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Do incentives increase performance?

November 20th, 2008

The NY Times had this editorial today about incentive bonuses. In the article, he presents seemingly strong evidence that bonuses shouldn’t matter. In experiments in India and MIT, participants who were offered truly substantial rewards performed *worse* than people who were offered small rewards. His conclusion: don’t pay large performance bonuses to investment bankers.

I take exception to the author’s interpretation of the experiments. It misunderstands how incentives operate. Offering higher rewards doesn’t necessarily make individuals perform better. I can only run so fast, and try as I might, I can’t shave a minute off my fastest mile run even if you offer me $1 million or even $1 billion.

However, there are runners out there who can beat my time 60 seconds or more. And some of them are doing more lucrative things, like professional sports or even investment banking etc. If you offered them the right price, you might be able to get them to leave those other jobs and participate in your race.

So, Dan Ariely is way off the mark in drawing the conclusion that investment banks could perform just as well without performance bonuses. Run back to the Ivory Tower at Duke, Dan!

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