BEHAVIORAL ECONOMICS OF INCENTIVES SCOTT JEFFREY, PH.D. MONMOUTH UNIVERSITY 1.

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BEHAVIORAL ECONOMICS OF

INCENTIVESSCOTT JEFFREY, PH.D.

MONMOUTH UNIVERSITY

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“What a piece of work is man. How noble in reason, how infinite in faculties”

Hamlet, Act II, Scene 2

“What fools these mortals be”

A Mid-summer’s Night’s DreamAct III, Scene 2

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Source: John Maurice Clark, "Economics and Modern Psychology“, Journal of Political Economy 1918

The economist may attempt to ignore psychology, but it is sheer impossibility for him to ignore human nature. If the economist borrows his conception of man from the psychologist, his constructive work may have some chance of remaining purely economic in character. But if he does not, he will not thereby avoid psychology. Rather, he will force himself to make his own, and it will be bad psychology.

Behavioral Economics:

Good Economics and Good Psychology

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TWO “ACADEMIC” VIEWS OF PEOPLE

• “Econs”: Economists and Decision Scientists

• Self-Interest with guile

• Optimization (max or min some objective function)

• Expected Utility

• Full information (or at least well specified uncertainties)

• Unlimited computational ability

• “Rational” preferences

• Known, Non-transitive, Stable

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TWO “ACADEMIC” VIEWS OF PEOPLE

• “Humans”: Psychologists and Sociologists• Heuristics (Cognitive Short Cuts)

• Biases (Cognitive Errors)

• Myopic Decision Making

• Changing Preferences often constructed “real time”

• Limited Cognitive Powers

• Poorly behaved utility functions

• Hard to specify arguments to “utility function”

• Fairness, Altruism, Reciprocity

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SCOTT’S SECRETS

1. Your employees are humans, not econs, although they may want to look like they make decisions like econs

DOES THIS SOUND FAMILIAR?

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SOME EVIDENCE

555 Sales People were asked: “If you had the opportunity, would you trade in your incentive travel for the equivalent cash?”

No: 5% Yes: 95%

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MORE EVIDENCE

“What is the most motivating reward?”

$1,500 Cash: 79%

$1,500 Travel: 15%

$1,500 Merchandise: 6%

Source: Incentive Magazine, 1988

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REASON BASED CHOICE

• When people are making a decision they like to have a compelling reason for their choice

• Justify to others

• Justify to themselves

• Many different ways to provide these reasons but the presence or absence of a reason changes behavior

• Choice of Cash much easier to justify

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WHAT DO WE WANT FROM EMPLOYEES?

Striving?

Choosing?

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THE ESSENTIAL PROBLEM

• “Dual Self” problem

• Planner/Doer (Self-Control)

• (Thaler & Shefrin, 1981; Adam Smith, 1759)

• Elephant and Rider

• (Haidt, 2006, Heath and Heath, 2010)

• Competing Internal Preferences

• (Bazerman et al., 1998, Schelling, 1984)

• System 1 and System 2

• (Kahneman, 2011)

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ADAM SMITH (BEHAVIORAL ECONOMIST?)

• Adam Smith wrote that all behavior is determined by the struggle between “the passions” and the “impartial spectator”

• The passions are driven by physical needs and wants such as hunger and sex, emotions such as fear and anger

• The spectator does not feel the solicitations of our present appetites. To him the pleasure which we are to enjoy a week hence, or a year hence, is just as interesting as that which we are to enjoy this moment

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“I’m holding the reins in my hands, and by pulling one way or the other I can tell the elephant to turn, to stop, or to go. I can direct things, but only when the elephant doesn’t have desires of his own. When the elephant really wants to do something, I’m no match for him.”

Jonathan Haidt, The Happiness Hypothesis

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Everybody behaves like two people, one who wants clear lungs and long life and the other who adores tobacco, or one who wants a lean body and the other who wants dessert …the “straight” one is often in command…but the wayward one needing only to get occasional control to spoil the other’s best laid plans.

Thomas Schelling, Choice and Consequence: Perspectives of an Errant Economist.

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SYSTEM 1 AND SYSTEM 2

• System 1:• Fast• Emotional• Effortless

• System 2:• Slow• Cognitive• Deliberative

0.5 oz. of chocolate

2.0 oz. of chocolate

Majority of participants would feel better eating the heart

Majority of participants would choose the cockroaches

Participants in a survey study told they won a lottery and had a choice of prize

Source: Hsee, C.K. 1999. Psychonomic Bulletin and Review

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EFFORT VS. CHOICE

If you worked at a company where the top 5% of sales people had a choice of cash or a trip to Hawaii, which option would you choose?

Hawaii: 17% Cash: 83%

If you worked at a company where the top 5% of sales people earned _____, how much effort would you expend (7 point scale)?

Hawaii: 4.7 Cash: 3.8

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LAB EXPERIMENT

• 63 University of Chicago Staff Members

• Played a “Word Prospector” word game twice

• Raw difference in scores used as dependent measure

• 3 Incentive conditions given to separate groups

• No Incentive

• Monetary Incentive

• Non-Monetary incentive

Source: Jeffrey, S.A. 2009. Justifiability and the Motivational Power of Noncash Incentives, Human Performance, 22. 143-155.

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Relative Performance Level

Non-Monetary Award

Monetary Award

No Award

Top 5% 1 Hour Massage

$100.00 Thank you!

Next 20% 20 minute massage

$30.00 Thank you!

Next 30% 5 minute massage

$10.00 Thank you!

Next 30% Fancy Candy Bar

$2.00 Thank you!

PERFORMANCE REWARDS

Hedonic prizes for non-monetary with stated market values as monetary prizes at multiple performance levels.

0.0%

StronglyDisagree

1Disagree

2 3Neither

Agree Nor Disagree

4 5 6 7Agree Strongly

Agree

9.1% 9.1%

18.2%

13.6% 13.6%

36.4%

“I would prefer to receive the cash value of the prize rather than the prize itself”

STATED PREFERENCE

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14.6%

38.6%

Cash Tangible

Relative to No Incentive

PERFORMANCE UPLIFT

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SCOTT’S SECRETS

2. Be careful what you are asking and that you know how to interpret the response.

3. Choice is sometimes inconsistent with value

4. Companies should be more concerned with performance (valuation) than preference (choice)

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MORE EVIDENCE

• 156 working professionals in a semi-conductor factory

• Three types of short term performance bonuses

• 100 NIS ($25)

• Voucher for pizza

• Choice of reward

• Verbal reward

• Measured performance in pursuit of incentive and after receipt of incentive

Source: Bareket-Bojmel, Hocman, and Ariely. Fortcoming. It’s (not) all about the Jacksons: Testing different types of short term bonuses in the field, Journal of Management.

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MORE EVIDENCE

• 72% of employees in choice condition chose cash

• Uplift from base productivity

• Cash: 4.6%

• Pizza: 6.7%

• Verbal Recognition: 6.6%

• Choice: 4.6%

• Differences not statistically significant

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MORE EVIDENCE

• After Bonus Removal:

• Cash:

• -13.2% relative to first day

• -6.5% relative to base productivity

• Pizza:

• -8.7% relative to first day

• -2.1% relative to base productivity

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MORE EVIDENCE

• After Bonus Removal:

• Verbal Recognition

• -5.9% relative to first day

• +0.64% relative to baseline productivity

• Choice

• -5.9% relative to first day

• +0.2% relative to baseline productivity

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WHAT ABOUT GIFT CARDS?

BAD NEWS ON GIFT CARDS

• Recipients spend gift cards much like they spend income from other sources

• $2.7M of $8.3M taken out as cash

• People do not purchase “luxury” items

• “Hedonicity” Score: 3.21 Cash, 3.28 Card

Source, Mu and Jeffrey, Unrestricted Gift Cards: Compensation, not Recognition,

0.0

5.0

10.0

15.0

20.0

25.0

Enterntainment Food Away fromHome

Food at Home Apparel andServices

HouseholdFurnishings

Personal CareProducts

AlcoholicBeverages

HouseholdOperations

HousekeepingSupplies

Percentage of Total Spend

Cash Card

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MORE BAD NEWS

• Research has shown “monetized” non-cash rewards act much like cash

• Moves from “social exchange” to “economic exchange”

Source: Heyman and Ariely, 2004. Effort and payment: A tale of two markets, Psychological Science, 15 (11), 787-793.

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SUMMING UP….

• Your employees are “human” and are susceptible to all the limitations associated with being human.

• We are each “Two people” competing for control. Reach the right one

• Choice and the decision to exert effort are driven by different psychological processes

• Just because they state a preference for cash does not mean it is the best incentive

• Be careful what you ask and that you understand what the response means

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SUMMING UP

• Cash incentives can have negative effects on the social relationship with employees

• They move relationship into the “money for service” domain

• Can also crowd out intrinsic motivation to do a good job

• Gift cards are NOT tangible incentives, they are just like cash

• Monetizing “gifts” makes them behave like cash

• Be honest with yourself, gift cards are really just a convenient method for distributing cash

• Gift cards may be “efficient” but they are not as effective as other recognition