So what’s the best way to motivate employees to not only work hard but also take the kinds of risks that could really move the needle for an organization?
This question was the starting point for new research by Jeroen Swinkelsprofessor of management and strategy at the Kellogg School and co-author Hector Chade, professor of economics at Arizona State University.
Through mathematical modeling and analysis, they found that the ideal approach favors rewarding high-value outcomes in grand fashion while being kind to failure.
“The way you get people to work hard is to have big rewards for big results,” says Swinkels. “And the companies that are also good at managing the failure process so that it’s graceful and survivable, and good at taking advantage of the projects that then succeed, are companies that are going to thrive.”
The problem of moral hazard
Employers have a lot to consider when designing compensation contracts with their employees.
After all, companies generally want their employees to work hard, while employees may prefer to avoid. A contract that simply pays employees for showing up presents what economists refer to as moral hazard, where employees are not exposed to the consequences of a bad job. Hence the allure of redirecting some of that risk back to employees, rewarding their success and punishing their failure.
But this raises a problem from the worker’s side because there are times when their projects fail even when they work very hard.
In light of this risk, companies that choose to punish failure often need to pay well enough to attract employees.
“The classic moral hazard model, which has been hugely influential and has had a huge impact, is where the business faces this big trade-off,” says Swinkels, “that if as an employer I put you in harm’s way, they might make you work hard, but your average compensation must be very high.”
With this classic moral hazard model in mind, companies “will punish low performance, be fairly good to average performers, and be very good to high performers,” he says.
A more complex scenario
The real world, however, can be more complex than the classic moral hazard problem allows.
Take, for example, the case of Mary Barra, CEO of General Motors. If all GM wants from her is to work hard, then they will punish her or possibly fire her if the company’s stock is low, be nice to her if the stock is at an acceptable level, and make her rich if the stake is high. .
“The problem is that neither for Mary Barra nor for many employees is this the very right problem that the organization is trying to solve,” says Swinkels.
That is, many companies today want their employees not only to work hard, but also to take the initiative in high-risk tasks that have the potential to provide significant value to the company. In Barra’s case, that could mean GM’s transition from natural gas vehicles to electric vehicles or unlocking a new market — projects that could propel the company’s stock price to new highs. However, those same projects, if not successful, could cause the stock price to fall and potentially cost Barra her job.
Reward the ends
To better understand how companies can motivate employees to work hard and take initiative in high-risk, high-reward projects, Swinkels and Chade turned to mathematical modeling.
They created a model that simulates this multidimensional version of the moral hazard problem. But unlike pastresearchtheir new model also takes into account the possibility that employees can “play it safe” by choosing middle-of-the-road projects that are unlikely to fail but also unlikely to have a large impact on the organization.
Through a formal analysis of the model, the economists determined that the key to an optimal employer-employee contract is an incentive structure that—compared to the standard prediction—yields steeper rewards for high-value outcomes but less punishment for low-value outcomes.
In other words, an organization that hopes to elicit both hard work and initiative should reward employees generously when they succeed and be lenient when they don’t. And the incentive for high-value results should be so compelling that it lures workers away from mediocre work.
This is different from the motivational patterns that emerge in a classic moral hazard model, where failure is harshly punished and mediocrity is more harshly rewarded.
“Compared to the standard model, you want to reward the edges,” says Swinkels. “You punish failure less than you used to. You reward big hits more than you used to. But you also have to make it so that merely performing adequately is a little less comfortable and not as rewarding for employees as it used to be.”
Impact matters
This dynamic is reflected in many work environments where success is sharply rewarded while failure is thinly punished, including a scenario that hits close to home for Swinkels.
“If all the university cared about was how hard I work, then they can very effectively make me work hard by punishing failure,” explains Swinkels. “But that’s not all the university wants. he wants me to pursue important high-risk research projects and work very hard on them.”
The university has great achievements with very high respect. The kind of work that wins Nobel Prizes or gains admission to distinguished societies has a serious positive impact on the university. And it can be worth an extraordinary amount—billions of dollars in the case of Lyrica, a blockbuster drug that came from Northwest Research, says Swinkels. If the researcher behind Lyrica had written several mediocre papers, it would have been of little value to the university and society at large.
“And so from the institution’s point of view, the difference between writing nothing this year and writing something mediocre doesn’t matter that much,” he adds. “But the difference between writing something mediocre and writing something that has serious intellectual impact is a big one.”
And the institution’s incentive structure reflects these values. For junior faculty, low research output and mediocre output are similarly rewarded—and neither leads to tenure. The difference between doing mediocre and writing important papers, however, is that you get tenure. For tenured faculty, who are somewhat shielded from the consequences of failed research, high-impact work can lead to significant professional success and rewards.
Google, Amazon, Netflix
In addition, the model’s optimal incentive structure validates the approach that many large companies have already been using for years.
Google, for example, found success with its once-secret innovation lab, Google X, which not only offered huge paydays for breakthrough innovation, but also gave bonuses to teams whose work was canceled. And Amazon CEO Jeff Bezos has attributed its growth in large part to its willingness to fail.
“Google and Amazon live and breathe this idea,” says Swinkels. “They have a culture of celebrating failure. And the model helps us understand why they might think it’s a good idea.”
Instead, one company that could perhaps benefit from these research findings, Swinkels points out, is Netflix.
Unlike network TV viewers, where an unpopular program can directly prompt someone to change the channel, Netflix viewers, even when they encounter an unpopular one, tend to stay on the platform and simply choose to watch a different show.
This safety net of viewers is pushing Netflix to a big rise. The difference between a viewer who likes a show and actually loves a show is incredibly valuable because it can keep current customers and attract new ones.
So for Netflix, “the right thing to do with a show is to be innovative and creative,” Swinkels says. “If that creates a show that people love, that’s fantastic. And if it happens to misfire and create a show that people just don’t connect with, it’s not too bad. Netflix clearly understands this. It’s public to want performances that take risks and to be comfortable with failure.”
“But when the rubber hits the road,” he continues, “most of the work Netflix puts out looks generic. suggesting they may not be taking enough risks, even though they know they should.” And, Swinkels says, it turns out that Netflix is very quick to fire people, so “maybe that leads too many people to be a little too cautious.”
While Netflix can offer huge incentives for high-value results, if they’re heavy on failure, it can limit their ability to score at home.
“If the cost of success is that sometimes we try something new and it doesn’t work out, that’s a cost we should be willing to bear,” says Swinkels. “We’ll just have to get more comfortable with small setbacks. It’s just a natural part of being good at what you do.”
