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(Frank Franklin II/AP)
(Frank Franklin II/AP)

Big Idea

Bonuses don't mean better performance Add to ...

Of the most lucrative pay packages ever handed out in Major League Baseball, the top two spots are held by one man: Alex Rodriguez. The $252-million (U.S.) contract he signed with the Texas Rangers in 2000 was topped only by the $275-million deal he inked with the Yankees in 2007. And that's not counting the seldom-disclosed payouts he will receive for reaching certain milestones-playing in the All-Star game, for instance, or making the playoffs. But in baseball, as in business, paying top dollar is no guarantee that talent will come through in the clutch. A-Rod (or A-Fraud, a sobriquet his teammates once bestowed upon him) has a dismal playoff record. The Yankees haven't won a pennant since he joined the team in 2004. And since 2005, he's batted 7-44 in the post-season (a .159 average). It appears the richest player in the game-a three-time MVP-chokes at the prospect of winning it all.*

We're all chokers, in a way. While few of us will ever face a shareholder audience as diehard as Yankee fans, most of us can relate to the stress of making year-end numbers. Bonus season is our post-season, but research suggests that our reward-based culture is undermining our ability to excel at our professions. Bonuses don't work.

In 2008, Dan Ariely, a professor of behavioural economics at Duke University and the author of Predictably Irrational, led a series of experiments to determine exactly how people respond to financial incentives. Participants in the study were asked to play memory games, put together puzzles and perform physical tasks, such as throwing a ball at a target. When they performed very well, they earned a payout. Some subjects were promised a small bonus, about the equivalent of a day's pay, while others were shooting for a much bigger reward.

Here's what happened: For tasks that required no cognitive skill, such as repeatedly pressing the same key on a keyboard, performance improved when researchers upped the bonuses. But for tasks that demanded any intelligence at all (some participants played an electronic game of Simon Says), the incentives didn't work. In fact, the bigger the bonus, the worse the performance.

Nina Mazar, one of the co-authors of the study, is an assistant professor at University of Toronto's Rotman School of Management. She warns that individuals should be aware of the added pressure they take on when a large portion of their compensation is contingent on performance. "It could wind up reducing their performance, thereby hurting their pay or their prospects," she says.

Of course, many in the C-Suite already know that bonuses are bunk. In 2003, Harvard professors Michael Beer and Nancy Katz anonymously surveyed over 200 senior executives in more than 30 countries about their bonus plans. The overwhelming consensus was that bonuses had little or no effect on how their companies or employees performed. Many execs even admitted to low-balling expectations, to ensure everyone was eligible for a bonus.

And there's the rub: You don't hope for a bonus; you expect one. The first company to voluntarily scrap its bonus pool will undoubtedly watch as talent flocks across the street (right into the arms of Goldman Sachs, whose current $12-billion U.S. compensation kitty is the biggest it's ever had). One might have thought a long and painful recession would have compelled companies to reconsider their most basic practices, but, this year, many will carry on as usual. Welcome to the new economy-same as the old economy.

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