Crowding-Out Effect: The Wrong Incentives Erode the Right Motives

The crowding-out effect refers to the phenomenon where external incentives, such as monetary rewards, strict regulations, or performance-based evaluations, diminish an individual’s intrinsic motivation to perform a task. This effect is particularly relevant in behavioral economics and psychology, as it highlights how well-intended interventions can have unintended negative consequences.

The underlying mechanism of the crowding-out effect is that extrinsic incentives shift the individual’s perception of their task from being internally motivated (driven by personal satisfaction, curiosity, or ethical commitment) to externally controlled. When individuals feel that their autonomy is undermined, they may become less engaged, less creative, and more focused on meeting external expectations rather than acting in alignment with their intrinsic values and professional judgment.

The Self-Determination Theory (Deci & Ryan, 1985) provides a theoretical foundation for the crowding-out effect, emphasizing that autonomy, competence, and relatedness are essential for sustaining intrinsic motivation. When external incentives replace or override these psychological needs, motivation deteriorates.

This text is part of the series on decision governance. Decision Governance is concerned with how to improve the quality of decisions by changing the context, process, data, and tools (including AI) used to make decisions. Understanding decision governance empowers decision makers and decision stakeholders to improve how they make decisions with others. Start with “What is Decision Governance?” and find all texts on decision governance here.

What is the Empirical Evidence for the Crowding-Out Effect?

Empirical research supports the idea that excessive reliance on external incentives can lead to unintended consequences. Below are several key studies that illustrate the crowding-out effect:

• Deci (1971) Experiment on Monetary Rewards: One of the earliest studies demonstrated that participants who were paid to solve puzzles spent less time on them voluntarily when the payments stopped, compared to those who were never paid. This suggested that monetary compensation reduced their intrinsic motivation to engage in problem-solving.
• Frey and Jegen (2001) Meta-Analysis: A comprehensive review of studies found that financial incentives tend to undermine intrinsic motivation in tasks that require creativity, ethical judgment, and social responsibility.
• Gneezy & Rustichini (2000) Study on Fines and Compliance: A study on daycare centers found that imposing a fine for late pickups led to an increase in late arrivals by parents. Instead of reinforcing the ethical obligation to be punctual, the fine transformed punctuality into a transactional decision, reducing parents’ intrinsic responsibility.
• Ariely et al. (2009) Study on Performance-Based Incentives: In experiments conducted in India, high-stakes monetary rewards reduced performance in cognitive tasks, suggesting that excessive external pressure impaired participants’ ability to think creatively and solve complex problems.

These findings illustrate that financial or performance-based incentives can shift individuals’ focus from internal motivations (e.g., interest in the work, ethical commitment) to external rewards, ultimately reducing their engagement and effectiveness.

Which Factors Enable the Crowding-Out Effect?

Several factors contribute to the emergence of the crowding-out effect:

1. Loss of Autonomy: When individuals feel coerced or excessively controlled by external rewards or punishments, they may resist or disengage from tasks they previously found fulfilling.
2. Short-Term Focus: Extrinsic incentives often emphasize immediate performance metrics rather than long-term learning, mastery, or ethical decision-making.
3. Perceived Distrust: Strong external controls may signal to employees or decision-makers that they are not trusted to act responsibly on their own, diminishing their sense of responsibility.
4. Overjustification Effect: When extrinsic incentives dominate, individuals may attribute their actions solely to external rewards rather than personal interest, leading to disengagement once those rewards are removed.
5. Unintended Competition: Incentive structures that reward individuals based on relative performance (e.g., sales targets, performance rankings) can create a narrow focus on rewards rather than the intrinsic value of the task.

Example of Decision Governance Leading to the Crowding-Out Effect

Consider an organization implementing a strict, performance-based decision governance system where decision-makers are financially rewarded based on the number of proposals they generate each quarter. At first glance, this may seem like an effective way to encourage proactive decision-making and innovation.

However, this approach is likely to crowd out the intrinsic motivation of decision-makers by shifting their focus from making high-quality, well-reasoned decisions to simply meeting numerical targets. The following unintended consequences could emerge:

• Quantity Over Quality: Decision-makers may prioritize generating a large number of proposals instead of focusing on their strategic impact.
• Gaming the System: Employees might submit redundant or superficial proposals to meet quotas rather than genuinely improving decision-making.
• Loss of Autonomy: Decision-makers may feel they are being micromanaged, leading to disengagement or reduced willingness to take initiative beyond the rewarded metrics.
• Erosion of Ethical Judgment: Instead of making ethically sound decisions, individuals may be incentivized to focus on maximizing personal rewards.

How to Reduce the Risk of the Crowding-Out Effect?

Organizations can mitigate the risk of the crowding-out effect by designing incentive structures that reinforce, rather than replace, intrinsic motivation. Below are key strategies:

1. Promote Autonomy: Ensure that external incentives provide flexibility and allow decision-makers to exercise professional judgment rather than dictating rigid targets.
2. Use Non-Monetary Rewards: Recognition, career development opportunities, and meaningful feedback can reinforce intrinsic motivation without reducing personal engagement.
3. Balance Intrinsic and Extrinsic Incentives: Instead of purely quantitative targets, integrate qualitative assessments that encourage learning, ethical behavior, and creative problem-solving.
4. Encourage Purpose-Driven Decision-Making: Align incentives with organizational values and long-term goals rather than short-term performance metrics.
5. Minimize Controlling Language: Avoid framing incentives in a way that implies coercion or distrust. Instead, emphasize support, professional growth, and shared goals.
6. Design Incentives to Complement Intrinsic Motivators: Incentives should be seen as supportive tools rather than as primary drivers of behavior. For example, rewarding employees for mentoring colleagues reinforces both intrinsic and extrinsic motivations.
7. Foster a Learning-Oriented Culture: Encourage decision-makers to reflect on their work, learn from experiences, and improve their decision-making skills over time rather than focusing solely on meeting performance targets.

The crowding-out effect is a critical consideration in designing decision governance systems and incentive mechanisms. While external rewards can be useful in motivating behavior, they must be carefully structured to avoid undermining intrinsic motivation. Empirical evidence suggests that excessive reliance on monetary incentives or strict performance controls can lead to unintended consequences, including reduced engagement, ethical shortcuts, and strategic myopia.

By incorporating principles of autonomy, purpose-driven decision-making, and balanced incentive structures, organizations can minimize the risk of the crowding-out effect and create environments where decision-makers remain intrinsically motivated to act.

References

• Ariely, D., Gneezy, U., Loewenstein, G., & Mazar, N. (2009). “Large Stakes and Big Mistakes.” The Review of Economic Studies, 76(2), 451-469.
• Deci, E. L. (1971). “Effects of Externally Mediated Rewards on Intrinsic Motivation.” Journal of Personality and Social Psychology, 18(1), 105-115.
• Deci, E. L., & Ryan, R. M. (1985). Intrinsic Motivation and Self-Determination in Human Behavior. Springer.
• Frey, B. S., & Jegen, R. (2001). “Motivation Crowding Theory.” Journal of Economic Surveys, 15(5), 589-611.
• Gneezy, U., & Rustichini, A. (2000). “A Fine is a Price.” Journal of Legal Studies, 29(1), 1-17.