How Does Pay Influence Motivation?

Abstract

Variable performance-related pay (or "pay for performance") has become an increasingly popular form of compensation. It is also the preferred form from the point of view of economic theory, specifically with reference to the principalagent theory. In practice it is being used more and more for management grades and other levels of the corporate hierarchy. The key to performance-related pay is that compensation is adjusted to reflect an employee's individual performance. However, research has shown that variable performance-related pay does not lead to a general increase in a company's productivity and earnings. Improved performance only occurs in simple, easily measured activities. In other circumstances, pay for performance can even reduce a person's willingness to perform by "crowding out" the intrinsic motivation to work.