Pay Enough, Don't Pay Too Much or Don't Pay at All? The Impact of Bonus Intensity on Job Satisfaction

This paper attempts to examine the effect of the intensity of financial incentives (i.e. the proportion of workers' salary that is tied to bonuses) on job satisfaction. Understanding the influence of monetary incentives on job satisfaction is important given that the composition of an employee's remuneration package is an integral element of his/her overall working conditions. According to the standard microeconomic paradigm, in long‐run equilibrium one would not expect to observe any differences in the marginal utilities of comparable workers under fixed or variable payment schemes. This should hold since the expected value of the higher wages paid under performance‐related pay (PRP) should be just sufficient to compensate for the additional earnings risk and the disutility of extra effort. However, once the standard assumptions of the agency model are relaxed, and psychological arguments such as those of motivation crowding out theory (Frey and Jegen, 2001) are taken into account, it is expected that PRP is likely to have a non‐negligible impact on job satisfaction. To the extent that incentive schemes allow for optimization of effort, facilitate worker autonomy and enhance self‐determination they should increase job satisfaction, other things equal. Yet increasing earnings risk, crowding out of the inherent pleasantness in performing one's job and lower morale can lead to disgruntled employees. Based on the above reasoning, a number of previous studies have focussed on the impact of the incidence of PRP on job satisfaction (Drago et al., 1992; McCausland et al., 2005; Heywood and Wei, 2006; Green and Heywood, 2008; Artz, 2008; Pouliakas and Theodossiou, 2009). This masks the possibility that the utility of workers may vary according to the magnitude and intensity of incentives, as suggested by the experiments of Gneezy and Rustichini (2000[a][b]) and Pokorny (2008). An important common element of the above experiments is that “small” incentives are likely to exert a negative effect on behaviour (with discontinuity close to zero), while for high powered rewards (or punishments) the standard price effect is expected to prevail. This paper attempts to test these contrasting hypotheses by looking beyond the mere incidence of incentive pay and examining the impact of the intensity of incentives on job satisfaction instead. Specifically, 10 waves (1998–2007) of the British Household Panel Survey (BHPS) are used to investigate the ceteris paribus association between the intensity of bonus/profit‐sharing payments, the dynamic change in bonus status and the utility derived from work. After controlling for individual heterogeneity biases, it is shown that job utility rises only in response to ‘generous’ bonus payments, primarily in skilled, non‐unionized, private sector jobs. Evidence is also presented that revoking a bonus from one year to the next is likely to have a detrimental impact on employee utility, and that over time job satisfaction tends to diminish as employees potentially adapt to the payment of bonuses (Georgellis and Tabvuma, 2010). The findings of the paper are therefore consistent with previous experimental evidence, suggesting that employers wishing to motivate their staff should indeed “pay enough or don't pay at all”.