Design Elements and Requirements of Incentive Systems in Organizations

Academic Paper, 2018

15 Pages, Grade: 1,3


Table of Content

1. Definition of Important Terms

2. Function of Incentive Systems

3. Design Elements of Incentive Systems
3.1 Basics of Design
3.2 Systematization of Incentive Types
3.3 Basis of Assessment
3.4 Reward Function
3.5 Distribution Policy
3.6 Addressed Audience

4. Requirements of Incentive Systems
4.1 Transparency
4.2 Actuality of Determination
4.3 Cost-Efficiency
4.4 Justice
4.5 Acceptance

5. Constraints of Incentive Systems

6. Extrinsic vs. Intrinsic Motivation
6.1 Extrinsic Motivation 12
6.2 Intrinsic Motivation 12
6.3 Extrinsic vs. Intrinsic Motivation 12

7. List of References

1. Definitions of Important Terms

If you look for any specific definitions, you will find a huge variation considering the term incentive systems. Weber paraphrases incentive systems as having the aim to encourage employees positively through their performance, with benefits for the organization to reach its stated goals and objectives.1

In turn, Bartscher identifies incentive systems as the sum of all created working conditions, directly or indirectly to impact the motivation and thus work performance of employees, evoking a certain desired behavior.2

Coherently, incentive systems aim to control behavior of employees. But they do not only support a certain behavior, such systems additionally are designed to avoid unwanted behavior. Think of any internal regulations which intent to avoid behavior patterns by providing rules and/or punishments. Furthermore, as an example, a low performance might result in a curtailed income and loss of personal reputation.3

2. Function of Incentive Systems

There are three major functions of incentive systems, which include motivation, coordination and selection. The motivation function seeks to increase work performance by influencing the employees’ motivation positively through selected incentives. The second function is all about coordination and can be seen as a “steering function”. Coordination steers the actions of employees in such a way, that they are consistent with the goals of an organization. The last function, called selection function, is considering the selection of employees. This includes selection of employees during recruitment processing, keeping the best employees within organizations over time as well as making less suitable employees leave.4

The motivation function can be divided into two broad goals: On the one hand encouraging a good performance which can lead e.g. to more creativity and awareness for quality. On the other hand, a certain commitment and loyalty toward the organizations is implemented. Undesired fluctuation is costly and should therefore be avoided.5

3. Design Elements of Incentive Systems

3.1 Basics of Design

The following aspects are important to consider when implementing an incentive system:

- Incentive types: What type of incentives to be included?
- Assessment basis: How can the achievement of goals be measured? In what form and amount do we provide rewards, considering measurability?
- Remuneration: How do we design the relationship between assessment basis and the amount of reward?
- Rewards: What forms and types of rewards do we choose?
- Addressee group: What employees do benefit in what way from the incentive system?6

3.2 Systematization of Incentive Types

Different incentive types can be divided into categories such as object type (tangible or intangible), recipient (group or individual) and through their sources (extrinsic and intrinsic).7 To provide a better understanding, incentive types are divided from the top (their source) and are then broken down. The first subdivision is done using the source, which distinguishes between intrinsic and extrinsic types of incentives. Intrinsic incentives are almost exclusively of an intangible nature and mainly relate to the content and design features of a task.8 The extrinsic incentives are subdivided into their incentive object; a distinction between tangible and intangible incentives is made. Finally, tangible incentives can be divided into non-monetary and monetary incentives.

Incentive objects are connected to the content of the incentive that is offered. For intangible incentive components, the costs incurred can usually not be allocated directly to the employee or the company. Examples of intangible incentives include job security, freedom of action, work environment or overseas activities. The development of intangible incentive systems is complex and challenging, as many companies have established constraints of cultural and structural nature. These are often difficult to change, but that does not mean that this is not possible. Another part consists of tangible incentives. In contrast to intangible incentives, the costs of potential incentives can be directly matched with the recipient.9 Regarding the subdivision of tangible incentives, the following should be noted: Monetary incentives are paid out in the form of direct pay; non-monetary incentives can only be described indirectly through monetary values.10 The monetary incentives include fixed and variable components of remuneration as well as the related quantitative social benefits.11

3.3 Basis of Assessment

The assessment basis, often referred to as the performance measure, is an essential criterion in the design of an incentive system and answers the question of how the achievement of goals can be accurately measured. The basis of assessment serves to ensure that the activities of the employees are aligned with the goals of an organization. The actions of employees should be consistent with the interests of an organization at all times. This is feasible if the incentive system works in such a way that, when the employee reaches his required goals, the company goals are positively influenced at the same time. In other words, if the employees achieve their personal goals supported by the incentive system, the organization likewise reaches its proclaimed goals.12

The assessment basis can be set either at the output or at the input of employees. Measurements which are based on input refer to the employees’ actions carrying out tasks, e.g. with a high degree of dedication and accuracy. An employee’s qualification level can further serve as a benchmark. Output-oriented assessment bases, on the other hand, start from the result of the work provided. Out- as well as input-oriented bases can be monetary or non-monetary, but usually a monetary form is preferred in which financial measures are used. Examples such as the annual result or the result of a particular project can be used as a reference.

In addition, it must be determined whether the assessment base is absolute or relative. If the assessment basis is designed in an absolute way, the determination of the reward level is directly related to the measurement used. In a relatively oriented implementation, the assessment is compared either internally with the characteristics of other employees or externally with features of other organizations to determine the amount and type of reward. It has to be taken into account the problem of complex comparability between organizations, projects, groups and individuals.13

3.4 Reward Function

One more element of incentive design is the reward function. The reward function answers the question of what level of goal achievement leads to what type and amount of reward. It results from the amount of incentives related to an employee's performance. Here, a functional relationship between the assessment base and the variable amount of the reward is established.14 Employees can influence the amount of their reward through a measurable relationship between their performance and a performance-based reward. Prerequisite is that the employee knows the components and relationships between his performance to be delivered and the associated reward, which, however, requires an appropriate level of communication efforts.15 The design of the reward function is also dependent on the individual risk and time preferences of each employee.16

Design alternatives arise with regard to shape, a possible lower and / or upper limit and the combination of several bases of assessment. The shape is differentiated between a linear and a non-linear function, wherein the slope of a linear function is either proportional, under- or disproportionate, depending on whether the incentive increases constantly with the rise of the assessment basis or not. In addition, a lower limit or cap of the reward level is to be decided. A lower limit appears to be useful, for example, for risk-averse employees who do not want to be exposed to a high income­risk. Although an upper limit lowers the cost risk for companies, it can also have a negative effect if motivation is taken over by employees who are too low to cover the reward level, and thus they no longer undertake value-adding activities.17

3.5 Distribution Policy

As part of the distribution policy, it is decided at what intervals performance-related rewards will be distributed to the recipient. The selectable points of time range from a short-term payout to a long-term payout over one year or even longer. In this context, the increased effectiveness of behavior combined with a close temporal relationship between performance and the required incentive must be considered. If the performance and prospective incentive fall too far apart, the effectiveness of the incentive will be reduced.18 The distribution policy includes three possible ways of selecting the dates: an immediate distribution, a periodic distribution and a final distribution. The effect of the incentive is highest when the reward is distributed immediately after a performance appraisal. Problems arise in assessing benefits associated with strategic goals. At the time of the distribution, it is not clear whether the activities lead to sustainable success. In contrast, the quality of performance, considering a final distribution, is much easier to assess: At the time of payment, there is already clarity about the success of the activities performed, meaning that the performance can be assessed much more accurately based on the existing results.

Due to the differing consequences and effects of various distribution times, it proves expedient to use a combination of short-term and long-term distribution.19 In case of an immediate distribution, this is done immediately after the investment decision. Based on the investment planning and its expected success, the reward to be distributed is determined. Although this option provides a timely connection between decision and reward, it is inadequate with regard to deviations from the designed plan. In the case of a periodic distribution, the affected employee receives his reward at the end of each period. In the assessment, not only the performance delivered during the last period plays a role, but also the overall success achieved so far. This has the great advantage of providing the employee with regular incentives. In addition, this type provides the ability to evaluate performance based on target and actual data, allowing a more accurate determination of the reward. Although a detailed performance assessment is possible in the case of a final payout, the timing between the action and the reward is far from one another, which can lead to a lack of motivation.20


1 Cf. Weber 2006, P. 11

2 Cf. Bartscher 2016, online

3 Cf. Winkler 2013, P. 38

4 Cf. Seng 2003, P. 8

5 Cf. Bea and Göbel 2010, P. 329

6 Cf. Dahlhaus 2009, P. 126

7 Cf. Bartscher 2016, online

8 Cf. Zaunmüller 2005, P. 37

9 Cf. Motzkuhn et al. 2014, P. 44

10 Cf. Holzmann 2016, P. 254

11 Cf. Brose 2006, P. 50

12 Cf. Hungenberg and Wulf 2015, P. 370

13 Cf. Dahlhaus 2009, P. 129 ff.

14 Cf. Hungenberg and Wulf 2015, P. 371

15 Cf. Kunz 2011, P. 5

16 Cf. Wollscheid 2013, P. 15

17 Cf. Huber 2014, P. 21 ff.

18 Cf. Huber 2014, P. 23 ff.

19 Cf. Hungenberg and Wulf 2015, P. 372

20 Cf. Dahlhaus 2009, P 131

Excerpt out of 15 pages


Design Elements and Requirements of Incentive Systems in Organizations
International University of Applied Sciences Bad Honnef - Bonn
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ISBN (Book)
Incentive Systems, Organisational Culture, Motivation, Incentive Management
Quote paper
Manuel Jacoby (Author), 2018, Design Elements and Requirements of Incentive Systems in Organizations, Munich, GRIN Verlag,


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