Why Did You Do that? An Economic Examination of the Effect of Extrinsic Compensation on Intrinsic Motivation and Performance

Abstract

According to empirical evidence, extrinsic incentives often crowd out intrinsic motivation, thus reducing the effort choices of workers. This article presents a principal-agent model that incorporates insights from cognitive evaluation theory in order to show how the introduction of explicit incentives causes a discontinuous reduction in worker effort and why motivation crowding out occurs. Motivation crowding out is shown to be a rational response of the agent to the introduction of incentives when rewards are perceived as controlling, since controlled behavior does not provide intrinsic satisfaction. Extrinsic rewards could be perceived as controlling under two conditions. The first is when the object of an agent's intrinsic motivation is also the source of the agent's extrinsic compensation. The second is when the incentives offered to the agent are too large.

Keywords: Principal-agent problem, incentive compensation, intrinsic motivation, motivation crowding out

JEL Classification: J30, L20