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Dirty, Sexy, Money: The Complications of Compensation

Updated: Sep 10, 2018

First, a story: A few months back, I was talking to a leadership team about the results of its employee engagement survey. The leadership team, very much to its credit, cared deeply about the results and how to impact the lower-scoring statement. Take a guess at which statement scored the lowest out of the whole batch….

“I am compensated fairly.”

Yup – that’s right, the lowest scoring statement was around pay. The leadership team immediately went into diagnostic mode, trying to understand why this score was so much lower than the others. Which is all well and good, EXCEPT, every single engagement survey has this same problem.

Everyone wants to be paid more. Everyone thinks that they are not paid enough for their brilliant skills and capabilities they bring to the world. And, everyone, when given the opportunity to anonymously tell their leaders and managers that they think they are underpaid….WILL. Heck, I’d be worried if I got an employee survey back where my whole organization responded that they wholeheartedly agreed that they were paid just right.

Cash is motivating, no doubt about it. But many managers and leaders assume that compensation is the primary way of motivating individuals and that if the compensation puzzle is solved, their teams will be happy, engaged, and willing to jump through hoops as long as there is a fiscal reward on the other side. In day-to-day practice, I see this phenomenon most acutely as start-ups raise their next round of funding: the instinct with a cash influx is to give everyone a bump in salary or bonuses, with the expectation that it will solve all of the creaks and groans coming from current employees.

But, compensation is a funny thing. Research has shown that paying someone extra to do something, in fact, decreases intrinsic motivation, and reduces the enjoyment of doing an activity because it’s challenging or meaningful. Yup – you read that right….those spot bonuses you thought were a great innovation to encourage your team members to work outside their swim lanes might be having the opposite effect. Or, how about those referral bonuses you gave employees for finding someone to work at the company…would people work harder to find referrals if they weren’t paid, and instead thought of it as a crucial organization-building opportunity that everyone chips in to do?

Along with the phenomena described above, there are three additional effects that wreak havoc on compensation.

What Makes Comp Complicated

1. Loss Aversion: Loss aversion is encapsulated by the concept “Losses loom larger than gains”. We’re far more bummed out by losing $10 that was in our pockets than we are elated by finding $10 on the street. So, when we expect that we’ll make $1m at the end of the year, but only make $950,000, that impacts us far more from a motivation perspective than if we expect to make $900,000 and end up making $950,000. We should feel the same about both outcomes given that we end up with $950,000, but we’re irrational humans, so we don’t.

2. Equity Theory: In short, equity theory states that an individual’s motivation is correlated to his perception of fairness and equity in relation to others around him. Put another way, people care more about RELATIVE value than ABSOLUTE value (despite it not being economically rational!). Hypothetical employee Bob would rather make $100,000 a year if his hypothetical office mate Lucy is also making $100,000 a year THAN make $110,000 a year if Lucy is making $120,000 a year. Bob would rather leave $10k on the table for the feeling of fairness.

3. Procedural Justice: People are more supportive of a decision - regardless of whether they agree with a the decision - when there is a high degree of transparency and input into the process used to make the decision. I’ll feel better about a decision outcome I hate when I feel bought into the process to make that decision, than about a decision outcome I actually love when I wasn’t bought into the process.

So what does this all mean for you as a manager? What can you do to make sure that compensation motivates your employees?

Ways to Crack Comp

1. Set-up and communicate a compensation philosophy to your group. Be open about why you compensate the way you do (e.g., you pay slightly over-market, you don’t have bonuses) and how this strategy fits into your overall culture as an organization. For example, your strategy may include components of equity theory (e.g., folks of the same level / functional area are paid the same) balanced with clear, decisive actions taken for under-performers.

2. Clearly articulate how decisions are made for compensation and promotions: Being clear about the process of how decisions are made is not equivalent to being transparent about what people make, nor is it a push to try to “metric-ize” every activity that goes into a model that spits out a comp number at the end of the year. Rather, it’s an overview of what information is collected, who is making the decision, and the understanding that certain decisions will use subjective data and management intuition (and that’s life!).

3. Be careful with bonuses: If you tell people upfront what bonus they are going to get at the end of the year….you better a) have the money to pay it and b) understand the impact that “dinging” that bonus will have on them. Even a small decrease in an expected bonus will wreak havoc on an individual (back to loss aversion!). You may think that reducing someone’s bonus by 5% at year-end will give him the kick-in the butt that he needs, but remember that people respond irrationally to money being taken away from them.

4. Continue to be careful with bonuses: Similarly, if you are planning to add a little bit to someone’s bonus, don’t expect him to be jumping for joy. Sure, people will always appreciate a boost to a bonus or a salary, but there’s just as much risk with people thinking: “I busted my butt and only got a 5% increase on my bonus?”

5. Don’t kill intrinsic motivation with money: And lastly, be careful about over-compensating for activities that employees currently may derive joy and engagement from – you may decrease their internal motivation to do that activity when all of a sudden they feel like they’re doing it for the money.

Compensation is just one piece of the puzzle when it comes to motivating employees, and it’s often the piece of the puzzle that we actively get wrong (as opposed to just ignore to do, which is the case with many other ways to motivate.) It’s important to understand how compensation is perceived by your team members and how it makes them behave (both rationally and irrationally).


  • Compensation motivates your team, but often not in ways that are rational, and there are times when paying people more money might demotivate them.

  • Loss aversion, procedural justice and equity theory are three effects that impact how a team members feels about his compensation.

  • A well-defined compensation strategy that aligns to your company culture and clearly articulates why choices are made regarding how you pay people, will help to ensure that compensation is motivating.


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