Mind the economy

Relational incentives and the quality of human relationships

The impact of social relations on work performance: an analysis of relational incentives in the organisational environment

22 December 2024

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In the so-called 'principal-agent theory' as applied in the organisational context, it is assumed that the utility of the principal - the employer, for example - increases as the effort exerted by the agent - the worker - increases, and that the utility of the latter, on the other hand, increases with increasing remuneration. The employer would like the worker to work as hard as possible by paying him/her as little as possible and the worker would like to work as little as possible by receiving the best possible remuneration. It is further assumed that an information asymmetry exists between principal and agent, which allows the employer to verify the level of commitment of the employee only incompletely and inaccurately.

These two elements, the conflict of interest between employer and employee and the information asymmetry that characterises their relationship, generates, so the theory tells us, an inefficiency that can only be reduced by making the worker responsible through some form of risk-sharing. Since the worker's commitment is not precisely verifiable and the results are dependent on many other factors and not only on the worker's commitment, the only possibility is for the worker also to assume a share of the business risks.

We have seen in last weeks' Mind the Economy what are the strengths and limitations of these practices. In particular, we discussed the role of incentives, considering these as part of the contractual relationship that governs the relationship between employer and employee. Going a little deeper, however, we discover that incentives can also have a more social dimension, which goes beyond the simple principal-agent relationship. Let us imagine, for example, that the employer chooses to reward a particularly productive worker with a wage increase. Let us try to ask what effect this increase will have not only on the motivation of the rewarded worker, but on that of the less productive workers in the same company, who learn of the differential treatment reserved for their colleague. It is far from unlikely that the inequality generated by the productivity bonus will lead to a reduction in the commitment and productivity of these already less productive workers. This example helps to highlight an additional dimension of incentives, namely the 'social' nature they can acquire within organisations.

The "relational incentives"

The economists of the London School of Economics Nava Ashraf and Oriana Bandiera call them 'social incentives', to me the expression 'relational incentives' seems more appropriate, but the substance does not change. We are still talking about all those factors that, on the one hand, influence the marginal benefit or marginal cost of employee commitment and, on the other hand, derive from the social relationships we have with others, employers, managers, colleagues, customers, family members, friends. ('Social Incentives in Organisations. Annual Review of Economics 10, pp.439-63, 2018). It is imperative to take this 'relational' dimension of incentives into account both because it can interact with the functioning of monetary incentives, reducing their effectiveness or even making them counterproductive, and because it generates non-trivial implications related to the way complex organisations should be designed and managed.

The effect of the 'relational' dimension depends, as can be guessed, on the very nature of the relationships and the type of social group of reference - colleagues at different levels of the organisational hierarchy, customers, users or beneficiaries of the organisation, as well as friends, family or 'others', more generally. In this regard, I am reminded of the case of an organisation operating in the world of care work whose managers were telling me of their difficulty in retaining workers, especially males, who, after having started work with competence and satisfaction, were easily demotivated by the low social esteem in which their friends and family held their work. "But how!!!? You have studied so much and now you are content to assist a disabled child or a poor derelict? You deserve better. Despite personal and even economic satisfaction, the impact of social disaffection can prove decisive in career choices.

Relationship with colleagues and productivity

Let us focus on the effect that the closest peer group, i.e. colleagues, can have on motivation and thus on productivity. A few years ago, economists Emily Breza, Supreet Kaur, and Yogita Shamdasani conducted an experiment in a series of production sites in the city of Bhubaneswar, India, assessing the productivity of individual workers in relation to the pay of their colleagues. The study considered groups of three workers randomly trained and subjected to two different wage regimes. In the groups of the first type, each worker received the same hourly wage, while in the groups of the second type, workers received different wages in relation to their productivity. Thus, by comparing the productivity of workers receiving the same wage with that of those working with colleagues receiving different wages, it was possible to identify the effect of relative pay on workers' commitment.

Data show that working with people who earn more leads to a 12% reduction in productivity and a higher level of absenteeism. By contrast, when working with workers who earn less, productivity does not change. This means two things: that wage inequality demoralises weaker workers without motivating more productive ones. The net result for the firm, therefore, is entirely negative ('The Morale Effects of Pay Inequality'. Quarterly Journal of Economics 133, pp. 611-663, 2018).

An even clearer effect emerges from the study by Alain Cohn and colleagues focusing on pairs of temporary workers. In the first phase of the study, workers in the same group are paid the same. In the second phase, without explanation, the pay is reduced by 25%, for some groups to both members, for others to only one of the two group members. The result is that the pay cut to both workers causes a 15% reduction in performance compared to the control group. If, on the other hand, the wage cut affected only one of the two workers in the group, then the reduction in performance was, on average, up to 34%, more than double (Cohn A., et al., "Social comparison and effort provision: evidence from a field experiment". Journal of the European Economic Association 12, pp. 877-98, 2016).

The response to incentives

This clearly shows that workers respond to incentives, both individual and relational. Many experimental studies have shown, in fact, how inequality, especially disadvantageous inequality, represents a real psychological cost that we try to minimise with our choices. A cost linked to precise neuronal correlates. Research using functional magnetic resonance imaging (fMRI) has shown that when faced with situations of inequality and blatantly unfair treatment, our brain activates the same circuits that are involved in processing feelings of anger and disgust. Feelings that drive us to react to injustice even at the cost of a personal loss. In this case, a reduction in productivity.

A second category of 'relational incentives' is related to all those actions that the individual worker performs and that can have, directly or indirectly, an impact on other workers. Let us think, for example, of the effects of company profit-sharing policies. From a theoretical point of view, such policies should be completely ineffective. In fact, each agent would bear the full cost of his or her eventual increased effort but would only receive a small part of the marginal benefit he or she generates, because this would have to be shared among all the workers in the firm. The fact that, on the other hand, these incentive schemes work shows that workers are interested not only in the benefits they themselves will receive but also in those their colleagues will receive.

Oriana Bandiera, Iwan Barankay and Imran Rasul investigate this fact through an ingenious experiment involving fruit pickers of a major British brand. Two different remuneration schemes are compared. Initially, the workers are paid piecework, i.e. on the basis of a fixed fee per kilogram of fruit picked. In the second phase of the study we switch to a remuneration where each kilogram of fruit is paid a price equal to a fixed quota divided by the average productivity of the workers in that particular field on that particular day. This scheme generates a negative externality because if one worker works harder than the others this increases the average productivity and thus reduces the unit remuneration for all other workers as well.

The results show that when the second scheme is applied, workers' productivity is reduced by about 50%. This is explained by the fact that no one wanted to penalise colleagues for earning more ("Social preferences and the response to incentives: evidence from personnel data". Quarterly Journal of Economics 120, pp. 917-62, 2005).

The nature and quality of social interactions in the workplace, therefore, do not constitute an irrelevant dimension of organisational design, and not only with regard to the well-being of workers but also because through such relationships relational incentives can be conveyed that impact on the performance of the workers themselves.

Also from the point of view of companies and organisations more generally, it is crucial to understand how a plural vision of human motivations can open up new scenarios and offer management tools based on social incentives as well as on the quality of human relations both within the organisation itself and with all the other stakeholders with whom the organisation interacts.