The Psychology of the Bonus

President Obama called them “obscene”. Gordon Brown, when Prime Minister, said he was very angry with them. David Cameron demanded some be capped at £2,000. The payment of six- and seven-figure bonuses led to an open season on bankers following the collapse of major Wall Street and City of London institutions, stock markets tumbling and governments stumping up $1.6 trillion to prevent global meltdown.

The debate, such as it is, has focused almost exclusively on ethics, with few addressing whether bonuses actually do what they are designed to achieve. “The press gets very giddy about bonus size and culture,” says Barbara Stcherbatcheff, a former derivatives consultant who in 2009 published an insider account called Confessions of a Citygirl. “People get jealous about individuals getting seven-figure bonuses, but there is little intelligent discussion.”

At first glance, the answer may seem so obvious that even asking the question can appear absurd and, while thousands of column inches have been filled with rhetoric and criticism over the last three years, performance-related schemes are in fact becoming more common in  areas including healthcare, public services and teaching.

“Economists and workplace consultants regard it as almost unquestioned dogma that people are motivated by rewards, so they don’t feel the need to test it,” says American teacher-turned-writer Alfie Kohn. “It  has the status more of religious truth  than scientific hypothesis.”

No one disputes that bonuses help companies attract and retain high quality staff, or that they can be used to encourage employees to do short-term specific tasks. What is open to discussion is their long-term effect on performance. In fact, there is a large and growing body of evidence suggesting that, at least in some circumstances, paying people for results can have the opposite effect and undermine their performance. Early work promoting this perspective was carried out by psychologist Professor Edward Deci of the University of Rochester, in New York State. 

In 1971, he asked students to solve puzzles, with only some offered cash prizes for doing well. He found those who were paid less were likely to continue working on the puzzles after they had done enough to get paid. In other experiments children, aged three to five, were asked to draw. Only some were told they would receive ribbons as prizes for doing so, and did so. These children were less likely to choose drawing when they were later given a free choice of activities.

A ‘do-this-and-get-that’ approach turns play into work and work into drudgery, and undermines creativity, collaboration and responsibility, Kohn argues. He says people often fail to distinguish between wanting to do something because you like it in its  own right and doing something  because you want the reward. 

“It’s not just that these two are different, it’s that they are often inversely related. The more you reward people for doing something, the more their intrinsic motivation tends to decline,” he says. 

So do bigger bonuses lead to better results when people have no intrinsic motivation? Professor Dan Ariely of Duke University in Durham, North Carolina recruited Indian villagers to do creativity, memory and motor skill tests. Different groups were offered four, 40 or 400 rupees for achieving high scores in each of them. The maximum reward was equivalent to five months’ local average spending. Those offered 400 rupees earned just 20% of the maximum possible on average compared with around 36% for those offered the lower sums. 

Professor Ariely then offered 24 American students cash rewards if they performed well in maths and repetitive key-pressing tasks. Some were offered from $15 to $30, others from $150 to $300. For key-pressing, the higher rewards led to a better performance, but in the maths task, they appeared to do the opposite. 

Prof Ariely concluded that bigger bonuses can boost the performance for simple manual labour, but not for mentally challenging work. Sports psychologists call this failure to performunder pressure ‘choking’. Dr Sian Beilock, a psychologist at the University of Chicago, author of the 2010 book Choke, has carried out tests showing how expert golfers perform worse when asked to think about aspects of their putting. 

“When people are doing demanding tasks in stressful situations, the working memory system in the pre-frontal cortex malfunctions,” she explains. “Basically, they think too much and fail to go with their gut instincts.”

Some suggest that reaching conclusions about banking based on giving ribbons to children for drawing is overly simplistic. “Bankers and brokers are full of testosterone, full of adrenalin and fiercely competitive,” says David Buik, who has worked in the City for 45 years and is now with inter-dealer broker BGC Partners. “Without the financial incentives there would be no need to be competitive. 

Psychologists may have done plenty of research on this but they’re making generalisations that don’t necessarily apply in the City.” 

Professor Malcolm Higgs, of the School of Management, University of Southampton, focuses on individuals’ internal value systems, and, based on earlier research, divides people into three categories. Those known as ‘sustenance-driven’ seek order, a sense of belonging and safety; ‘inner-directed’ individuals tend to focus on the universal good, knowledge, self development and having autonomy; while the ‘outer-directed’ value recognition, achievement and power most highly.

“I would bet that people who work in roles with highly-leveraged bonus schemes, such as traders, would pretty much all be outer-directed,” says Professor Higgs. “With outer-driven people, bonuses can be very effective, because a big bonus is a public recognition that you are doing better than others. Sustenance-driven individuals find bonus plans disturbing and prefer regular, understood base pay, while those in vocational jobs are  inner-driven and are unlikely to be motivated by bonuses.” Of course, stimulating motivation is not the same as improving performance. 

“I have spoken to people who work from 9am to 2am every day and 7am until 8pm at weekends, doing 100–110 hours per week,” says Joris Luyendijk, an anthropologist currently publishing the anonymous interviews he is carrying out with people in banking online. “Yet many say they spend a lot of time on Facebook or doing other useless stuff. They are highly motivated only to appear to be a very hard-working employee.” 

Professor Higgs’s emphasis on how values influence motivation does seem more nuanced than some other analyses. He also believes that the way bonuses are designed determines whether they boost individual performance. “A bad bonus system will encourage people to take risks in the short term. Effective bonuses are related to the things that drive overall business performance. It also doesn’t make sense to give people annual bonuses if you don’t know the outcome of their decisions and work for three years.” 

In broad terms, it seems bonuses can boost performance for people who care a lot about status and public recognition if schemes are designed to align the interests of employees with the long-term interests of the company.

Perhaps the last word on how not to design bonus schemes should go to someone who received large bonuses. Geraint Anderson, square mile regular, worked for four City of London banks over 12 years before leaving to write his insider account Citybo
y: Beer and Loathing in the Square Mile. Like many analysts, Anderson’s bonuses depended partly on external client surveys. He says his last two bonuses were £500,000 each. 

“Bonuses can incentivise criminal behaviour such as insider trading and market manipulation by spreading false rumours, as well as short-term, reckless gambling,” he says. “If you can steal your colleagues’ thunder, claim the credit for their work, blow your own trumpet and kiss your boss’s arse, you can boost your bonus.” 

His tactic was to take clients to Michelin-starred restaurants and strip clubs in the run-up to the survey votes. “It goes on all the time, but I was particularly good at it. Clients would say, ‘we could give you and your bank a commission or we can vote for you in the survey’. I chose the option that brought me self-aggrandisement and a bigger bonus.”