Bonus or pay rise?

Many companies try to motivate their employees through pay packages, including merit rises, bonuses and performance pay. Few employers, however, know how efficient different incentives are.

by MIT Sloan Management Review
Last Updated: 23 Jul 2013

New research by Michael Sturman from Cornell University in Ithaca, New York, reveals that how employees are paid is at least as important (if not more) than how much they are paid when it comes to improving employee performance.

Sturman's study was conducted in a large, diversified US company. In terms of pay levels, he found, like many other studies before, that employees were more likely to push themselves if they were paid above market rates.

He also found that smaller pay rises were more effective than equal-sized or even bigger bonuses in improving performance. Employees perceived increases in their salary as more beneficial in the long-term, and therefore more valuable.

Conversely, Sturman found that when financial rewards were linked with performance, bonuses were more effective than pay rises in improving employee motivation. This was because employees were more likely to see performance-related bonuses as 'extra pay' and therefore worth going the extra mile for.

A problem for companies is that even though (non performance-linked) salary increases are more effective in spurring employees into action, bonuses are more economical as they don't carry over into successive years. So what's the most cost-efficient way to motivate employees?

After a series of experiments, Sturman found that if managers tied bonuses strongly to an individual's performance, a company could theoretically see an overall 16% increase in employee motivation. Substantial increases in motivation could therefore be achieved without increasing the payroll budget.

By contrast, increasing the average annual salary raise from 2 to 3% would only improve performance by 2.2%, and at considerable cost to the company. However, if that raise were combined with changes to how bonuses are allocated, the overall rise in performance could be as much as 19%.

Source: What's the best way to pay employees?
Michael Sturman
MIT Sloan Management Review, Winter 2007, Vol 48, No 2, pp 8-9

Review by Emilie Filou

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