Equity theory and the design of your incentive scheme

Equity theory and the design of your incentive scheme

As part of the 16th annual Compensation & Benefits Forum organised by IIRME last month, I delivered a one-day workshop on how do design a recognition and retention scheme.

I mention a few motivation strategies at the outset of the workshop. The equity theory in particular holds my attention.

What is equity theory ?

The theory looks at how satisfied a person can be in (interpersonal) relationships, based on the perceived amount of effort both parties put into the relationship or transaction as well as the related results.

In short, a person compares his or her inputs and related outcomes with the inputs and outcomes achieved by others.

If the comparison is deemed equal, fairness is perceived, equity “exists” and the person will be satisfied.

If not, inequity is perceived. The person might work harder or less hard (modify their behaviour) in order to achieve equity.

Here is an excellent video description from Ben Baran on YouTube. In 8 minutes you will get a comprehensive overview as well as an example in the workplace, and if you are interested in motivation theories you should check out the other videos on his YouTube channel.



An example of how equity perception is affected by incentive design

Let’s imagine you have just designed and implemented for the first time an incentive scheme in order to motivate your employees to achieve a certain goal, for example the number of complaints solved on the phone by your call centre operators.

Here are the features of your scheme :

The average base pay of your call centre operators is 1,000 $ per month.

The current average number of complaints solved per operator per month is 95.

Here are the monthly incentive amounts they will get based on the number of complaints solved :

  • Less than 75 complaints solved : 0 $
  • 75 complaints solved : 80 $
  • TARGET : 100 complaints solved : 100 $
  • 150 complaints solved : 120 $
  • More than 150 complaints solved : 120 $

There is always a straight proportionate line of reward between 2 consecutive data points. For example, if an employee solves 88 complaints in a given month, he/she will receive a little over 90 $.

You have followed best practice in incentive design :

  • Expectations are clear and easy to communicate and measure.
  • There is line of sight because the bonus payment comes closely after the fact (not at the end of the year for something that you measure every month).
  • There is a threshold, ie a minimum performance level below which your scheme does not pay.
  • Your target achievement is a bit of a stretch at 100 complaints compared to the current actual average of 95, but it is reasonable and achievable.
  • Your target bonus payment, at 100 $ or 10% of base pay, is aligned with market practice for customer support functions.
  • You have introduced cost control by putting a cap so that you never spend more than 120 $ per month per employee.

So you’re thinking : Great ! Now let’s see productivity increase, and most importantly, let’s see how my top performers will react and increase their performance even more now that they have a financial incentive.

Well, there is a great chance that you won’t see your top performers achieve significant increase in output with the scheme.

Why ?

It all comes down to equity theory.

Your staff will see that to get 10$ less than target, they “need” to miss the target by 12 complaints per month. But to make 10$ more than target, they need to solve 25 complaints more than the goal.

In short, they will perceive that the balance/ratio of effort and output that they get for superior performance, is not as rewarding for them than that being granted to the under-performers.

As a result, they are likely to not increase their effort, or maybe even to reduce it if they think the rules of engagement are really not fair.

This is especially relevant when the % of target bonus are not very high, or when the salaries themselves are not so high and therefore the actual bonus amount is also not very high.

People don’t live off percentages. What matters to them is the actual amount that ends in their bank account at the end of the month. The absolute value of their bonus or incentive and the impact it has on their financial stability and the achievement of their dreams is important to them, not a percentage value.

When high performers see that their incentive amount is not significantly higher than that of lower performers, they are likely to modify their behaviour in order to restore balance to what they perceive as inequity.

I work in the Middle East, and in this region, there is a lot less pay differentiation than in the USA or even Europe.

For instance, in their online Compensation training with Oxford Academics, Mercer report that short-term incentives represent 8 to 10% of the total package (including benefits) in the MEA region while they represent nearly 20% in the US. And that does not include Long-Term Incentives, which are quite rare in the region but represent up to 30% of the total package of senior executives in the US but less than 2% for their MEA-based counterparts.

Pay differentiation in our region is not very prevalent, due to a culture of saving face. In the Gulf a high percentage of local Nationals are employed by their governments, who traditionally do not practice much meritocracy and pay for performance.

But talented people react the same everywhere, no matter where they come from or where they work. So next time you design an incentive scheme, try to make sure that your incentive payout really represents an incentive to drive the behaviour you are trying to promote through your scheme. Try to put yourself in the shoes of the recipient, and look at he absolute numbers.


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