
v Bonus measures quality, cooperation, etc.
§ Employees are more productive
v Piece rate motivates effort
v Selected for ability and risk tolerance

Session 2 – Incentives and Motivation

LEFO – Kakkar
 P4P Incentives in Action
In New Mexico, an
incentive program
designed to cut down
on overtime offered
garbage truck drivers
the opportunity to
get paid for 8 hours
work even if they
finished their routes
in, say, five hours.

The consequences?

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Unintended Effects of Incentives
The consequences?

§ Increased traffic
accidents
§ Many trucks were
over the weight limit
§ A lower % of garbage
was collected

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Targets as Motivators

Session 2 – Incentives and Motivation

LEFO – Kakkar
Who will do more? Psychological
PROBLEM 1
Principle
Amy and Barbara just joined a company as
new sales reps. The average new rep makes
Provides target,
20 sales in first month. sense of
• Amy is told: “Do your best” satisfaction
• Barbara is told: “Your goal is 30”

PROBLEM 2
Jeff and Bill are doing sit-ups. Each has
finished 35 so far and they are equally Loss aversion –
exhausted. motivating to
• Jeff’s goal: 31 eliminate a loss
• Bill’s goal: 39

PROBLEM 3
Jill and Tina are preparing for a financial
certification exam in two months. There are Distance effect –
600 practice questions. Each has worked on
12 practice problems the first night and problems when
feels exhausted. too far above or
• Jill’s goal: 600 in 2 months below
• Tina’s goal: 10 per night
Session 2 – Incentives and Motivation
LEFO – Kakkar
 Use of Goals to Motivate
“Mere” goals i.e. No pay tied to achieving goal
§ Specific goal is more motivating than do your best goal?
§ Psychologically provides target, sense of satisfaction
§ Distance effect – problems when too far above or below goal
§ Loss aversion – motivating to eliminate a loss (which is painful)

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Tying Pay to Targets
§ A discrete bonus is tied to a specific level of
performance
§ E.g., a sales target of 20 sales per month earns you a
$1,000 bonus

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Obstacles to Contingent Reward
• Inflated perceptions of contribution
• Process perceived as unfair
• Cultural Context

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Inflated Perceptions of Contribution
Participants: 40 Married Couples (answering separately)
Question: “What is the extent of your responsibility for each of the
following activities?”
§ Cleaning dishes 0 – 100%
§ Shopping for groceries 0 – 100%
§ Keeping in touch with relatives 0 – 100%
§ Mowing the lawn 0 – 100%
§ …Etc.

§ For 80% of the items, the average couple gave a sum greater than
100%

§ Couples were then asked to write down examples of their own

contribution and their spouse’s contribution for each activity
§ Number listed for self = 10.9
§ Number listed for spouse = 8.1
(Ross & Sicoly)

Session 2 – Incentives and Motivation

LEFO – Kakkar
Determinants of Fairness Perceptions
Distributive Fairness
§ Were the outcomes allocated fairly?
§ Different distribution rules:
§ Outcomes are distributed in proportion to contribution
§ Outcomes are distributed in proportion to need
§ Outcomes are distributed equally
§ Obstacle: Self-serving interpretations of a) which
rule should apply, b) level of contributions or
needs, and c) weight on different contributions
§ Reward = w1 (x1) + w2 (x2) + w3 (x3) …

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Session 2 – Incentives and Motivation
LEFO – Kakkar
Determinants of Fairness Perceptions
Procedural Fairness
§ Was the allocation process fair?
§ Characteristics of a fair process:
§ Participation or “voice” of those affected by decision
§ Impartiality of decision maker
§ Transparency of decision process
§ Why do people want fair procedures?
§ People believe it yields more accurate outcomes
§ It is also an important signal of respect
§ The fair process “cushion”

Session 2 – Incentives and Motivation

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 The Fair Process Cushion
Fair procedures make unfavorable distributions more acceptable
1

Favorable Outcome Unfavorable Outcome

0.9

0.8
Satisfaction With Outcome

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0
Unfair Fair
Procedure

LEFO – Kakkar Typical pattern over dozens of studies Session 2 – Incentives and Motivation
 Alternatives to Contingent Reward

Session 2 – Incentives and Motivation

LEFO – Kakkar
 SAS

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Session 2 – Incentives and Motivation
LEFO – Kakkar
 A Low CR Company: SAS (Cary, NC)
Nature of compensation and
Nature of work and worker
other “rewards”
• Development of new products • Located in North Carolina
is highly interdependent • Mainly salary—roughly market
(team based) and takes 2 to 3 • No stock options (compare to
years Silicon Valley)
• Programmers • No formal evaluation process;
• Playing with cutting edge there is regular feedback
technology to build cutting • Benefits—well above market
edge technology
• Health care, day care, elder
• Writing code care, health club, campus
• Programmers meet with SAS
User Groups during the year—
what’s good and what’s bad
about SAS products

Session 2 – Incentives and Motivation

LEFO – Kakkar
 SAS Compensation Scheme

1) What are the biggest differences between SAS and Lincoln Electric in
terms of how incentives and motivation are managed?

2) What are the advantages and disadvantages of the current SAS

compensation scheme, and what would be the advantages and
disadvantages be of a PFP scheme? Consider the implications of this
incentive change for motivation and performance, and for the selection
and retention of SAS employees.

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Alternatives to Contingent Rewards
What else do employees care about?
§ Social Motivation
§ Respect/Status within company
§ Group Acceptance
§ Competition with other companies
§ Intrinsic Motivation
§ Internal drive to perform well
§ Inherent motivation to do the task itself

Session 2 – Incentives and Motivation

LEFO – Kakkar
So how can businesses tap into these other
motivations?

To increase intrinsic motivation, consider the

design of the work itself

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Alternatives to Contingent Rewards
What else do workers care about?
§ Intrinsic Motivation
§ Meaningfulness
v Skill variety (use different skills in work)
v Task identity (see whole process, final product)
v Task significance (create a product that benefits users)
§ Responsibility
v Autonomy
§ Knowledge of results
v Feedback
§ Social needs can also lead to intrinsic motivation
§ Respect/Status
§ Group Acceptance

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Task significance in university fundraisers
Pre Post
600
Field experiment
500
(3 conditions):
• Control
Amount raised

400 no intervention
• Letter
300 read letter from
previous employee
200 • Meeting
met the scholarship
recipient and asked
100
questions

0
Control Letter Meeting

(Grant et al., 2007)

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Most jobs require extrinsic and
intrinsic motivation, which is tricky…

Can you Create Extrinsic and

Intrinsic Motivation at the Same
Time?

Session 2 – Incentives and Motivation

LEFO – Kakkar
 “Undermining” Study
Adults taking an IQ test (like SAT)

Receive a payment of $20 for participating

Four conditions
§ No pay for solving IQ questions
§ 3 cents per correct answer
§ 30 cents per correct answer
§ 90 cents per correct answer

Must stay until end of experiment to be paid

Session 2 – Incentives and Motivation
LEFO – Kakkar
 Pay-Performance Relationship
Undermining Study (IQ Questions)

40
# Correct (of 50)

34.7 34.1
35

30 28.4

25

20
?23.1

$0.00 $0.03 $0.30 $0.90

Pay per Correct Answer

Session 2 – Incentives and Motivation

LEFO – Kakkar
 How do incentives affect later motivation?
Preschoolers drew pictures with magic markers
§ Randomly assigned to one of three conditions
§ No reward
§ Expected “Good player reward”
§ Received unexpected “Good player reward”

How much time did they spend drawing next time

they had the chance?

(Lepper, Greene, & Nisbett)

Session 2 – Incentives and Motivation

LEFO – Kakkar
A Doctor’s Reflections

Despite my conscious disagreement with many of the values

assigned by price, I noticed that surgery, procedures, hospital
admissions, and emergency-room work slowly became a more and
more important part of my practice.
Dealing with emotionally hurting patients, taking time to educate
patients about the course of their disease and the nature of their
treatment, even obtaining a comprehensive medical history, became
less central.
Not that I consciously changed my routines; but money had
powerful ways of bending my perceptions… It is not an exaggeration
to say that money seeped into every crack in my life…

From Barry Schwartz, Why We Work, 2015

Session 2 – Incentives and Motivation

LEFO – Kakkar
 How Extrinsic Can Hurt Intrinsic
Pay can affect the “attributions” or explanations people
use to understand their reason for working
§ Signals that a task must be “work,” not “interesting”—
otherwise, why would you need to pay me for it?
§ Signals that employer doesn’t trust work to be carried out
without incentive
§ Shifts thinking to narrow benefit-cost calculations—”what’s in
it for me?”

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Rewards and Motivation
Extrinsic rewards change behavior
§ The good and bad news is… you get what you pay for.
§ LE illustrates practices necessary when using powerful
extrinsic rewards in organizational settings

Extrinsic rewards are often insufficient for

organizational goals
§ Scarcity of adequate performance measures
§ Need a balance between individual motivation and
coordination/cooperation with others
§ Can’t write a “complete” contract, e.g., extra-role
tasks
Session 2 – Incentives and Motivation
LEFO – Kakkar
 Why Intrinsic Motivation Matters

In the absence of Intrinsic motivation

Intrinsic motivation
extrinsic motivation, creates enthusiasm,
predicts “extra-role”
organizations must rely excitement for work and
behavior
on intrinsic motivation for the organization
• Intrinsic motivation is • “going above and
perfectly suited to “fill in beyond the call of duty”
the gaps” when you • i.e., doing work that is
can’t measure and not in job description,
monitor such as doing one’s job
more creatively, helping
others, cooperation

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 DISCERNING SAINTS

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 MOTIVATION PURITY BIAS

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 Session 2 – Incentives and Motivation
LEFO – Kakkar
 MOTIVATION PURITY BIAS - IMPLICATIONS
As a job candidate avoid talking about
salary/bonuses until the other party asks for it or
you have an offer in hand

As a recruiter be aware of this bias

Session 2 – Incentives and Motivation

LEFO – Kakkar
 Session 2 Takeaways
1) Pay for Performance (PFP) shifts risk to employees. Because employees
are typically risk-averse, the extra incentive doesn’t come for free.

2) Imperfect links between effort, measurement, and compensation

decrease the effectiveness of PFP.

3) You get what you pay for – which makes life tricky if you need more
than one thing or measure the wrong thing.

4) You can use fair procedures to cushion the blow of unfavorable

distributions.

5) Your business can use intrinsic motivation as a substitute for extrinsic

rewards. Intrinsic is especially important if the things you desire cannot
easily be measured.

6) Beware the message you send with extrinsic rewards—you don’t want
to undermine intrinsic motivation.

Session 2 – Incentives and Motivation

LEFO – Kakkar