Using money to motivate bosses to improve company performance doesn't always pay off for organizations, new research finds.
While incentive compensation for managers is becoming more popular with many businesses, not all company leaders respond positively to performance-based pay, found a study recently published in the Journal of Organizational Behavior.
Companies think that if they provide managers with incentive pay, which is closely related to firm performance, then managers will take more risks, said Joyce Cong Ying Wang, one of the study's authors and a doctoral student at the University of Texas at Dallas. However, the research shows that such payment doesn't always pan out like companies expect.
The study's authors found that the level of career ambition and task attention a manager has is really what drives the effectiveness of incentive pay.
"We found that managers with higher career ambition will be more responsive to incentive pay by taking more risks," Wang said in a statement.
The researchers also discovered that managers who are very attentive to tasks also take more risks when offered incentive pay. [Does Upbringing Impact CEO Risk Taking? ]
"They tend to invest more strategically, and they also are more likely to change strategies," Wang said.
For the study, researchers created a model and tested it using a computer-based simulation with part-time MBA students who work as managers in companies. The students were presented with a business scenario and had to make strategic decisions.
In addition to uncovering the types of managers for whom incentive pay works best, the study also revealed that the financial status of the company plays a role in the strategy's performance. Researchers found that incentive pay does not work as well when a company's performance grows as when performance declines.
The study's authors said the research shows that businesses need to design compensation plans according to the types of managers they have, and not just blindly give uniform incentive pay to these managers.
"Leaders really need to know the manager, and design the package accordingly," Wang said. "If the manager is ambitious and attentive to tasks, then it's appropriate to give them performance-based pay to incentivize them to take more risks."
Overall, organizations need to understand that incentive compensation isn't a one-size-fits-all tool, said Wang.
"Companies need to provide this kind of compensation package according to individual characteristics and also according to context," Wang said.
The study was co-authored by Daniel Han Ming Chng, an assistant professor at the China Europe International Business School.