Impact of Incentive Bonus Plan

20 Nov 2010 Sandeep Mehta

Here is a cool article from Management Science on Empirical Examination of Goals and Performance-to-Goal Following the Introduction of an Incentive Bonus Plan with Participative Goal Setting:

Prior research documents performance improvements following the implementation of pay-for-performance (PFP) bonus plans. However, bonus plans typically pay for performance relative to a goal, and the manager whose performance is to be evaluated often participates in setting the goal. In these settings, PFP affects managers’ incentive to influence goal levels in addition to affecting performance effort. Prior field research is silent on the effect of PFP on goals, the focus of this paper.

The authors studied retails store performance (I believe retail stores have a much better handle on performance bonuses than most R&D organizations I know)

Using sales and sales goal data from 61 stores of a U.S. retail firm over 10 quarters, we find that the introduction of a performance-based bonus plan with participative goal setting is accompanied by lower goals that are more accurate predictors of subsequent sales performance. Statistical tests indicate that increased goal accuracy is attributable to managers ‘meeting but not beating’ goals and to new information being impounded in goals.

So, managers lower the goals and then meet them!

we find that prior period performance has incremental power to explain goal levels in the postplan period. Our results provide field-based evidence that PFP and participative goal setting affect the level and accuracy of goals, effects that are associated with both information exchange and with managers’ incentives to influence goals.

Take home message is to be very careful with setting up an incentive bonus plan.  In R&D organizations, it is even more difficult because the results are often not measurable and incentives tend to get disconnected from performance to start with.  Please let me know if you would like to discuss this further.

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