To avoid the charge that pay is distributed on the basis of subjective judgments or favoritism, pay-for-performance systems tend to rely on objective indicators of performance.6 This may lead some managers to use whatever “objective” data are available to justify pay decisions. Unfortunately, the more closely pay is tied to particular performance indicators, the more employees tend to focus on those indicators and neglect other important job components that are more difficult to measure. Consider the following examples:

• ▪ In some school systems where teachers’ pay has been linked to students’ scores on standardized tests, teachers spend more time helping students do well on the tests than helping them understand the subject matter. Teachers report that they fear negative evaluations for themselves and their schools unless they teach to the test.7

• ▪ Many blame the meltdown of the financial system in the United States at the end of the prior decade to executive bonus systems at companies such as Lehman Brothers, Merrill Lynch, and Bear Stearns. These bonus systems pegged executives’ and analysts’ incentives to the achievement of challenging financial targets, inducing these individuals to make risky, speculative investments and to engage in creative financial maneuvers (so called “derivatives”) that resulted in “paper wealth,” but not much real value in terms of goods and services. This generated a situation where executives of some of these firms garnered large bonuses while their company’s debt was socialized, with the federal government becoming the “investor of last resort.” Despite these well-documented cases of imprudent risk taking in response to badly designed incentives, one still finds that the practice of taking poor risks in order to secure higher rewards is alive and well. In 2013, for instance, the British bank Barclays, one of the largest in the world, agreed to pay a $450 million settlement after its executives were found to have taken bad risks on behalf of their clients “because of a bonus system that encouraged risk taking over serving clients.”8

• ▪ Part of the reason for the scandals associated with Arthur Andersen (once one of the five largest accounting firms, with 85,000 employees) and its subsequent legal problems may have been the way its managers were rewarded for the volume of revenues generated through consulting and accounting fees. This may have led managers to poorly monitor their clients (and in some cases approve of outright fraud) for fear of losing lucrative contracts.9 Because auditing firms depend on a good reputation for their business, the legendary Arthur Andersen never recovered from the scandals and ended up closing its doors almost a century after its founding.

By creating pressure to produce and to “keep score,” incentives may induce employees to engage in undesirable behaviors, to cut corners, deceive, misinform, hide negative information, take more credit than they deserve, and the like. Managers may look the other way, because it could be to their advantage to preside over a unit that “meets or exceeds” targets. What starts as a matter of interpretation, or perhaps “white lies,” may eventually cross over into unethical or even illegal terrain. Several examples have recently come to light across a variety of industries, as discussed in the Manager’s Notebook, “Incentives Come to Medicine: Do They Promote Unethical Behaviors Among Doctors?” These examples are only the tip of the iceberg. The majority of cases are never reported; hence, it is difficult to know the extent of the problem.

Unfortunately, employee cynicism about company ethics and senior leadership are also on the rise. A survey showed that only 50 percent of employees believed their top executives had high integrity, and approximately the same percentage shared similar feelings about the entire organization.10 As a result, employees may unconsciously blame their employer for their own questionable behaviors or ethical lapses in order to meet incentive criteria (“they made me do it,” or “that is the way things get done around here”) rather than take full responsibility for their actions.

The experiences of Century Telephone Company clearly show that pay-for-performance systems may provoke conflict and competition while discouraging cooperation.11 For instance, employees may withhold information from a colleague if they believe that it will help the other person get ahead. Those who are receiving less than they feel they deserve may try to “get back” at those who are receiving more, perhaps by sabotaging a project or spreading rumors. Internal competition may set off rivalries that lead to quality problems or even cheating.

Factors beyond an employee’s control include the supervisor, performance of other work group members, the quality of the materials the employee is working with, working conditions, the amount of support from management, and environmental factors.12

For instance, many medical doctors in group practices now receive a substantial portion of their pay in the form of a bonus. As can be seen in the Manager’s Notebook, “Incentives Come to Medicine: Do They Promote Unethical Behaviors Among Doctors? ” these programs are generating a great deal of controversy. Doctors commonly complain that managed-care bureaucrats try to slash revenues as doctors’ overhead costs rise. As a result, the managed-care system pressures physicians to see more patients in less time. This means that nurses and pharmacists can take over some of the duties previously reserved for doctors.13 Union membership is soaring among doctors as many see such a situation as demoralizing and inequitable.14

MANAGER’S NOTEBOOK Incentives Come to Medicine: Do They Promote Unethical Behaviors Among Doctors?

Ethics/Social Responsibility

Unknown to their patients, doctors often receive incentives from pharmaceutical firms, private insurance companies, and even the federal and state governments. Some estimate that more than half of all health maintenance organizations (HMOs), accounting for 80 percent of HMO enrollees in the United States, make such payments. Incentives are cropping up in the federal Medicare program; they already exist in more than half of state-run Medicaid programs (which provide health care for low-income individuals). The United Kingdom’s state-run primary care system includes a broad-based pay for performance program for doctors.

Could incentives cloud a doctor’s judgment, tempting someone to put financial gain ahead of patient welfare? Here is a sample of controversial situations that have arisen in the wake of physician incentives.

Rewarding Hospitals for Quality Care

The U.S. federal government as well as the British Health Service are trying to set reimbursements for hospitals based on how well they do on quality measures. These reimbursements in turn will affect the income of doctors affiliated with the hospitals. Although this sounds good in theory, most physicians believe that the difficulties of accurately measuring hospital quality are insurmountable. As noted by one doctor “[quality of health care] outcomes studies require controlling for so many patient factors from genetics to diet and premorbid exercise levels that they are almost impossible to do across large populations, so that it becomes like deciding the quality of an artist’s work by the staying ability or vibrance of his paintings’ colors over time.”

Gainsharing for Doctors

Because doctors might be tempted to use more expensive procedures than are necessary, some insurance companies are providing incentives to minimize this problem. They are doing this through gainsharing plans. The idea is simple: The doctor’s practice or clinic receives a lump sum payment per year from the insurance company based on number of patients. If the doctors do not use the full amount allocated by the insurance company, at the end of the year the savings revert to the doctors in the form of a bonus. The downside? Although gainsharing may discourage unnecessary procedures and treatments, it is difficult to know the extent to which patients may receive suboptimal care, because doctors may cut corners to keep expenses to a minimum.

Doctors Paid to Prescribe Generic Pills

Some health insurance plans pay doctors $100 for prescribing a generic drug instead of a name-brand one. The rationale is that generics save money for patients, employers, and insurers. Some practitioners say it takes time to decide which drug is better for a specific patient’s health, and they feel they should be reimbursed for that effort.

Report Cards for Surgeons

Some states try to improve the quality of coronary bypass surgery by issuing report cards for surgeons who perform the procedure. Hospitals and surgeons who failed to meet standards were required to improve. An unintended result of this effort is that many cardiologists now report that it is difficult to find surgeons who are willing to operate on their sickest patients. In New York State, for instance, a survey found that almost two-thirds of cardiac surgeons responded to the report card process by accepting only relatively healthy patients for heart-bypass surgery.

What the Doctor’s Aren’t Disclosing

Researchers at Duke University were recently surprised to discover that four of five published studies on heart stents lacked an important detail required by many medical journals—whether the studies’ authors were paid consultants. When the companies funding the research were identified, stent manufacturers Johnson & Johnson, Boston Scientific, and Medtronic were named most often. Only one-quarter of the articles describing clinical trials identified who paid for the testing; top research supporters included Bristol-Meyers Squibb and Sanofi-Aventis, which comarket a drug for stent patients. Some journal editors say there’s a limit to their power to police their contributors. “I’m not a cop. I’m not the FBI,” says the editor-in-chief of the Journal of the American Medical Association.

Use of Orthopedic Devices

When orthopedic devices such as replacement hip and knee joints are brought to market, their manufacturers often hire doctors to train other doctors and medical sales reps on how to use them. These are often the same doctors who have already served as consultants to help develop the devices. Some companies spend more than $1 million a year compensating surgeons who use their device instead of another manufacturer’s, even though the devices are all very similar in performance.

Sources:Based on Andorno, N. B., and Lee, T. H. (2013, March). Ethical physician incentives—from carrots and sticks to shared purpose. New England Journal of Medicine, 980–982; Schmidt, H., Asch, D., and Halpern, S. D. (2013). Fairness and wellness incentives: What is the relevance of the process-outcome distinction? Preventive Medicine, 55(1), 118–123; www.pbs.org . (2011). As Medicare moves toward pay-for-performance, study highlights need for better data; www.sciencedaily.com . (2011). Pay for performance programs may worsen medical disparities; Rangel, D. (2011). When pay for performance does not work and may impair patient care. www.kevinmed.com ; Gemmil, M. (2008). Pay-for-performance in the US: What lessons for Europe? Eurohealth, 13(4), 21–23; Fuhrmans, V. (2008, January 24). Doctors paid to prescribe generic pills. Wall Street Journal, B-4; Jauhar, S. (2008, September 9). The pitfalls of linking doctor’s pay to performance. New York Times, D-5–D-6; Weintraub, A. (2008, May 26). What the doctor’s aren’t disclosing. BusinessWeek, 56; Feder, B. (2008, March 22). New focus of inquiry into bribes: Doctors. New York Times, B-1.▪▪

As we saw in Chapter 7, a ssessing employee performance is one of the thorniest tasks a manager faces, particularly when the assessments are used to dispense rewards.15 At the employee level, the appraiser must try to untangle individual contributions from those of the work group while avoiding judgments based on a personality bias (being a strict or a lenient rater), likes and dislikes, and political agendas. At the group or team level, the rater must try to isolate the specific contributions of any given team when all teams are interdependent.16 Appraisers experience the same difficulties in attempting to determine the performance of plants or units that are interrelated among themselves and with corporate headquarters. In short, accurate measures of performance are not easy to achieve, and tying pay to inaccurate measures is likely to create problems. For instance, pay-for-performance programs for teachers are criticized for focusing on narrow criteria of student achievement (such as test scores) while ignoring more general problems that limit student learning such as crowded classrooms, lack of up-to-date equipment, and dysfunctional families.

Once implemented, a pay-for-performance system creates a psychological contract between the employee and the firm.17 A psychological contract is a set of expectations based on prior experience, and it is very resistant to change.

Breaking a psychological contract can have damaging results. For instance, when a computer-products manufacturer changed the terms of its pay-for-performance program three times in a two-year period, the result was massive employee protests, the resignation of several key managers, and a general lowering of employee morale.

Two other problems may arise with respect to the psychological contract. First, because employees feel entitled to the reward spelled out in the pay-for-performance plan, it is difficult to change the plan even when conditions call for a change. Second, it is sometimes hard to come up with a formula that is fair to diverse employee groups.

Employees often do not believe that pay-for-performance programs are fair or that they truly reward performance, a phenomenon called the credibility gap. 18 Some studies indicate that as many as 75 percent of a typical firm’s employees question the integrity of pay-for-performance plans.19 If employees do not consider the system legitimate and acceptable, it may have negative rather than positive effects on their behavior. A big part of the problem is that, to defend their egos, employees who receive lower performance-related payments than others tend to blame management rather than themselves. Unless an effective performance appraisal and feedback system is in place (see Chapter 7), incentive programs are unlikely to produce the expected results.

Going back to the case of teachers noted earlier, in a well-intended attempt by the British government to reward good teaching, “superhead” teachers can earn up to $140,000 a year, a big change from a system where teachers were stuck at the $46,000-per-year level. The “bumper” pay raises are linked to exam results, lower truancy rates, and improved mathematical and literacy rates. Even though no teacher would receive a pay cut (that is, there is only upside potential to earn more money), teachers’ unions have vigorously opposed the program. They argue that teachers cannot always be blamed if pupils do badly and that the bonus received may depend more on luck than performance.20

Pay-for-performance systems may lead to greater productivity but lower job satisfaction.21 Some research suggests that the more pay is tied to performance, the more the work unit begins to unravel and the more unhappy employees become.22 For instance, Lantech (a small manufacturer of machinery in Kentucky) experimented with various incentive programs, yet the company dropped them altogether after the CEO and founder Pat Lancaster concluded that the competition for bonuses means that managers may have to spend much of their time in conflict resolution.23

Pay-for-performance programs may push employees to the point of doing whatever it takes to get the promised monetary reward, and in the process may stifle their talents and creativity. Thus, an organization that puts too much emphasis on pay in attempting to influence behaviors may reduce employees’ intrinsic drives, or internally driven motivation. One expert argues that the more a firm stresses pay as an incentive for high performance, the less likely it is that employees will engage in activities that benefit the organization (such as overtime and extra-special service) unless they are promised an explicit reward.24 Exhibit 11.1 illustrates how extrinsic motivation may crowd out intrinsic motivation when incentives are introduced.