From the June 2013 issue of Investment Advisor • Subscribe!

May 28, 2013

Do Incentives Really Motivate People?

Think about your desired outcome before throwing more money at unhappy people

I get a twisted kind of pleasure when good arguments cause me to reconsider my long-held beliefs. The recent book by Clayton Christensen, “How Will You Measure Your Life?” spurred such a transformation.

Based on a speech he gave to Harvard Business School’s graduating class in 2010, Christensen’s book observes that although many business people seem to be wildly successful, their lives do not appear to bring them happiness. This truth reminds me of one of my favorite one-liners, attributed to Confucius: “Choose a job that you love and you’ll never work a day in your life.”

Christensen’s book did not give me pause until I reached the chapter on motivation and incentives. He cited an influential study from the 1970s about incentive theory, the idea that people work in accordance with how you pay them. The authors of the study, Professors William Meckling and Michael Jensen, asked why managers don’t always act in the best interest of shareholders. They concluded that the solution to this contradiction was to “create financial incentives that are aligned with the behavior you seek.” Their solution seems so intuitive that many companies have used this reasoning to issue awards ostensibly designed to make shareholders and executives happy.

According to Christensen, Meckling and Jensen’s theory on incentives has been widely applied to all types of businesses, including financial services firms. The incentive theory says that when you want to convince others to do one thing over another, you just need to pay them in order to “motivate them.” Of course, many of the companies that have ­utilized this strategy, including Bear Stearns and Lehman Brothers, no longer exist.

Christensen holds a contrary view to Meckling and Jensen. He noted that some of the hardest working people are employed in nonprofits and charitable organizations. Despite working in challenging and uncomfortable environments, such as war zones and areas devastated by drought, disease and natural disasters, you almost never hear complaints about motivating people who work for these organizations. Christensen gives other examples of modestly-compensated jobs that attract people who are driven to excel including teachers, social workers, military personnel and clergy (though the latter may be banking on the ultimate reward).

He argued that hiring motivated people, matching them to the right jobs and eliminating distractions will produce the desired outcome regardless of whether you pay them more for their results. He also stated that compensation itself can be one of those distractions if it is not competitive, fairly distributed and well-designed. Money itself is not necessarily a motivator.

To make his point, Christensen referenced motivation theory, the idea that people do things because they want to, not because they get paid to. Motivation theory distinguishes between “hygiene factors” and “motivation factors.”

Examples of hygiene factors include status, job security, work conditions and even compensation. Unsatisfactory hygiene factors can cause people to become dissatisfied. Interestingly Christensen does not regard compensation as a motivation factor, but rather a hygiene factor.

Motivation factors include challenging work, recognition, responsibility and personal growth. Motivated people don’t require external pressures or incentives because they are driven by what’s inside them and by the excitement and challenge of their work. What they do require is an environment in which they can grow, be intellectually stimulated and enjoy the appreciation of their peers and superiors.

That’s not to say that money doesn’t influence behavior. Clearly money can motivate people, at least in the short term. The question is whether the reward yields the behavior you seek or if it produces the opposite result. For example, if a large percentage of an advisor’s income is tied to new business growth or increased profits, will he take shortcuts, bring in clients who are not optimal, defer investments that will benefit the firm long-term, take excessive risks or act outside of a team environment in order to hog the rewards? Or will the pressure to perform in jobs he doesn’t enjoy yield an unhappy, abusive and resentful employee or manager?

Natural business developers wake up every morning with a fierce desire to win and an even stronger fear of losing. Money is a driver, clearly, but so is their competitive DNA. While some non-salespeople can perform well for a short time, they are not able to sustain high performance for long periods if they lack a passion for this type of work. It’s no coincidence that financial services has been shifting away from the ultimate short-term reward—commission—while client advocates paid on a fee basis are growing their businesses exponentially.

Business development is not the only area in which advisory firms use money to motivate people. Firms commonly create bonus plans for all roles tied to firm profitability. Inevitably, however, the rank-and-file complain that they can’t impact profitability directly because they don’t control spending, decide which investments to make or generate new clients.

Money is not an effective substitute for active management. Building an understanding of each person’s role and offering meaningful work contributes to improved productivity, a better client experience and a dynamic and growing workplace. Employee rewards include sharing in the success of the enterprise and achieving personal growth goals. Financial incentives by themselves will not make employees work harder, smarter or faster. If you doubt this argument, just consider what drives you to accomplish what you have.

The key to creating a dynamic business is to match people to the right jobs and to create an environment in which motivated people will flourish. It’s also critical to incorporate a performance management process that is applied regularly and systematically, as well as in difficult situations that invite teaching moments. Measuring an employee’s effectiveness helps to sustain their focus.

Take a look at these five areas of performance: financial contribution, leadership, risk management, people development and client service. Define excellence in each of these categories, and align both rewards and recognition with the targeted goals. These measures foster engaged, satisfied employees who are more productive and happy in the near term and more likely to stay with the firm to continue their careers.

This subtle approach separates hygiene factors—the elements that can minimize distractions to associates—and the motivation factors that drive behavior change. When people perform well, managers gain an opportunity to increase their responsibilities, challenge them more and even promote them to new positions. Management is an art as well as a science; understanding which levers keep your associates engaged and how to reward an individual’s contribution enables you to build a business and a culture that will endure.

Does incentive compensation motivate people? If you desire specific short-term activity or results, spiffs and bonuses can be effective. Over the long term, however, a poorly designed compensation plan is a disincentive. In the end, an individual’s motivation comes from within. Employees excel because they are committed to the firm’s mission, they are given challenging work, they are recognized for their accomplishments—and they have few distractions that cause dissatisfaction in the workplace.

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