Digest 45. The bright side of managerial discretion in bonus allocation
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Organizations use incentives, such as pay-for-performance, to motivate their workforce (see Digest 38) sometimes without realizing that this may also be harming employees’ intrinsic motivation, that is their inner drive to work because they enjoy, value, and identify with the job. Academics have described this phenomenon of extrinsic rewards overruling intrinsic motivation as “crowding out”. It is crucial to emphasize the modal verb “may” here, because research does not seem to have an unequivocal answer to whether incentives really damage intrinsic motivation or not. What seems more important for motivation than the incentive itself is an employee’s perceptions of how fairly this is distributed in the organization (that is, procedural fairness). Managers, inevitably, can influence such perceptions in light of their responsibility of assigning bonuses. Moreover, managers are more and more encouraged to use their discretion in managing people in light of the so-called HR devolution, which decentralizes HR practices to give managers greater control and freedom over HR practices and processes, including handling the reward system.
At first thought, managerial discretion in reward allocation may sound like a very bad idea, as it can look detrimental to employee perceptions of procedural fairness. In other words, a manager who exerts personal discretion when deciding on bonuses as opposed to relying on standardized, objective reward systems may appear unfair. However, performance is a complex matter, often difficult to capture through objective tools, hard to quantify, and underpinned by many different factors; therefore, managerial judgment is essential to recognize an employee’s unique contribution to an organization. For instance, managers can observe the impact of each individual on the organization, and they also have an overview of the contextual factors that may have influenced their collaborators’ performance, allowing them to form a more rounded assessment to compensate their employees. Consequently, when individuals receive a bonus based on managerial discretion, they may perceive this as a fair way to reward their added value to the organization. Even better, their intrinsic motivation, which is particularly cherished when individuals feel valued, is boosted.
… Does research back up this counter-intuitive idea that something so idiosyncratic as managerial discretion can support employees’ perceptions of fairness and their intrinsic motivation?
Hewett and Leroy (2019) conducted three empirical studies to understand when managerial discretion can enhance fairness, ultimately resulting in higher intrinsic motivation. Their first study aimed at clarifying the concept of perceived managerial discretion in bonus allocation. This refers to the employees’ perceptions that their manager professionally used their evaluation of performance-relevant information to distribute rewards. Managerial discretion is different from personal bias, which is a manipulation of the evaluation based on performance-irrelevant information such as personal characteristics of the employee (e.g., gender or age). The authors provide a clear example of perceived managerial discretion. Consider an employee who fails to achieve his/her annual sales target, to which the bonus is attached, because they have been working on developing a relationship with a client with important long-term benefits for the organization, which has resulted in delaying sales. The manager decides to award the bonus to the employee anyway to recognize the long-term perspective and their value to the organization. In such a situation, the employee would perceive that the manager exerted their discretion to allocate rewards.
The second study was an experiment conducted with MBA students from a University in the Netherlands to understand whether perceptions of managerial discretion could be favorable when employees benefit from this discretion, that is when they receive the bonus (spoiler alert: the answer is yes). Participants randomly received different scenarios where fictitious employees were attributed low vs. high bonuses and managers had low vs. high discretion in this decision. They then needed to assess the fairness of how the bonus was allocated. The results showed that higher bonuses increased procedural fairness only when the perception of managerial discretion was high, meaning that managerial discretion enhances perceptions of fairness in the workplace when associated with high incentives.
Finally, the researchers conducted a field study by surveying employees of a UK service organization that adopted pay-for-performance incentives. They not only confirmed the above results but also found that managerial discretion was beneficial for intrinsic motivation. In fact, bonuses fostered fairness, which, in turn, led to motivation, but only when employees perceived that their manager exerted discretion in allocating the incentives.
Infographic created by REAL PAL - The effect of managerial discretion in bonus allocation on employee perception of fairness and intrinsic motivation
Organizational implications
Due to the complexity of evaluation performance, managers should not be afraid of using discretion when allocating bonuses in light of its positive effects on perceptions of procedural fairness and intrinsic motivation. However, they should be aware of the conditions of this discretion, that is it bears beneficial effects only when favorable bonuses are distributed.
It is important to educate managers on what managerial discretion in a performance management system is, encouraging them to base their judgment on performance-relevant information. Training on cognitive biases and political manipulations is recommended.
Organizations and HR managers should prioritize the principle of equity in the reward system and acknowledge that standardized procedures may be more harmful to employee motivation than idiosyncratic ones (if these are inspired by agreed-upon principles and coherent with the organizational culture). Therefore, they should recognize the importance of empowering managers to use their discretion in reward decisions.
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Reference: Hewett, R., & Leroy, H. (2019). Well it’s only fair: How perceptions of manager discretion in bonus allocation affect intrinsic motivation. Journal of Management Studies, 56(6), 1105-1137. https://doi.org/10.1111/joms.12445