Academic Research in Action: Non-Cash Rewards in a Period of High Inflation

Non-Cash Rewards in a Period of High Inflation: Scope Sensitivity and General Evaluability Theory

Firms should review and optimize their incentives and rewards programs to address the unique workforce challenges they face in 2022.

Inflation in the United States has reached an annual rate of 8.5%, heights not seen since the early 1980s.[i] Though wages increased faster in 2021/2022 (~5%), than they have in more than 25 years, they have not kept pace with inflation.[ii]^,[iii] The war in Ukraine has impacted shipments of fertilizer and the supply of food staples, driving food costs higher, even while the threat of severe energy shortages in Europe adds to worries of recession.[iv] Meanwhile, the US economy shrunk 1.4% during the first quarter of 2022 as unemployment rates hovered in the 3.5% range, and many employers struggled to hire and retain an adequate workforce.[v]^,[vi]

No one can say what the next quarter will bring let alone what might happen through 2022 and beyond. But the situation in Ukraine is not improving, few expect supply chain issues to resolve anytime soon, and the US Federal Reserve has stated its intention to raise interest rates six more times in 2022.[vii]^,[viii] 

In this unpredictable environment, one major dilemma for organizations is how to plan wages, salaries, and rewards. Firms naturally prefer to avoid creating a higher total compensation ceiling, especially if, as some anticipate, a recession takes hold and the economy contracts.[ix] According to Payscale, fewer than one in ten US organizations plans to raise wages 5% or more over the next 12 months.[x] Yet firms must continue to attract and retain employees in a highly competitive talent market where workers – many overburdened due to staff shortages – might lose patience as their real wages decline.[xi]^,[xii]

The alternative to raising compensation to keep pace with inflation is to increase benefits, bonuses, and other rewards. Like raises, benefits increases create long-term liabilities. Nevertheless, many firms have added benefits like extra time off, wellness programs, and enhanced childcare to their offerings. Many more have expanded flexible work options, including work from home.[xiii]

Using Non-Cash Incentives and Rewards to Address Current Workforce Challenges

One reason firms use one-off cash and non-cash rewards is to motivate and retain high-performing employees while avoiding permanent increases in costs via higher wages, salaries and benefits – signing and retention bonuses may be the most direct example.[xiv] A large body of research suggests that non-cash rewards are more effective motivators than cash in many cases, but little has been written about cash versus non-cash rewards in times of high inflation and low unemployment.

Intuitively, one might expect that unless cash rewards have increased at the pace of inflation or better, recipients might look at them the same way they assess wages and salaries – as having eroded in value. In this case, the impact of the reward will diminish. Non-cash rewards more likely sidestep this issue and may be better received. Firms that offer merchandise, travel, and other non-cash rewards will likely pay more for them today than they might have two years ago, but effective sourcing should keep those costs below the overall inflation rate. More importantly, however, is the feeling that non-cash rewards can evoke beyond cash rewards.

Scope Sensitivity and the Impact of Non-cash Rewards

In 2004, University of Chicago professors Christopher Hsee and Yuval Rottenstreich conducted experiments to test their hypotheses on the “psychology of value” – how people feel versus calculate value.[xv]  Hsee and Rottenstreich found that when people rely on feeling to assess value, the ‘scope’ – quantity of a thing (e.g., reward) – is significantly less important than when they calculate the value of a thing. In other words, when a person rationally calculates the real value of a reward, they care a great deal about quantity, but when they rely on feelings to assess the value of a reward, the importance of quantity drops off.

“We suggest that under valuation by feeling, value is highly sensitive to the presence or absence of a stimulus (i.e., a change from 0 to some scope) but is largely insensitive to further variations in scope.”

In their experiments, Hsee and Rottenstreich used a boxed set of 5 Madonna CDs versus 10 (this was the early 2000s after all). Those indifferent to Madonna tended to calculate the cash value of ten CDs versus five. Those who expressed fondness for Madonna assessed the value of the reward based on feeling and had no more utility for ten CDs than five! In the authors words: “When primed to feel, participants were essentially insensitive to the number of CDs available.”

The researchers also found that the more salient (affect-rich) a thing or reward, the more likely a person will value it based on feeling. This underscores the importance of presentation of non-cash rewards, for example, ‘selling’ a high-performer on the excitement or luxury of an experience or material item and presenting the reward in an affect-rich manner. Social psychologist and Nobel laureate Daniel Kahneman has drawn similar conclusions from his research. Based on “the sign and intensity of the emotional response to objects,” Kahneman finds that valuations are scope-insensitive, in other words, the importance of quantity disappears.[xvi]

Insights for Incentive/Reward Design in Inflationary Times

Hsee, Rottenstreich, and Kahneman’s findings indirectly support insights garnered from the IRF’s 2017 study involving biometrics.[xvii] In this case, subjects’ subconscious reactions to a range of cash and non-cash rewards were analyzed using eye-tracking, heart rate, and perspiration sensors. Subjects were subconsciously attracted to the most vividly presented rewards. Later, after the sensors were removed and subjects were offered a choice of reward, the great majority selected non-cash rewards over equivalent cash. They claimed to have done so because they were “attracted” to certain non-cash rewards during the experiments. This suggests that they based their valuation of the options on feeling.

In subsequent research, Hsee investigated evaluation beyond that based on feeling versus calculation. In 2016 he and a co-author published a paper which proposed a “General Evaluability Theory (GET).”[xviii]  The GET argues, in part, that knowledge of a thing (or reward) might shift a person’s valuation from feeling to calculation. For example, one’s knowledge of diamonds (clarity, origin, etc.) might replace some of the feeling involved in receiving a diamond and replace it with a tendency to calculate monetary worth.

Hsee and colleagues’ research should interest incentive and reward designers no matter the economic conditions, but during inflationary times compounded by a tight labor market and threat of recession, rewards that trigger feelings might cost less (quantity is less important) and motivate (attract/retain) more, while avoiding permanent increases to compensation or benefits.

Firms should always aim for a balance of cash and non-cash incentives, but in an economy that is highly unpredictable – even in the short term – remember that cash rewards are perfectly suited to evaluation by calculation. Consider rebalancing your incentive system to include more non-cash rewards that are geared to a person’s likes (to trigger feeling) yet novel enough that the recipient’s knowledge of the reward type won’t turn feelings into calculation.

References

[i] https://tradingeconomics.com/united-states/inflation-cpi

[ii] https://www.wsj.com/articles/inflation-drives-worker-pay-down-not-up-wage-price-spiral-raises-goods-keynes-friedman-cost-push-fed-11643662537

[iii] https://www.nytimes.com/live/2022/04/01/business/march-2022-jobs-report

[iv] https://www.chathamhouse.org/sites/default/files/2022-04/2022-04-12-ukraine-war-threats-food-energy-security-benton-et-al.pdf

[v] https://www.wsj.com/articles/us-economy-gdp-growth-q1-11651108351?mod=trending_now_news_1

[vi] https://www.nytimes.com/live/2022/04/01/business/march-2022-jobs-report

[vii] https://www.barrons.com/articles/from-geopolitics-to-covid-policies-supply-chains-are-still-taking-a-beating-51646090656

[viii] https://www.cnbc.com/2022/03/16/federal-reserve-meeting.html

[ix] https://www.cnn.com/2022/04/26/economy/inflation-recession-economy-deutsche-bank/index.html

[x] https://www.vox.com/recode/22933594/pay-raise-price-inflation-employers-great-resignation

[xi] Ibid

[xii] https://www.brookings.edu/blog/the-avenue/2021/12/13/with-inflation-surging-big-companies-wage-upticks-arent-nearly-enough/

[xiii] https://www.shrm.org/resourcesandtools/tools-and-samples/toolkits/pages/managingflexibleworkarrangements.aspx

[xiv] https://www.investopedia.com/articles/personal-finance/092915/raise-vs-bonus-your-small-business-employees.asp

[xv] Hsee, C., Rottenstreich, Y. (2004) Music, Pandas, and Muggers: On the Affective Psychology of Value. Journal of Experimental Psychology, Vol 133, No.1, 23-30

[xvi] Kahneman, D., Ritov, I., & Schkade, D. (2000). Economic preferences or attitude expressions? An analysis of dollar responses to public issues. In D. Kahneman & A. Tversky (Eds.), Choices, values, and frames (pp. 642–672). New York: Cambridge University Press.

[xvii] https://theirf.org/research/reward-presentation-and-attraction-a-biometric-experiment/2348/

[xviii] Hsee, C., Zhang, J. (2016). General Evaluability Theory. Psychological Science. 5(4) 343-355