Introduction

Variable pay for performance may undermine employees’ efforts: Rewards crowd out intrinsic motivation under identified conditions. A bonus system then makes employees lose interest in the immediate goal. Moreover, monetary incentives in complex and novel tasks tend to produce stereotyped repetition, and measurement is often dysfunctional. Therefore intrinsic motivation is crucial for these tasks. However, for some work extrinsic incentives are sufficient. We offer a framework of how managers can achieve the right balance between intrinsic and extrinsic motivation.

Variable pay for performance and motivation

Variable pay for performance has become a fashionable proposal over recent years in private companies as well as in the public sector. Many firms have given up fixed salaries and have adopted performance-related pay. Firms try to match payment to objectively evaluated performance. It is reflected in such popular concepts as stock options for managers and various types of bonuses. In the public sector, efforts to raise productivity in the wake of New Public Management have also resulted in attempts to variably adjust the compensation of public employees to their performance. This means that firms and public administrations increasingly rely on price incentives, i. e. on extrinsic motivations.

We argue in this contribution that variable pay for performance under certain conditions has severe limits. In situations of incomplete contracts – and these dominate work relationships – an incentive system based only on monetary compensation of work is insufficient to bring forth the performance required. In many situations monetary incentives even reduce performance. Work valued by the employee for its own sake or by fulfilling personal or social norms is often indispensable. These values or norms may be undermined or even destroyed by offering monetary incentives.