Incentive first, achievement later

From corporate bonuses to wellness premium reductions, employers drive productive and healthy behavior with the promise of future rewards. But what if employees received their rewards up front, with the threat that the cash would be taken away if they didn't perform to standards?

That's the thought behind a recent experiment that tested the psychology of loss aversion to incentivize teacher improvement, in which one group was paid in advance and asked to give back the money if their students did not sufficiently improve.

Lab studies have documented the power of this concept, that "when somebody loses a dollar that hurts a lot more than the satisfaction they gain when they get an extra dollar," explains one of the study's authors, John List, a professor of economics at the University of Chicago.

In a randomized experiment, List and his colleagues - Harvard's Roland Fryer, University of Chicago's Steven Levitt, a co-author of Freakonomics, and UC San Diego's Sally Sadoff - randomly selected teachers to participate in a merit pay scheme at nine K-8 public schools in Chicago Heights. Divided into two groups, the "gain" group was promised a reward of up to $8,000 at the end of the school year depending on the percentile improvement in their student test scores. The "loss" group was given $4,000 upfront and signed a contract saying they would pay back any rewards they didn't earn at the end of the year, or they could keep the money plus a bonus up to $8,000 total, depending on their teaching success.

"The only thing that differed between those two groups was the framing of the reward as a loss or gain," explains Sally Sadoff, assistant professor at the Rady School of Management, University of California, San Diego.

Students whose teachers were part of the "loss" group gained "up to 10 percentile points and seven percentile points on average" in their test scores, says Sadoff.

Workplace incentives

"This is a very novel concept," List says about applying loss aversion psychology in a business context.

When asked why employers haven't experimented or implemented such a strategy to incentivize their employees, he says "I don't think they realize how important loss aversion is to people. I don't think businesses have a good handle on the power of this approach."

He does admit, however, that once they full understand this idea, many employers' gut reaction is that they could never take money away from their employees - even if they believe loss aversion has merit.

"Loss aversion has been well documented in lab studies and there are suggestions that it influences people's financial decision-making. So it has been found in a lot of areas, but it hasn't really been applied in the context of incentive pay. But we think it has a lot of potential there," says Sadoff.

List believes the concept could translate to a corporate setting to promote business goals and increase productivity, such as for employees in a sales division. In order to apply, though, he insists there be some observable metric, such as widget production or services sold, to measure employees' progress.

In a corporate setting, List still suggests having employees sign a contract, but recommends deducting the amount from payroll or future raises. He believes this would be just as powerful a loss for employees based on research he conducted at a Chinese manufacturing plant.

Based on weekly quotas for factory employees who produced GPS systems and laptop computers, the company either promised a bonus at the end of the week or offered a bonus with the threat of taking it away if goals were not met.

In this experiment, no money was given up front. Instead, List told the workers that the bonus was theirs, but if they didn't perform to expectations, they wouldn't receive that bonus at the end of the week.

"It was all about framing. There wasn't any physical gift of money; we just told them that they provisionally had it. That was powerful enough," says List.

"The workers that received the [offer of] money up front and were threatened to have it taken away produced anywhere from 1% to 5% more than the people who received a typical bonus. It was over a six month period; it had lasting productivity effects," List explains.

Wellness applications

Loss aversion could also engage workers to participate in wellness programs. Employers could use the premise to keep employees engaged in a weight loss program, for example, using an individual or team framework.

"There's some suggestive evidence that if you combine the concept of loss aversion with teams, it's even more effective. Especially in a corporate setting, you may not want to pit employees against each other, [but rather] tap into peer pressure and the productivity of teams," explains Sadoff.

For some employees, the pressure of the very incentive could be too much.

"One reason why loss aversion works, probably, is because it carries with it a psychological burden. Teachers did not want to be in the loss group," says Sadoff. "I think they are very sensitive to this idea of having the money and not wanting to lose it, which is exactly what we're counting on."

In fact, 69% of teachers reported they hadn't spent any of the money in March. Some even asked if they needed to deposit the check and said they would rather receive the money at the end of year if they had earned it.

"They put [the money] aside. I think that in their minds, this was a separate pot of money they didn't want to touch," explains Sadoff.

Sadoff explains loss aversion is effective because people are more sensitive to its implications and will therefore increase their productivity.

The question that remains unanswered is whether employee morale suffers and is worth the productive uptick.

In experiments with summer laborers on Midwest farms, List says that the workers in the group incentivized by loss aversion were less likely than those in other groups to return the following year."Some people may be averse to the incentive scheme and might leave the job. That's a potential pitfall you need to think carefully about," advises List.