Why Financial Incentives Can Reduce Motivation

July 8, 2019 / by Lydia Stevens

Whether it be in the office or at school, people tend to think financial incentives would make them or their team work harder. If only you could get paid directly for putting in that extra effort, and perhaps your overall performance would improve as a result of the additional motivation. And sometimes, especially when the reward is big enough, that is what happens. The opportunity to earn more money for improved performance presents itself, and thus, performance improves.



The plot twist, however, is due to the extrinsic nature of financial incentives. For example, if a manager handed out gift cards as rewards for good behavior, then the department will be largely motivated by something outside of themselves. Often, they become dependent on these incentives to do something that would otherwise be expected and completed using internal or intrinsic motivation


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The Theory

Here's where motivation crowding theory comes in. Bruno S. Frey is an economist and researcher who wrote extensively on the topic of motivation crowding theory and specifically on the “crowding-out effect.” The concept describes a surprising phenomenon where offering financial rewards leads to decreased motivation and reduced performance due to the “crowding-out” of intrinsic motivation by extrinsic motivating factors. When this idea was first argued by Titmuss in his 1970 book The Gift Relationship, there was a general lack of empirical evidence backing up his theoretical yet quickly popular position. Since then, however, there have been a considerable number of studies looking at the “crowding-out effect” that demonstrate the actual impact of financial incentives on behavior modification.


The Evidence

Today, there is more empirical evidence gathered on motivation crowding theory and examples of crowding-out than can ever be discussed in a single article. The crowding-out of intrinsic motivation can be seen nearly everywhere, from academic achievements to learning an instrument to volunteer work.

One study by Levitt, List, and Sadoff (2016) looked at motivation crowding in an academic context by paying high school freshman in Chicago for meeting a certain achievement standard based on grades, attendance, and need for disciplinary actions such as suspension. They had two research groups, one who received a $50 monthly reward for reaching the standard and another who was entered in a monthly lottery to win $500 (with a 10% chance of winning) if the standard was achieved. In both treatments, it was only the students on the border of success or failure who were significantly impacted by the financial incentive.

Though the short term results show these students’ improved performance, by the time they reached their junior and senior years in high school, the motivation was no longer there. Therefore, graduation rates were unaffected. The payment program was only in place for the eight months making up the freshman year, and by the end of the sophomore year, any detectable performance improvements were gone. Ultimately, this demonstrates the short term quality of extrinsic motivation from financial incentives, in particular once the incentive has been removed.

Similarly, you can imagine a parent who tries to pay their child as a reward for reading books struggling down the road when they cut off the funds and subsequently the child has no internal desire (a.k.a. intrinsic motivation) to read.




In an office context, the crowding-out effect could quickly become a company-wide issue. Financial rewards might seem to motivate some employees in the short term, but what happens when the HR budget changes or an employee who has gotten used to monetary rewards doesn’t meet the standards one month? The expected result, based on research evidence, is the intrinsic motivation an employee has to work hard and meet company goals will have been crowded out by the extrinsic motivation provided by extra money. Very quickly, the lack of financial incentive can feel like a punishment. Employees might struggle to connect with the piece of themselves that makes going to work feel meaningful, contributing to their willingness to put in solid effort.


The Solution

As Levit, List, and Sadoff discuss in their paper, there’s no questioning the value of growing human capital, a fundamental part of any company’s continued success. The key, however, lies in the way organizational bodies like schools and businesses try to enhance human capital by molding behaviors and improving performance. Many organizations still hold on to the financial incentive technique, hoping it will motivate employees and change behaviors in order to add economic value via human capital. But as the research demonstrates, this is typically not the best way to go.

In their last sentence, the researchers argue “we believe interventions aimed at building human capital in ways that allow for individualization hold the greatest promise.” Because the issues with financial incentives are clear, it is now time to push forward and consider ways to support an individual’s intrinsic motivation. From sharing encouraging recognitions to highlighting the higher purpose behind the work, it’s more important than ever to focus on human relationships and making others feel capable and important so they can sustain success and happiness throughout their lives.


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Topics: Recognition, Employee Recognition

Lydia Stevens

Written by Lydia Stevens

Lydia is the Digital Marketing Manager at Preciate. A recent college graduate, she brings youthful Gen Z energy to the team while working towards our company vision of bringing the recognition and relationship-building experience to as many people as possible.