Incentives: Negative Consequences of Incentive Mechanisms

Let’s assume that decision governance in a firm includes an incentive mechanism which is designed to financially reward decision makers in proportion to the number of options they consider in a decision situation. What could go wrong? While this is an odd example, in that it is unlikely it would ever be implemented, it is reasonable to expect that in some cases, individuals may believe that the number of options they consider does correlate with their performance assessments, and eventually, their career path and compensation. The example simply makes this causal link simple and obvious, for the sake of discussion.

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.

Academic research has identified several criticisms of incentive mechanisms, particularly in economic, managerial, and organizational contexts. These criticisms revolve around their unintended consequences, misalignment with long-term objectives, and their impact on intrinsic motivation. Below are the primary concerns.

1. Distortion of Behavior and Goal Misalignment

Incentive mechanisms can lead to goal displacement, where individuals prioritize rewarded behaviors at the expense of broader objectives (Kerr, 1975). This occurs when financial incentives focus on a specific aspect of performance, leading individuals to adjust their behavior in ways that may not align with the organization’s overall goals. Instead of fostering well-rounded decision-making, such mechanisms encourage decision-makers to optimize for the rewarded metric alone. In the context of rewarding decision-makers based on the number of options considered, this could result in individuals generating more options than necessary, even when many of them are not useful. While the intention behind such incentives is to promote thorough decision-making, they may lead to inefficiencies, where quantity is emphasized over quality. This could slow decision processes, increase cognitive load, and introduce complexity within organizations, ultimately reducing decision effectiveness.

• A system that financially rewards decision-makers in proportion to the number of options they consider may encourage excessive option generation rather than careful evaluation of viable alternatives. This could lead to inefficiencies and decision paralysis rather than improved outcomes.

2. Crowding Out of Intrinsic Motivation

According to self-determination theory (Deci & Ryan, 1985), monetary incentives can reduce intrinsic motivation, particularly in tasks requiring creativity, problem-solving, or social responsibility. When individuals engage in decision-making because they find the process rewarding, introducing financial incentives can shift their motivation from intrinsic to extrinsic sources. This phenomenon, known as motivation crowding, occurs when an externally imposed reward system replaces an individual’s natural interest or sense of responsibility with a transactional mindset. Over time, reliance on extrinsic rewards can diminish commitment to quality decision-making. In a firm where decision-makers are rewarded based on the number of options they consider, employees may begin to view option generation as a way to increase financial gain rather than an integral part of effective decision-making. This can lead to superficial compliance, where decision-makers fulfill incentive requirements but do not engage fully in evaluating the best possible choices for the organization.

• By linking financial rewards to the number of options considered, decision-makers may focus on quantity over quality, potentially reducing their motivation to carefully assess each alternative and make well-informed decisions (Frey & Jegen, 2001).

3. Gaming and Manipulation

Individuals and organizations sometimes find ways to exploit incentive structures without improving performance in meaningful ways. This occurs when an incentive system creates opportunities for individuals to maximize rewards through strategic manipulation rather than genuine contribution. Gaming behavior emerges when employees learn how to meet performance metrics without necessarily enhancing actual decision quality. This can be particularly challenging in contexts where numerical targets, such as the number of options considered, are rewarded. Decision-makers may inflate the number of options they present, adding choices that have little relevance or feasibility simply to meet incentive thresholds. This behavior does not contribute to better decisions but instead increases complexity, leading to inefficiencies and wasted time. Instead of encouraging thoughtful decision-making, incentives structured in this way may encourage superficial box-checking that shifts focus away from meaningful deliberation.

• Gaming performance metrics, where decision-makers artificially inflate the number of options considered to maximize rewards without genuine deliberation (Gneezy et al., 2011).
• Superficial compliance, where irrelevant or unfeasible options are included in the decision-making process simply to meet incentive criteria rather than improve decision quality.

4. Risk-Taking and Ethical Considerations

High-powered incentives, such as financial rewards tied to option quantity, can encourage risk-taking, where individuals add unnecessary or uncertain alternatives to decision sets to maximize compensation. When individuals are rewarded based on the volume of options considered rather than the quality of their choices, they may begin to propose extreme, impractical, or high-risk alternatives to meet their metrics. This situation introduces a form of moral hazard, where decision-makers are incentivized to act in ways that may not align with the organization’s best interests. Increased risk-taking can be problematic in industries where sound decision-making is essential, such as finance, healthcare, or engineering. Additionally, when financial gain is linked to a metric that does not reflect real performance, ethical considerations may be overlooked, and decision-makers may prioritize personal incentives over the organization’s well-being.

• This structure may also create moral hazard, where decision-makers focus on expanding the set of options without considering the consequences of poor decision-making (Jensen & Meckling, 1976).

5. Measurement and Implementation Challenges

Designing effective incentives requires measurable performance indicators, but assessing the value of considering multiple options is inherently subjective. Unlike objective performance measures, such as sales figures or cost reductions, the quality of decision-making is difficult to quantify. Simply counting the number of options considered does not provide insight into whether those options were meaningful, relevant, or useful in improving the final decision. This creates a challenge for organizations attempting to implement incentive structures effectively. Without a qualitative assessment mechanism, decision-makers may be rewarded for generating numerous low-quality alternatives rather than focusing on thoughtful and strategic deliberation. This misalignment between measurement and actual performance can lead to unintended consequences, where the wrong behaviors are encouraged, ultimately affecting decision quality.

• Poorly designed incentives can create unintended inefficiencies, such as decision-makers spending excessive time generating options rather than executing well-considered choices.

6. Short-Term Focus and Sustainability Issues

Incentive mechanisms often prioritize short-term outputs, such as the number of options considered, rather than the long-term quality of decisions. When incentives are structured around immediate and easily quantifiable metrics, decision-makers may focus on achieving those targets rather than considering long-term outcomes. This short-term focus can result in decisions that appear productive on the surface but lack depth, sustainability, or alignment with organizational goals. Additionally, constantly striving to meet arbitrary numerical targets can lead to decision fatigue and reduced effectiveness. Instead of fostering a culture of meaningful deliberation, such incentives may create an environment where decision-makers prioritize meeting immediate performance benchmarks over developing sustainable and well-informed strategies.

• This issue can lead to decision fatigue and overcomplication, where the focus shifts from strategic clarity to bureaucratic box-checking in order to meet incentive thresholds.

References

• 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., Meier, S., & Rey-Biel, P. (2011). “When and Why Incentives (Don’t) Work to Modify Behavior.” Journal of Economic Perspectives, 25(4), 191-210.
• Jensen, M. C., & Meckling, W. H. (1976). “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.” Journal of Financial Economics, 3(4), 305-360.
• Kerr, S. (1975). “On the Folly of Rewarding A, While Hoping for B.” Academy of Management Journal, 18(4), 769-783.