Taking Bonuses Back as an Incentive

Clawback – it’s a term that’s been bantered about recently in response to the ongoing LIBOR money laundering bank scandal when discussing the bonus money given to executives. It’s a particularly descriptive term used primarily within the finance industry to refer to bonuses tied to provisions that allow those bonuses to be reclaimed by the organization that gave them out, usually with an additional monetary penalty applied.

Although this monetary disincentive doesn’t seem to have discouraged the types of behaviors it was meant to, the concept of pulling back bonuses may have some applications in other jobs that can yield positive results. Specifically, there was a recent report by the National Bureau of Economic Research (NEBR) that showed a strong positive effect on student test scores when teachers were rewarded with bonuses that would have to be returned if certain goals were not met.

The psychological phenomenon being exploited by this compensation method is loss aversion, and it has recently been gaining popularity as a powerful but practical incentive method. In this instance, loss aversion refers to the tendency of people to favor avoiding risk over gaining rewards. Put simply, humans are more concerned with not loosing than they are with winning.

This behavioral tendency has recently been explored for practical application in the medical health field, and now the first experiments in applying this concept to the business world are beginning to come out. In July, the NEBR released the aforementioned “Enhancing the Efficacy of Teacher Incentives through Loss Aversion: A Field Experiment,” which showed that by giving teachers their bonus at the beginning of the year, and then taking the money back if goals were not met, students test scores increased significantly (one standard deviation to be exact).

Obviously, this is different structurally from the clawback bonuses used by the large banks – which, as noted previously, has limited effectiveness – but it still raises some interesting ideas on how this compensation system might be used for other professions. As with anything new, more research needs to be done (and is being done), but the idea is one well worth remembering

Until those results are in, please let us know what you think about this type of incentive design. Have you ever explored anything like this in your own organizations? Do you think it would be effective or do you think it would incur too many unintended consequences?