Performance incentives may undermine honesty: Study

A new study from the University of Technology Sydney (UTS) is challenging one of the most influential ideas in modern economics, arguing trust and professional integrity may, in some cases, deliver better organisational outcomes than performance-bases incentives.

Published in the Journal of Business Ethics, the paper by UTS associate professor Gordon Menzies and professor Isa Hafalir revisits the long-established principal-agent model, suggesting fixed salaries can outperform incentive contracts when employees have a genuine commitment to honesty.

The researchers argue excessive reliance on incentives may inadvertently weaken trust by signalling employers expect dishonest behaviour.

"For decades economic theory has often treated people as if they will only do the right thing in organisations when incentives force them to," Menzies said.

"This research is especially timely for debates about performance pay, executive incentives, professional standards, compliance culture and trust in institutions."

The study builds on Menzies' public lecture at the University of Oxford examining lessons from the global financial crisis and questioning whether traditional economic assumptions accurately reflect how people behave in organisations.

According to the researchers, the principal-agent model, widely used to justify executive bonus structures since the 1980s, assumes employees will not tell the truth unless incentivised to do so. Their revised model instead recognises many people value honesty alongside financial reward.

"In many business situations, people are neither perfectly self-interested nor perfectly trustworthy. Our model captures that more realistic middle ground," Menzies said,

"A key implication is that offering an incentive contract can itself send a signal of distrust. That can discourage honesty, reduce trustworthiness and create a downward spiral where even more incentives are needed."

The findings also help explain why fixed salaries remain prevalent across professions such as medicine, law and financial advice, where ethical judgement client trust is central to service delivery.

"Doctors, lawyers and other professionals are note just service providers responding to price signals. Their work depends on duties of loyalty, care and truthfulness," Menzies said.

"The persistence of salaried professional roles is not an accident. It reflects the very economic value and economic value and economic efficiency of trust, judgement and moral responsibility."