Keep pay simple. Motivate with meaning.

Think back to the financial year just passed: Was your best work motivated by your individual performance incentive? If your salary had been commensurate but fixed, would you have been less effective? And was all the time and energy you spent on performance bonuses for your team really worth it?

In some jobs – think sales – the case for performance-based incentives is more obvious. But if the work you do is more intangible – strategic, creative, collaborative – can your contribution really be accurately determined? 

Tying pay to performance is logical. My PhD advisor, Eddie Lazear, wrote a simple, but beautiful paper on this 25 years ago. He looked at what happened when a windshield replacement business, the Safelite Glass Corporation, replaced flat salaries with piece rates. Not surprisingly, output per worker rose 44 per cent.

There’s an important part to the Safelite Glass Corporation story that is often missed, however. Installing windshields is easy and inexpensive to measure. The windshield is either there, or it isn’t.

But many of us don’t stand in assembly lines making things. We’re a service-driven, knowledge-based economy, and this makes measuring performance difficult. The Productivity Commission tells us that non-routine cognitive work – the kind that is difficult to summarise in a metric – now represents over 40 percent of employment, compared to 27 percent forty years ago. Advances in AI will only accelerate this trend.

So does the remuneration of corporate Australia reflect this?

According to a recent article in The Australian Financial Review (AFR), 41 of the top 100 publicly listed companies in Australia track their Net Promotor Score (NPS), an indicator of customer loyalty, and of these companies, three-quarters tie remuneration to it. Unlike installing windshields though, customer loyalty is neither objective nor cheap and easy to measure. There are of course many reasons why executives are paid according to performance metrics (risk sharing, shareholder alignment, cost of variable vs. base pay, among other reasons), and NPS is only one of many feasible measures. But why are individual performance bonuses still so central to the way we reward so many people, even non-execs, at work?

Let’s return for a moment to the original questions: Are you pondering your performance metrics in the shower or when answering emails late at night? My guess is no. Do they fairly reflect your value? I can definitely hear the women of corporate Australia say “no”. (But, that’s a topic for another article). And, do you really look forward to the process of assigning bonuses to your team? 

Are you pondering your performance metrics in the shower or when answering emails late at night?

You might be one of the 12 million people who’s seen the Ted Talk by psychologist Dan Pink on what motivates people. He says that ‘one of the most robust findings in social science’ is that ‘contingent motivators’ (if you do this, then you get that) don’t work when the task isn’t simple.

Economists have been talking about this for years. Remuneration, after all, is about incentives, and there is no better framework to understand incentives than economics. The Nobel Memorial Prize-winning economist Bengt Holmstrom, together with Paul Milgrom, wrote a famous paper examining what happens when one party delegates a complex job with multiple tasks to another, but cannot perfectly measure performance. Unsurprisingly, it turns out that rewarding the measurable over the unmeasurable distorts what workers do. It incentivises them to focus on one thing to the neglect of the other.

Dan Pink likes to talk about the ‘narrowing’ effect of extrinsic motivation, like financial incentives. Workers narrow their concentration to moving the metrics that affect their pay packet. Sometimes that involves gaming the system.

And then there’s the fact that for many workers, bonuses aren't strictly tied to hard metrics. Manager discretion is involved. But when bonus criteria are vague or subjective, employees still modify their behaviour to impress. Good managers must prevent activities that appear to be useful, but are far from required. Organisations unintentionally encourage rent-seekers and diplomats, not contributors and leaders.

But when bonus criteria are vague or subjective… Good managers must prevent activities that appear to be useful, but are far from required.

The implication of Holmstrom and Milgrom is that in complex work with multiple tasks, a straight salary might be the preferable remuneration strategy. Compared with more complex financial incentives, a flat salary is the least distorting and lowest-cost way to motivate workers who have a bundle of complex duties to perform.

Sometimes, of course, salary negotiations also become performance theatre. When annual reviews tie salary increases to subjective assessments, we're simply moving the measurement problem from bonuses to base pay. These challenges can never be fully resolved, but they can be simplified. Transparent, grade-based salary structures is one mechanism to protect against subjectivity. 

None of this is to say that variable pay should be eliminated entirely. For some roles and some businesses, financial incentives tied to clear, measurable outcomes will remain optimal, especially where they relate to company or group performance.

But in the aggregate, we risk spending too much time thinking about, and overcomplicating, extrinsic motivators. Instead, business would be better to focus their energy on what really drives performance: giving people purpose, meaning, and growth in their work.

…business would be better to focus their energy on what really drives performance: giving people purpose, meaning, and growth in their work.

Dan Pink likes to talk about the values of ‘purpose’, ‘autonomy’ and ‘mastery’. I think about it this way: what value does your company contribute? What is your role in delivering on that? How can you be challenged to do that better each day?

Harvard psychologists, Robert Kegan and Lisa Lahey, talk of “deliberately developmental organisations”: companies that thrive in knowledge-intensive environments by treating employees not just as resources to manage, but as people to grow. In such organisations, motivation comes not from gaming KPIs but from a culture where workers feel challenged and supported; where learning and contribution are built into the fabric of work itself.

That kind of workplace isn’t achieved by tweaking individual incentives or negotiating salaries more. It comes from leadership that is inspiring, visionary and clear. Not from leadership transacted with a carrot and a stick.

CEOs must pay their staff enough, yes. But the greatest return comes from helping people find meaning in what they do, and the best incentive, in the end, may just be a sense of progress and purpose.