Understanding How Pay Motivates Humans

A few weeks back we discussed Money vs. Happiness, which is a key concept when it comes to compensation. Pay for performance continues to be a key issue for HR professionals and we will be doing a three part series with David Creelman on pay for performance over the course of the next two weeks. Today, we’ll look at how pay motivates humans and how the “mechanical model” of compensation just doesn’t work.

Pay for performance can be considered both the management of salary increments and that of bonuses. Pay may be based on individual, group or company performance – or a combination of all three.

There is extensive literature that is critical of pay for performance. The main reason for this criticism is that advocates of pay for performance have too often had a mechanical view of human nature. There is some truth to this; people can be motivated in simple, mechanical ways by pay. However, on the whole the mechanical model does not accurately predict how people will react to pay for performance. We need to approach pay as a psychological and social phenomenon if we are to boost performance. It is this more sophisticated approach that gives us reason to believe pay for performance can work at last.

How will someone react to a $900,000 bonus? Will they be highly motivated or quit in anger? Dr. Gary Latham, a professor at the Rotman School of Business in Toronto, explains that it all depends on the circumstances. In a real case, an investment banker, while admitting that $900,000 was lot of money, still quit in anger because it felt like a slap in the face – he couldn’t understand why they held his bonus just short of seven figures.

Or take the case of a team of five employees, one of whom gets an excellent bonus based on her performance. How does this work out from the company’s perspective? Perhaps not very well. The employee with the bonus may be motivated, but the other four may be angry and reduce their efforts.

How people react to pay depends not on the amount, nor on the design of the plan, but on how they interpret what it means. Success in pay for performance requires managers to spend a lot of time with their teams making sure pay is sending the right message. That’s the secret of success, not fiddling with the design.

On Friday we’ll look at how to approach pay from a non-mechanical perspective.