Duke economist Dan Ariely warns that monetary incentives can destroy quality of work. He also believes there are often alternatives to layoffs.

Topic: More money, more problems.

DAN ARIELY: People often think that people only work for money. Our model of labor is kind of, models of fretwork working in the cage. People hate to work, we have to pay them and we have to pay them more to work more. But it’s actually quite curious. Is this really the case? Imagine I took you and I locked you in a room, and in one case I paid you 1000 dollars a day, on another case I paid you 5,000 dollars a day. Would you produce more? Could you force yourself to focus more, to be more creative, to be more useful for me? Not really clear, and what’s the role of bonuses? How much value are they giving us compared to how much they costing us? All of those are basically unknown, people have strong intuitions about those but they don’t know.

So recently we tried to check it out. With all these issues about bonuses, we did an experiment and we created six different games and they games had to do with memory and concentration, and creativity and some mechanical tasks, like throwing balls at the target, and the whole task took about an hour, and we said to one group of people, look if you do these tasks, each of those very well, we’ll pay you for each of them for a total of basically giving you a day wages.  So if you do these tasks well you’ll get a day wages, you do half of them well, you’ll get half a day wages and so on. Another group we said, if you do these tasks well, we’ll give you two weeks of wages, but more interesting offered them a big bonus and to a third group we said we’ll give you a six months bonus, right. So now, if we asked people “Which group do you want to play with?” You said the six months. We ask people “Who do you think will produce the best?” They said, the six months of course, so much money was on the line. But in fact what happened was that these people produced the worst. When we move from the one day to the two weeks there was no difference in performance, when we moved to the six months salary there was a big deterioration of performance. Some tasks reduce from 40% of the people solving them to 5% of the people solving them. Now why is that?

It turns out that money is both a motivator and a stressor. I pay you more money, you want to do more but it doesn’t mean that you can do more. If I gave you 10,000 dollars to be funny in the next minute, could you do it? Or would spend this minute saying, ‘oh my goodness what joke is good enough, I can’t think of anything.’ It is a consequence of the stress actually does worse, and there’s an interesting link here to loss aversion.

Question: How do you let employees go while giving them the least amount of loss?

DAN ARIELY: It turns out that job loss is something that is very hard for people to get over and one of the reasons it’s very hard to get over because people have so much faith in their job, they relax for a long time and so on and all of a sudden when they lose their job, kind of the ground gets shaking underneath their feet and it’s very hard to create this trust again. When somebody has their spouses in affair, it’s very hard to trust other people after that, when bankers betray us, it’s very hard to trust other bankers after that. So, one of the things to help people is to explain to them that it’s not them, right. So, I know people break up, when they did; they say it’s not you, it’s me. But I think the same thing could happen when you say, “Look if it’s just you losing its one thing.” But if we give people a story, it helps explain what happened and they can make better sense out of it. There’s actually lots of research on that basically show that when people go through trauma, the process of writing about it or trying to explain to themselves or have somebody else explain to them, the reason for that actually eliminate much of the unknown. Think about something like crime. You walk down the street and somebody attacks you and steals your money.

What is better? To tell you it’s not your fault, it’s just random, it happens, or to say look, here is what happened: you were walking at night in a dangerous neighborhood. Now you could imagine that saying the random thing is better for you because it’s not your fault. But in fact telling you that it was your fault is more helpful because now you understand where it’s coming from and you can think about how you can deal with it next. So returning for people, kind of the center of control and ability I think is very important.

There’s also an interesting thing. Some companies offering employees are saying what do you want? We can fire 20% of the people or we can reduce pay by 20%. In Renault’s case in France a few years ago they said we’ll cut the workweek from five days to four days together with the 20% reduction in pay. And in many companies people are opting for the general reduction. So I think people that work together actually care more about each other than companies realize and are often willing to sacrifice something for their team and for their morale, especially if it’s defined as a short, as a short term.

I’ve heard this story from somebody from a consulting company called Diamond Consulting. And the CEO there told me that when the internet bubble bursts, all the partners at the consulting company took a pay cut. And they had a big town hall meeting with all the consultants and they said look, all the bigwigs, all the people who are partners took this and this pay cut and so on. And basically everybody in the company wanted to take this pay cut as well; which is just incredible, right? We don’t think about employees as caring about the company but I think often they really do. I mean I definitely feel like this for the university and I think many people do. And there’s ways to actually use pay cuts to get people to be more motivated, and more committed to their company.

Recorded on: July 29, 2009