The Dark Side of Monetary Bonuses: Theory and Experimental Evidence

To incentivize workers and boost performance, firms often offer monetary bonuses for the achievement of production goals. Such bonuses appeal to two types of motivations of the worker. On the one hand, the existence of a goal, on its own, triggers an intrinsic motivation associated with the desire to not fall short of the goal. On the other hand, the money paid to achieve the goal constitutes an extrinsic motivation. This paper studies the possibility that these two effects are substitutes when workers set their own goals. We develop a theoretical model that predicts that if the worker is sufficiently loss averse and faces uncertainty about reaching a production goal, offering a monetary payment contingent on reaching such a goal is counterproductive. This is because under the presence of monetary bonuses, the loss averse worker prefers setting lower goals, which yield lower but more likely bonus payments. Lower goals, in turn, negatively affect subsequent performance. Results from a laboratory experiment corroborate this prediction. This paper highlights the limits of monetary bonuses as an effective incentive when workers are loss averse.