Incentive

Template:Short description Template:Other uses Incentives are anything that persuade a person or organization to alter their behavior to produce a desired outcome.

Incentives are widely studied in personnel economics, where researchers and human resource managers examine how firms use pay, career opportunities, performance evaluation, and other mechanisms to motivate employees and improve organizational outcomes. Higher incentives are often associated with greater levels of effort and higher levels of performance. In comparison, disincentives discourage certain actions.

Incentives encourage specific behaviors or actions by persons and organizations, and are commonly employed by governments, businesses, and other organizations. Incentives may generally divided into two categories: intrinsic and extrinsic. Incentives, however, can also produce unintended outcomes, relating to the overjustification effect, principal–agent problem, moral hazard, free-riding, or adverse selection.<ref name=":153" />

Classification

Incentives encourage specific behaviors or actions by persons and organizations,<ref>Gibbons, Robert. "Incentives in organizations." Journal of economic perspectives 12.4 (1998): 115-132.</ref> and are commonly employed by governments, businesses, and other organizations.<ref>Template:Cite journal</ref> Incentives may generally divided into two categories: intrinsic and extrinsic.<ref>Template:Cite web</ref>

Theories

Political scientists Peter B Clark and James Q Wilson categorise incentives into three types: material, solidary, and purposive.<ref>Template:Cite journal</ref>

Author David Callahan identifies three broad classes of incentives.<ref>Template:Cite book</ref><ref name=":22">Template:Cite book</ref> Remunerative or financial incentives, involve material rewards.<ref name=":22" /> Moral incentives involve action being regarded as the right or admirable choice; individuals acting on moral incentives may experience self-esteem, praise, or admiration from others, while failing to act accordingly can result in guilt, condemnation, or even ostracism.<ref name=":22" /> Coercive incentives threaten, when failure to act in a specified way occurs, the use of physical or coercive force by others.<ref name=":22" />

Intrinsic and extrinsic incentives

An intrinsic incentive arises when an individual is motivated by personal satisfaction, interest, or enjoyment in an activity, without seeking external rewards or responding to external pressure.<ref>Template:Cite book</ref> Extrinsic incentives involve external rewards or pressures, such as monetary compensation, recognition, or the threat of punishment.<ref>"Extrinsic Rewards". AIHR. Retrieved 2025-10-11.</ref>Template:Citation needed

Both intrinsic and extrinsic incentives influence behavior,<ref name="auto1">Template:Cite journal</ref> though research suggests intrinsic motivation may have stronger and more sustainable effects by increasing genuine enjoyment and engagement.<ref>Template:Cite book</ref> Intrinsic incentives are often associated with greater autonomy, commitment, and work involvement.<ref>Template:Cite journal</ref> At the same time, excessive reliance on external rewards can diminish intrinsic motivation, a phenomenon known as the overjustification effect, and crowd out intrinsic incentives.<ref name="auto3">Template:Cite journal</ref>

Monetary incentives

Monetary incentives are financial rewards given to influence behavior and align an individual's actions with those of the provider of the incentive.<ref name=":03">Template:Cite journal</ref> They are a type of extrinsic incentive and are common in workplaces. The effects of monetary incentives are often described as a "standard direct price effect" and an "indirect psychological effect." These two effects can act in opposite directions, sometimes reducing the very behavior the incentives are designed to encourage.<ref name="auto3" /> Some research suggests that these crowding-out effects can be managed using models that account for nonstandard behavioral assumptions.<ref name="auto3" />

Examples of monetary incentives include profit sharing, bonuses, stock options, and paid vacation time.<ref name=":3">Template:Cite book</ref> When structured effectively, they can positively influence motivation, productivity, and output at both individual and organizational levels.<ref>Template:Cite journal</ref> Performance-based pay, such as commission-based compensation, ties rewards to productivity or output over a defined period. Firms may also pay overtime wages or provide rewards for work beyond expectations. Expectancy theory holds that if employees believe that greater effort will lead to better performance and value the associated reward, monetary incentives can help sustain high levels of effort and reduce shirking, thereby increasing both individual and overall productivity.<ref name=":03"/>

The effectiveness of monetary incentives depends on job type and task characteristics. In routine jobs, such as clerical or administrative work, they can help sustain consistent effort once intrinsic motivation declines. For difficult tasks, however, monetary incentives may have little effect on increasing performance.<ref>Template:Cite book</ref> The framing of rewards can also affect their impact. For instance, in cadaveric organ donation, funeral aid is perceived as more ethical and socially acceptable than direct cash payments of equal value, and may increase willingness to donate.<ref>Template:Cite journal</ref><ref>Template:Cite journal</ref> Firms may also use negative incentives, such as the threat of demotion or termination for poor performance, which can motivate employees when they perceive their careers to be at risk.<ref name=":3" />

Executive compensation

Template:Main Boards of directors use incentives to align CEO behavior with shareholder interests. CEOs may receive salaries, bonuses, shares, or stock options to reward performance, while dismissal or reputational loss serve as penalties for poor performance. Ownership of company stock provides additional motivation by tying CEO wealth to shareholder value.<ref name=":92">Template:Cite journal</ref> Non-monetary incentives such as prestige, recognition, or authority may also influence performance, though their impact is debated.<ref name=":92" />

Non-monetary incentives

Non-monetary incentives are rewards not directly tied to financial compensation but used to motivate individuals to perform specific actions or achieve desired outcomes.<ref>Template:Cite journal</ref><ref name="Lefebvre e02273602">Template:Cite journal</ref> They are based on the recognition that individuals are motivated by a range of factors beyond money, and can reinforce engagement and productivity.<ref name=":152">Template:Cite journal</ref>

Examples include additional holidays, recognition, praise, opportunities for growth, gifts, family benefits, or more engaging work assignments. These incentives often enhance job satisfaction, reduce turnover, and are perceived as more memorable than financial incentives by standing apart from normal pay.<ref name=":16">Template:Cite journal</ref> They have also been found to promote long-term commitment, loyalty, and positive perceptions of an organization.<ref name="Lefebvre e02273602" /><ref>Template:Cite journal</ref> Some research suggests that non-monetary incentives produce stronger and longer-lasting effects on motivation and productivity than financial rewards.<ref name="auto3" /><ref>Template:Cite journal</ref>

Non-monetary incentives may be less effective for individuals primarily motivated by financial rewards, such as those in low-paying jobs or under financial stress.<ref name="Lefebvre e02273602" /> They can also be more difficult to quantify and evaluate than monetary incentives, which makes designing effective programs challenging.<ref name="Lefebvre e02273602" />

Microeconomics

Template:Main In economics, incentives are analyzed through the systems that determine how agents can be motivated to achieve outcomes desired by a principal.<ref name=":3" /> Firms use incentives to link rewards to productivity, aiming to reducing turnover by retaining productive employees, and improving overall output by encouraging greater effort and engagement.<ref name=":3" /> Increasing pay variance within firms globally reflects the rising demand for high productivity, leading to a shift toward pay-for-performance models.<ref>Template:Cite journal</ref> These schemes reinforce the link between work and reward.

Incentives, however, can also produce unintended outcomes.<ref>Template:Cite journal</ref> Poorly designed systems may encourage "gaming" behavior, where individuals maximize rewards without meeting actual objectives. This is central to the principal–agent problem, in which the goals of the principal (such as a government or company) diverge from those of the agent (such as employees). Misaligned incentives can lead to moral hazard—where agents take risks without bearing full costs—or to adverse selection, when asymmetric information causes inefficient or distorted outcomes.<ref name=":153" />

Self-selection effects of incentives

Because employees know more about their own skills, competitiveness, and risk attitudes than employers do, firms also design incentives to recruit suitable workers. This is called the self-selection or sorting effect. For example, pay-for-performance schemes attract more productive, less risk-averse workers, while fixed wages appeal to more risk-averse individuals.<ref>Template:Cite journal</ref><ref>Template:Cite journal</ref><ref>Template:Cite journal</ref>

Misaligned incentives

A misaligned incentive arises when the goals of different parties conflict. This can occur within firms, but also in government, healthcare, education, and environmental policy. For example, principals in a firm want agents to act in the firm's best interests, but employees may pursue different objectives.<ref>Template:Cite journal</ref> Because of information asymmetry, principals often lack precise knowledge of how to motivate or evaluate agents.<ref name=":52">Template:Cite web</ref> Compensation plans are therefore difficult to design. Principal–agent theory is often used to align incentives with employee effort in order to achieve efficient output.<ref name=":4">Template:Cite journal</ref>

In this relationship, agents usually have informational advantages over principals. Moral hazard arises when principals cannot be sure that agents are exerting full effort, while adverse selection occurs when principals cannot determine which agents are best suited for tasks.<ref name=":132">Template:Cite journal</ref> Agents may shirk, leak information, misreport, or conceal abilities in order to reduce their workload or benefit competitors.<ref>Template:Cite journal</ref><ref>Template:Cite book</ref>

Tournament theory

Tournament theory describes a framework of compensation based on an individual's position within a firm's hierarchy,<ref name=":4" /> such that compensation is a function of relative, rather than absolute, performance. Ceteris paribus, the larger the difference in compensation between one position to the next, the greater the incentive to exert more effort in order to achieve a promotion.<ref name=":03"/> Larger firms, with more competitors, may dilute the effect of increasing effort by way of competition.<ref name=":03"/> Relative pay schemes may, however, foster rivalry and reduce cooperation, forcing firms to balance pay variance with workplace harmony.<ref name=":03" />

Team-based incentives

Due to constantly advancing technologies, individual employees seldom have an absolute advantage across all skills required within a firm.<ref name=":4" /> Many large firms organize production around teams to address complex, multidimensional tasks requiring diverse skills.<ref name=":4" /> In such settings, individual performance is difficult to measure, making team-based incentives preferable to individual piece rates.<ref>Template:Cite book</ref> Team-based incentives reward collective performance, fostering cooperation, trust, and cohesion.<ref>Template:Cite book</ref><ref>Template:Cite journal</ref> Studies find positive effects on efficiency, stability, pay, and company output.<ref>Template:Cite journal</ref><ref>Template:Cite journal</ref>

Payoffs of two employees assigned to a group project and faced with the choice of working hard or free riding.

Team-based incentives, however, may be seen as unfair if unequal contributions receive equal rewards.<ref name=":11">Template:Cite journal</ref>

Team-based incentives may also induce free-riding. This happens, for example, if employees have to share team output so that each employee only gets a fraction of what he or she generates.<ref name="Holmstrom1982">Template:Cite journal</ref> Managers may mitigate this through sufficiently strong incentives, penalties, or peer rating systems.,<ref name=":11" /><ref>Template:Cite conference</ref> or by relying on peer pressure or hiring intrinsically motivated employees.<ref name=":82">Template:Cite journal</ref><ref>Template:Cite journal</ref> Free-riding also arises when team members' responsibility diffuses because members cannot be jointly held accountable.<ref name="LiSchnedler2025">Template:Cite journal</ref> In this case, declaring a single person responsible may help.<ref name="LiSchnedler2025" />

Cultural differences

The effectiveness of pay-for-performance incentives varies across cultures. One study across six countries found that monetary incentives generally increased effort more than psychological nudges, but this effect was stronger in Western than non-Western cultures.<ref>Template:Cite journal</ref> Another study found that financial rewards improved test performance among US students, but not among students in China.<ref>Template:Cite journal</ref> These findings align with cross-cultural studies showing that pay-for-performance is more common in individualistic societies, such as the US and UK, than in collectivist ones.<ref>Template:Cite web</ref><ref>Template:Cite journal</ref>

Potential issues in firms

Ratchet effect

Incentives can sometimes reduce productivity through the ratchet effect. Firms may use an employee's initial output as a benchmark for future standards. Anticipating this, employees may withhold effort at the start or conceal their true capabilities, later increasing output strategically to gain rewards.<ref name=":62">Template:Cite journal</ref><ref>Template:Cite journal</ref> This reduces efficiency in both firms and planned economies.<ref>Template:Cite journal</ref>

Crowding-out effect

Economists and psychologists have also studied the crowding-out effect, in which extrinsic incentives undermine intrinsic motivation. Richard Titmuss's 1970 book The Gift Relationship argued that monetary incentives disrupted social norms around voluntary contribution.<ref name="auto52">Template:Cite journal</ref> Large incentives may temporarily offset this, but may also signal undesirable implications, reducing their effectiveness.<ref>Template:Cite journal</ref> Removing temporary incentives can also depress effort below baseline levels.<ref name="auto52" />

Stock options

Stock options were widely adopted in the 1990s to align CEO and shareholder interests, but often produced mixed outcomes. While successful decisions could raise long-term stock prices, some CEOs engaged in accounting manipulation to preserve incentive-based pay. Such schemes proved costly and were not always effective at ensuring alignment.<ref>Template:Cite book</ref>

Pay variance conflicts

Pay inequality within firms can also lower morale. Low-paid employees may reduce effort, disengage, or find it harder to cooperate with higher-paid colleagues, lowering overall productivity.<ref>Template:Cite journal</ref> Bonus-based systems may also reduce motivation if rewards fluctuate with company profits rather than effort. Firms sometimes offset this by using non-monetary rewards, such as promotions or extra vacation time, to maintain fairness and engagement.

Philanthropy and charity

When it comes to volunteering activities, monetary incentives can bring negative effects. According to the self-perception theory, humans constantly seek explanations for their behavior.<ref>Template:Cite book</ref> When individuals are involved in volunteering activities, they most likely perceive themselves as prosocial and altruistic, and attach a symbolic price to the act of volunteering.<ref>Template:Cite journal</ref><ref>Template:Cite journalTemplate:Expression of Concern</ref> When a monetary reward is attached to an otherwise prosocial activity such as volunteering, people may perceive that their originally altruistic actions are now linked to extrinsic incentives,<ref name=":10">Template:Cite journal</ref> causing their self-image benefit<ref>Template:Cite journal</ref> and prosocial motivation to decrease.<ref>Template:Cite journal</ref> A crowding-out effect leads to a decrease in individuals' desire to volunteer and people eventually stop contributing due to the rewards attached. For example, if monetary incentives are offered for voluntary blood donation, it will have a negative effect on the number of people donating blood.<ref name=":10" />

Education

Extrinsic incentives offered to unmotivated students can potentially have positive short-run effects.<ref name="auto52"/> However, the use of extrinsic incentives in education raises issues of morality and corruption, and have the potential to crowd out intrinsic incentives.<ref name="auto52"/> Empirical evidence also largely supports the success of monetary incentives in improving educational inputs such as attendance and enrolment, but not educational outputs such as academic achievement.<ref>Template:Cite journal</ref>

Studies have demonstrated that the impact of monetary incentives is dependent on previous academic performance and individual ability.<ref name=":12">Template:Cite journal</ref> Monetary incentives tend to improve the academic results of high-ability students but have an adverse effect on the performance of students with lower aptitude.<ref name=":12" />

See also

• Climate finance
• Climate Investment Funds
• Bounty (reward)
• Eco-investing
• Environmental Quality Incentives Program
• Externality
• Incentive-centered design
• Incentive payments
• Incentive program
• Incentive trust
• Incentivization
• Investment incentive
• Long-term incentive plan
• Loyalty marketing
• Loyalty program
• Motivation
• Motivational salience
• Motivations of open source programmers
• Motivations for online participation
• Performance-related pay
• Perverse incentive
• Positive-incentive value
• Profit motive
• Research and Development Tax Incentive
• Reward system
• Social Impact Incentives
• Steering tax
• Tax incentive
• Travel incentive
• Wicked problem