Editing Incentive (section)

=== Potential issues associated with the use of incentives in firms ===

==== Ratchet effect ====
Incentives are arguably beneficial in increasing productivity, however, they can also have an adverse effect on the firm.<ref name=":3" /> This is evident through the [[ratchet effect]]. A firm may use its observation of an employee's output level when they are first employed as a guide to set performance standard and objectives for the future.<ref name=":6">{{Cite journal |last1=Kanemoto |first1=Yoshitsugu |last2=MacLeod |first2=W. Bentley |date=1992 |title=The Ratchet Effect and the Market for Secondhand Workers |journal=Journal of Labor Economics |publisher=University of Chicago Press |volume=10 |issue=1 |pages=85–98 |doi=10.1086/298279 |jstor=2535130 |s2cid=154244118}}</ref> Knowing this, an employee may deliberately reduce their output level when first employed or hide their ability to produce at a higher output with the intent of exploiting being rewarded in the future when they strategically increase their output level.<ref name=":6" /> Best performances of employees can be limited from it. Thus, the ratchet effect can significantly diminish production levels of a firm and planned economies.<ref>{{Cite journal |last1=Cooper |first1=David J. |last2=Kagel |first2=John H. |last3=Lo |first3=Wei |last4=Gu |first4=Qing Liang |date=1999 |title=Gaming against Managers in Incentive Systems: Experimental Results with Chinese Students and Chinese Managers |journal=The American Economic Review |volume=89 |issue=4 |pages=781–804 |doi=10.1257/aer.89.4.781 |jstor=117159 |issn=0002-8282 |url=http://s3.amazonaws.com/fieldexperiments-papers2/papers/00038.pdf}}</ref>

==== Crowding-out effect ====
Additionally, in the 1970s psychologists began exploring the relationship between extrinsic and intrinsic motivation whilst economists were simultaneously studying the "crowding-out" effects of monetary incentives. This came as a result of Richard Titmuss' 1970 publication, "The Gift Relationship", which explained how the constant use of extrinsic incentives can result in conflict with intrinsic motivators and lead to the desired behavior being "crowded out".<ref name="auto5">{{cite journal |last1=Gneezy |first1=Uri |last2=Meier |first2=Stephan |last3=Rey-Biel |first3=Pedro |title=When and Why Incentives (Don't) Work to Modify Behavior |journal=Journal of Economic Perspectives |date=Fall 2011 |volume=25 |issue=4 |page=192 |doi=10.1257/jep.25.4.191 |doi-access=free }}</ref> In his publication, Titmuss argued that the use of monetary incentives was disrupting social norms around the idea of voluntary contribution and would ultimately have a crowding-out effect. He acknowledged that if the incentives are large enough, they are more likely to offset crowding-out effects (at least in the short run while the incentives are being offered). However, Titmuss noted that making the incentives too large could also have an adverse effect due to the possibility of negative inferences being drawn from the size of the incentives.<ref>{{cite journal |last1=Ariely |first1=Dan |last2=Gneezy |first2=Uri |last3=Loewenstein |first3=George |last4=Mazar |first4=Nina |title=Large Stakes and Big Mistakes |journal=The Review of Economic Studies |date=2009 |volume=76 |issue=2 |pages=451–469 |doi=10.1111/j.1467-937X.2009.00534.x |url=https://rady.ucsd.edu/_files/faculty-research/uri-gneezy/large-stakes.pdf |access-date=3 May 2022 |archive-date=March 26, 2023|archive-url=https://web.archive.org/web/20230326043518/https://rady.ucsd.edu/_files/faculty-research/uri-gneezy/large-stakes.pdf|url-status=live}}</ref> Crowding-out effects can also occur when temporary incentives are removed in the long run. In the workplace, the complete removal of extrinsic incentives can result in employee effort levels being lower than they were when the incentives were offered, thereby hindering motivation and performance.<ref name="auto5"/>

==== Stock options ====
Incentives are not always effective at aligning employees' incentives with those of the firm.<ref>{{Cite book |last1=Chiappori |last2=Salanié |year=2003 |chapter=Testing contract theory: a survey of some recent work |editor=M. Dewatripont |editor2=L. Hansen |editor3=S. Turnovsky |title=Advances in Economics and Econometrics |volume=1 |pages=115–149 |place=Cambridge |publisher=Cambridge University Press |doi=10.1017/CBO9780511610240.005 |isbn=9780511610240 |s2cid=3067063 |url=http://crest.science/RePEc/wpstorage/2002-11.pdf}}</ref> For example, some [[corporation|corporate]] policies popular during the 1990s aimed to encourage productivity have led to failures as a result of unintended consequences.<ref name=":7">{{Cite book |last=Jain |first=Abha |title=Sports Psychology |publisher=Friends Publications |year=2019 |isbn=978-93-88457-75-0 |location=India |pages=215}}</ref> Moreover, providing [[stock option]]s was intended to boost [[CEO]] productivity through offering a remunerative incentive to align the CEOs' interests with those of the shareholders to improve company performance.<ref name=":7" /> However, CEOs were found to either make good decisions which resulted in a reward of a long-term price increase of the stock, or were found to have fabricated the accounting information to give the illusion of economic success and to retain their incentive-based pay.<ref name=":7" /> Furthermore, it has been found to be extremely costly for firms to incentivize CEOs with stock options. Nevertheless, firms are forced to pay substantial amounts of money to ensure that CEOs act in the best interest of the firms.<ref name=":3" />

==== Conflicts generated by pay variance ====
Incentives can have a bipolar effect on the company.
On the one hand, the company's incentives to employees may create a pay gap. For example, low-paid employees may reduce their production or contribution to the company. Low-paid employees and high-paid employees may not be able to communicate and cooperate effectively, causing low-paid employees to gradually lose their enthusiasm for work.<ref>{{cite journal |last1=Breza |first1=Emily |last2=Kaur |first2=Supreet |last3=Shamdasani |first3=Yogita |title=The Morale Effects of Pay Inequality* |journal=The Quarterly Journal of Economics |date=10 October 2017 |volume=133 |issue=2 |pages=611–663 |doi=10.1093/qje/qjx041|doi-access=free }}</ref> Firms should provide a fair amount of incentives for both low-paid and other employees, incentives for low-paid workers can be breaks rather than monetary incentives. Motivating employees with financial rewards may make a difference. That's because if the company is profitable in the first year, it may have plenty of bonuses to hand out to employees. However, if the company makes less money in the second year than it did in the first year, the company may not be able to give employees the same bonuses as in the first year even though they put in the same effort. This also reduces employees' motivation to work. Therefore, incentives may be counterproductive. Firm can provide other types of incentives rather than monetary incentives, such as promotion or vacation breaks for high-performing employees.