This article was first published in the July/August 2015 international edition of Accounting and Business magazine.

Pay and benefits are such a key part of working life all around the world that you could be forgiven for thinking there isn’t anything else to learn about the key issue in the contract between employer and employee. But UK-based HR professional body CIPD has suggested that policy should be evidence-based and that management needs a better understanding of what shapes people’s behaviour, how they think and what pushes optimal performance. CIPD research adviser Jonny Gifford says: ‘Once we have that understanding, we should apply it to people management and development, processes and practices.’

According to a 2015 CIPD report Show me the money! The behavioural science of reward, the insights gained can help drive greater employee motivation as well as a better understanding of the science behind the impact of pay and reward on employee behaviour. The study looks at research that has been conducted by a range of academics around the world including in the US, Europe and Asia.

Its conclusions don’t come out of the blue – occupational psychologists have been looking for some time at areas such as recruitment and selection, particularly in the US. The understanding of the brain has advanced in recent years, but this knowledge is only starting to be put to practical use in the workplace for making business decisions. 

It appears that money may not be the straightforward workplace motivator of traditional assumptions. Those employers that can think about, design and implement alternative rewards could be more effective in motivating their staff to succeed. By adapting their reward structure, organisations can gain more control over the complex range of factors that determine motivation, and so enhance their chances of business success. 

The basics  

Employers are faced with perennial difficulties in managing basic pay. How employees respond to basic pay is contextual. External factors such as recession play a part, but in every » business there are internal factors such as expectations. Added together, this means that employees’ satisfaction with pay is not static, which suggests to HR professionals that they need greater flexibility in setting pay, looking at remuneration on a case-by-case basis rather than having clearly defined pay structures. 

On the other hand, says Gifford, human beings have a strong desire for equity, transparency and procedural justice. ‘When human beings are offered rewards that are perceived to be fair we are happier,’ he says. Or so neuroimaging and brain scans seem to suggest. Experiments in the lab have demonstrated that people would rather forgo reward for some tasks than gain what is seen as an unfair reward. Employees’ perceptions of rewards are therefore defined by the circumstances in which they are earned. A pay rise or a bonus during tough economic times will be seen as having much greater value than the same reward given in a time of boom. 

Endowment bias

Likewise, a bonus may be perceived as having less value if the recipient considers their own performance to be stronger than other employees who get the same amount as part of a team reward. Given the tendency of people to overestimate their own abilities when performing familiar tasks, skill will be needed to craft a performance-based pay scheme that avoids disillusioning employees who feel their rewards don’t match their expectations.

Employers should take account of this ‘endowment bias’ – people’s tendency to overestimate the value of our possessions and our own skills. Employers need to be aware of endowment bias when they create benefit packages – and even more so when they change them. ‘You may not use the gym membership or the subsidised canteen,’ explains Gifford, ‘but if it is taken away, employees would suddenly place more value on those benefits.’

The same goes for performance-related pay. Because we tend to overestimate our ability as individuals, many if not most people find performance-based pay attractive in the first instance, but ultimately disappointing and demotivating. The key is to have a flexible reward package that takes into account behavioural nuances and doesn’t rely solely on a wad of cash as the great staff motivator. It’s a change in direction for many but should also be welcome news for organisations that are looking to be more creative with their rewards packages.

When it comes to setting bonuses, businesses have to think about whether money is addictive. Behavioural scientists argue that money’s impact on us is more varied than we might think and less predictable. Gifford says: ‘We do respond to money like a tool. It has a utilitarian value that enables us to do things, but we also respond to money like a drug. If you offer people cash, then there is a sense that we get an instant hit.’ So money supplies immediate and deferred gratification.

Companies have often seen money as a ‘hygiene factor’, based largely on US psychologist Fredrick Herzberg’s theory. He suggested money would not make an employee extremely satisfied or motivated, but a level of pay seen as too low would be demoralising. That idea was mooted in the middle of the 20th century; in the 21st century, it is seen as an oversimplification. ‘Money is a powerful incentive – especially with that drug-like hit,’ says Gifford. ‘It can crowd out or interfere with other motivations that are desirable in an employment context.’ 

This is where paying a bonus can become a risk. Before setting up a bonus scheme, employers need to be clear about what they want people to do within their role. If there is a bonus for reaching a target, then the rational action is to aim for that even if it has harmful and unintended consequences. UK newspaper The Guardian reported that its analysis of oil company reports revealed that bosses at the world’s big five oil companies had been given bonuses linked to a £650bn spend on fossil fuel exploration – controversial because such projects may lead to climate change disaster. 

Unintended consequences

To incentivise one target could result in the disincentivisation of other desirable behaviours. So a bonus has to be linked to a measure to ensure fairness and is also an integral part of what employers want their employees to be doing. 

CIPD says that examples of good practice do exist, and the recommendations of its report are in line with the sort of practices already used by many organisations. One perhaps controversial example of this is UK teachers’ resistance to performance-related pay. Such pay may become accepted in that profession eventually, but resistance to it is based on fears that targeting some behaviours would detrimentally crowd out or interrupt other equally valid behaviours. 

Behavioural science clearly has taken only limited steps in the workplace, and it is not clear that organisations have yet grasped the idea of looking at the evidence over pay and benefits and then changing their approach. Gifford expects to see employees taking on board the idea of behavioural science soon. 

According to global consultancy Hay Group, salaries across the world are set to rise by 5.4% on average this year compared with 5.2% in 2014, so those involved in setting rewards may well have a more difficult task over the coming years. While employers need to recognise employees when they go the extra mile and add value, a number of behavioural factors should be considered when shaping a reward programme. Perhaps the key issue is to acknowledge that monetary rewards aren’t everything and may even distort the motivation that employers seek to foster.

Trying it out

The HR profession still needs to gather evidence from the real world – and be aware of global and sectoral differences – but corporates should be thinking about attempting to conduct some live experiments in the workplace to test the theories. Companies may shrink away from the idea of turning their workplace into a laboratory for behavioural scientists, but CIPD says such experiments should not be that onerous. 

The empirical evidence is building. CIPD cites the work of academic Claire Zedelius and her colleagues. They found that when people were promised reward for a later task, they started to perform better at intermediate tasks, even when those weren’t subject to a reward.

While that sort of work may provide insight, how people behave in the workplace environment at the moment remains a mixture of mystery and supposition, which is not a good basis on which to rest pay systems and policies. 

Aubrey Daniels, a US clinical psychologist often referred to as ‘the father of performance management’, says: ‘Because management processes and practices are not designed in accordance with what is known about the scientifically proven laws of human behaviour, organisations are not able to fully maximise the potential of their people. This has led to management systems that waste time and money and frustrate employees, resulting in low rates of engagement, productivity and customer service.’