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February 22, 2011

When Giving Incentives Doesn't Give Back

Incentives can sometimes destroy the benefits that peer pressure provides in organizations.


Incentives are a popular tool for motivating staff to improve performance or for rewarding people for hard work, or even good deeds. But incentives can backfire, incurring hidden costs above and beyond their initial price.

A growing body of research has focused on these hidden costs, particularly in examining the direct effects of providing incentives. Consider a kid who enjoys mowing the lawn, whose parents need only depend on his or her internal motive — enjoyment — to get the chore done. What if the parents, nevertheless, decide to occasionally reward their child’s lawn mowing with five dollars? Tinkering with inherent motivation by providing an external reward often has the effect of shifting motivation from intrinsic to extrinsic: no more free lawn trims.

Professor Stephan Meier, whose research focuses on the intersection of psychology and economics, worked with Andreas Fuster of Harvard to consider the indirect effects of incentives — not just changes in individual motivation, but whether providing incentives to individuals would bring about changes in others in an organizational system, in turn effecting overall contributions.

Their investigation is closely related to the work of Nobel Prize–winning economist Elinor Ostrom, who has shown that, when norm-enforcement mechanisms — even informal ones — are in place, shared resources do not inevitably fall prey to overexploitation by individuals (a dynamic often described as the tragedy of the commons). For example, among a regional group of small fishing villages, each village may want other villages to minimize fishing while maximizing its own. But if every village maximizes its own fishing, fish become extinct, and all the villages face decline. Ostrum documented that in such settings, participants observe each other, and heavy users or lackluster contributors face reprimand by peers, and keep each other from abusing their common benefit.

“Decentralized norm-enforcement mechanisms are important forces that compel us to contribute to public goods, like helping each other or recycling, and keep us from exploiting common resources,” Meier says. “People are often willing to make such contributions, but if there is no mechanism that enforces their efforts, over time people scale back their contributions, and the rate of free riding — taking benefits of public goods without contributing — rises so high that no one contributes.”

Of course, not all group environments require norm enforcement. If each member of a sales team doesn’t sell a certain number of products by a deadline, the threat of not getting paid ensures that goals are achieved. But in other group settings, it is difficult to measure how cooperative members are, or how readily individuals share information that others need to carry out their work. When these qualities matter, norm-enforcement mechanisms, formal or informal, are critical: peer pressure can be highly effective in keeping free riders in check.

Meier and Fuster wanted to know what would happen if they gave incentives to contributors in an environment that depended on informal norm enforcement. “In theory, rewarding those who contribute to the common pool should increase their inclination to contribute,” Meier explains. “But we thought it might also introduce a problem: quashing norm enforcement.”

In the first experiment, participants were asked to contribute to a public good (in this case, a common pool of cash) to be divided equally among all participants at the end of each of six rounds, whether or not all participants contributed. The best possible financial outcome for all participants was for everyone to contribute to the pool, which would have increased the total sum of money to be divided. For each individual, the optimal outcome was to have everyone else contribute, without contributing herself. Here, contributors were barred from exercising any form of norm enforcement.

In this setting, people give small amounts to begin with, but giving decreased over time. “At first, you might want to be a nice guy, so you give,” Meier says. “But once you see that others aren’t giving and no one is encouraging you to keep giving, you stop.”

Next, the researchers added incentives: every contributor got a lottery ticket (recipients stood a good chance of winning an attractive sum of cash if their ticket was drawn). “When you add incentives in a setting with no opportunity to enforce norms,” Meier notes, “people are more likely to contribute, including free riders. We see this in practice a lot.”

In the second experiment, participants who contributed to the common pool could punish other players, by imposing fees on free riders at the end of each round, simulating norm enforcement. Free riders who were punished, as most were, increased their contributions in subsequent rounds. When the researchers added incentives (also lottery tickets), contributors scaled back their punishment of free riders by almost half. Free riders, in turn, were much less likely to increase contributions in subsequent rounds whether or not they were punished, ultimately resulting in lower overall contributions than the scenario without incentives. The incentives changed the norm of contribution — making it okay to free-ride.

“When there are norm-enforcement mechanisms in place, free riders who are punished tend to come around and start to contribute,” Meier says. In contrast, when individual contributors receive incentives and continue to punish free riders, free riders tend to view the punishment as unfair, and they withhold contributions.

“Individual incentives can really change the structure of how we deal with one another, what the norms are, and how we enforce norms,” Meier says. “If social forces in an organization are important, managers need to be attuned to norm enforcement and peer effects. They should understand that adding monetary incentives can dramatically change this dynamic and lead to a net-negative effect.”

Stephan Meier is assistant professor of management and a senior scholar at the Jerome A. Chazen Institute of International Business at Columbia Business School.

Read the Research

Andreas Fuster, Stephan Meier

"Another Hidden Cost of Incentives: The Detrimental Effect on Norm Enforcement"

View abstract/citation  Download PDF  

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