Do Your Staff Really Need Bonuses?

Neil Woodford, one of the UK’s most respected fund managers with more than £14bn assets under management, has made the bold step of putting all staff at his Oxford-based Woodford Investment Management company on a flat salary this year.

Instead of a one-off cash incentive, Woodford will reward staff with a pay rise for the current financial year to more effectively improve employee behaviour and performance.

The move is a substantial challenge to the traditional bonus system in the City and financial world, whereby bonuses are often the cherry to entice staff to perform better.

And the initiative has its supporters, including fellow fund manager Daniel Godfrey, former boss of the Investment Association, who admits that pay levels and bonuses in the investment industry are too high.

Craig Newman, chief executive of Woodford Investment Management, said: “There is little correlation between bonus and performance and this is backed by widespread academic evidence.

“Many studies conclude that bonuses don’t work as a motivator, as expectation is already built in. Behavioural studies also suggest that bonuses can lead to short-term decision making and wrong behaviours.”

In the UK, there two main types of bonuses which are awarded to existing staff; the year-end bonus and the performance bonus. The year-end bonus (or the Christmas bonus) is rarely tied to any performance targets met by individuals or their teams, and is the type of bonus that’s customary at the same time each year.

On the other hand, the performance bonus is often given to employees who have overachieved in their role or met a significantly high standard of work over a period of time.

Typically acknowledged during annual (or bi-annual) performance appraisals, this type of bonus typically links the amount of the payment both to the level of performance and to the individual’s salary.

The Psychology Behind Bonuses

The reliance of many employers on cash bonuses as a motivation for staff to work harder can be traced back to the study of behavioural psychology.

Based on the arguments of John B. Watson, who proposed that all human behaviour was the result of external conditioning, and B.F. Skinner, who stated an individual’s behaviour is the response to either a perceived reward or punishment external to the subject, bonuses are meant to exist as external stimuli to encourage responses that will contribute to the development of normalised behaviours such as increased productivity, enhanced motivation, and a stronger work ethic.

Similarly, 20th century psychologist Abraham Maslow published the Hierarchy of Needs, which sets out a ranking of the most dominant desires and needs for humans.

Providing a link between the positive effects cash bonuses can have on staff performances, the thesis suggests money is a more fundamental need in the hierarchy than passion or purpose.

From an employer’s perspective, the key is to structure compensation optimally to get maximum productivity from staff, acknowledging that talented employees must be rewarded and retained in competitive job markets.

Bonuses are also frequently a way employer’s feel they can show their commitment to their best staff, who want to make a lot of money fast and work long hours each day to do so.

Over the past two decades, further scrutiny to these theories have revealed flaws.

In 2004, researchers Axel Engellandt and Regina T. Riphahn found that “there has been little empirical assessment of incentive provisions for workers”. Engellandt and Riphahn studied 6,500 workers using hours of overtime worked and levels of absenteeism as measures of effort.

The research concluded that an increased frequency of surprise bonuses to reward exceptional work significantly increased effort.

From the Libor scandal to the mis-selling of PPIs, experts have found that these scandals have stemmed from the toxic nature that the ‘bonus culture’ can sometimes bring.

The promise of big bonuses can lead workers to take shortcuts and act unethically, they can reduce intrinsic motivation, and they can cause envy between workers that could lead to higher employee turnover.

Furthermore, Harvard Business School professor Teresa Amabile and psychologist Steven Kramer talked with 600 managers about what they thought was the single-most important motivator for employees at work.

A shocking 95% of them got the answer wrong - it’s not money, safety, security, or pressure that drives employees at work. The most important motivator for employees at work is what Amabile and Kramer call “the power of small wins“.

Employees are highly productive and driven to do their best work when they feel as if they’re making progress every day toward a meaningful goal.

Steve Hatfield, principal and human capital financial services industry leader at Deloitte Consulting LLP, has suggested three alternative ways businesses can reward their best staff effectively, boost their motivation and retain their services.

“Develop a people strategy,” he said, “Different parts of the business have different needs and can benefit from different strategies. The same goes for different types of people. When it comes to managing and retaining talent, one size does not fit all. Develop a variety of customisable people strategies to increase success of attracting, retaining, and developing the right talent to drive the business.

“Differentiate your recruiting pitch. Instead of focusing heavily on bonuses and compensation, emphasise softer benefits such as teamwork, independence, and work/life balance.”

“Not everyone is only interested in making a quick buck,” he adds. “Emphasise learning and growth. Offer people early exposure to senior executives and high profile assignments.

“Accelerated involvement and development is particularly appealing to Gen Y’ers and Millennials, who want the opportunity to make a fast impact.”