The truth about bonuses

Bankers may well love them by the billion, but new research has claimed bonuses don't actually make us work any harder.

According to a study by economists at The University of Nottingham, fines are more effective than payouts when it comes to getting the most out of employees.

The finding emerged amid the continuing furore over the huge bonuses being paid to bankers in spite of global financial meltdown.

Last week Downing Street won only modest concessions in its bid to stop banks giving an estimated £7bn in extra payments to staff this year. The enormous figure has provoked widespread outrage at a time when the country is in the grip of cuts and austerity measures.

Now research by the University’s School of Economics suggests bonuses don’t even improve a worker’s productivity.

Experts in behavioral economics carried out a series of experiments to examine the effect of bonuses and fines on performance. The idea was to mirror not just a workplace scenario but other real-life situations such as tax inspections and even speed-limit compliance.

Study co-author Dr. Daniele Nosenzo said: “There are many situations where authorities have preferences over individuals’ choices. Regulators want factories to observe rules, police want motorists to observe speed-limits, and employers want employees to work hard. Exactly how authorities induce compliance when individuals have incentives to deviate from the desired behaviour is a fundamental problem.

“To study this we set up a novel experiment – the first of its kind, as far as we’re aware – to compare positive and negative influences.”

The study, involving more than 100 volunteers, was carried out at the School’s Center for Decision Research and Experimental Economics.

Subjects were assigned the roles of employers or workers and randomly paired over a number of rounds of an ‘inspection game’. In each round a worker had to decide whether to supply ‘high’ or ‘low’ effort, while at the same time the employer chose whether to ‘inspect’ the worker or not.

In some treatments the worker received a bonus for supplying high effort when inspected, while in others he was fined for low effort.

At the end of the experiments volunteers were paid a modest cash reward reflecting their performances and the bonuses and fines incurred.

Dr. Nosenzo, whose work focuses on how “social comparison” information affects behaviour, said: “We found paying bonuses didn’t encourage more effort. Employers tended to reduce the frequency of their inspections when they knew they would have to pay a bonus for high effort.

“This has a negative impact on encouraging working, which offsets any positive effect of bonuses. In fact, our subjects shirked slightly more often when bonuses were present. On the other hand, introducing harsher fines encouraged working. Shirking almost halved relative to a scenario without bonuses or fines. So it’s fines, not bonuses, that enhance efficiency.”

In fact, the joint earnings of employers and workers were almost 19 per cent higher when fines were handed out than when bonuses were paid. However, while employers were better off when fines were introduced, workers earned less than in the scenario without fines.

Prime Minister David Cameron recently threatened to introduce tough legislation to rein in bankers’ multi-million-pound payouts. But the coalition government eventually decided to back away from wider moves towards imposing a windfall tax or curbs on pay.

Ministers instead opted for a compromise that will publicise details of bonuses and set banks lending targets to kick-start the economy. Yet critics have dismissed the concessions secured under the Project Merlin agreement as “pitiful”, a “pantomime” and a “damp squib”.

At present the deal requires only that banks provide the details of their five best-paid employees below board level, though this may be reviewed next year.

Speaking at the weekend, Business Secretary Vince Cable insisted banks still face “fundamental surgery” in terms of structural reforms.