Many organizations encourage employees to propose innovative ideas that may improve company performance. Innovation is generally expected from employees operating in functions such as research and development, engineering, marketing, and advertising, yet companies often foster an organizational culture where innovative ideas come from nonprofessional innovators. Some companies, such as 3M, Google, and Red Gate, allow workers to use a certain amount of their paid time to pursue their innovation projects. Others, like Toyota and Whirlpool, implement dedicated information systems to track and evaluate proposed innovations.
Nonetheless, there’s widespread consensus among practitioners that, despite formal and informal supporting mechanisms, workers engage in employee-initiated innovation or EII (i.e., innovation proposals from nonprofessional innovators) less than the company wants.
Rewarding innovation is always difficult because it’s challenging to set standards ahead of time to evaluate the organizational benefits brought about by a new idea over an undetermined amount of time; establish expectations for the number, type, and magnitude of the innovation; and compare ideas to determine which may be the better one. Things become even more complicated when managers try to elicit innovation from workers whose organizational roles and responsibilities (i.e., standard tasks) don’t formally include innovation (that is, for these workers, innovation is an “extra-role” behavior), because there can be no explicit expectations for innovation output.
Thus, scholars have proposed to incentivize innovation activities indirectly by creating conditions that may allow innovations to arise spontaneously, for example, by reducing the time pressure on standard task deliverables, thus creating space for workers’ creativity to develop. Yet, while creating space to think outside the box is likely a necessary condition for EII, it may not be a sufficient one. This motivated us to explore additional factors that may influence employees’ propensity to engage in EII.
We conducted a study to better understand the role that compensation contracts for employees’ standard tasks may play in their participation in EII activities. We examined whether and how performance pressures embedded in the standard task compensation shape employees’ perception of their role within the company and determine the cost of diverting attention from their “in-role” responsibilities to “extra-role” behaviors such as EII.
Understanding this relationship is important, as it provides information about the trade-off managers face between incentivizing standard task performance and encouraging employees to contribute to organizational success by engaging in extra-role activities that are beneficial for the company but aren’t explicitly spelled out as formal employee responsibilities. (Details of the study will appear in “Incentive Contract Design and Employee-Initiated Innovation: Evidence from the Field,” forthcoming in Contemporary Accounting Research.)
STANDARD COMPENSATION AND EII ENGAGEMENT
We analyzed three years of data obtained from a Chinese manufacturing company that uses a dedicated information system to track workers’ EII idea submissions. Submitted ideas are categorized into types, which we aggregated into task-specific EII (i.e., ideas that benefit the standard task of the proponent—for example, to improve their productivity, make the job less effort-intensive, or reduce the incidence of errors and quality issues) and organization-wide EII (i.e., ideas that benefit other constituents in the company, for example, by making someone else’s job easier—or the organization as a whole—for example, by finding ways to reduce overhead costs).
In this company, employees’ compensation arrangements are structured either as fixed-pay contracts, whereby employees receive the same amount of money every month independently from production volumes; variable pay or pay-for-performance contracts, whereby employees’ pay depends entirely on volume-based metrics (akin to a piece-rate scheme); or a mixture of the two (i.e., mixed-pay contracts), whereby workers receive a fixed amount every month plus additional volume-based compensation.
Contract types are assigned at the time of hiring and don’t change throughout the worker’s employment period. Management tries to keep a healthy mix of contract types even among employees who play the same organizational role or work within the same team. Workers aren’t selected based on their creativity or innovation propensity, and no mention of innovation is made during the interview process or in their employment contract and job description.
We found that employees compensated with variable pay exhibit a lower tendency to engage in EII than their fixed-pay colleagues. Yet we observe this result only with respect to organization-wide EII. We didn’t find any significant difference in EII engagement across compensation contract types when ideas aim to improve the proponent’s standard task. These results are consistent with standard task compensation contracts shaping employees’ interpretation of their organizational responsibilities and their productive focus.
Rewarding workers for standard task performance certainly incentivizes them to work hard on their primary job responsibilities. But compared to fixed-pay arrangements, pay-for-performance contracts make it very costly to divert effort from the standard task to engage in EII. This can lead workers to become hyper-focused on performance metrics explicitly rewarded and ignore activities that are beneficial for the company but not set as formal responsibilities for them (i.e., extra-role behaviors).
While we found that pay-for-performance still drives employees to come up with ideas to increase their own efficiency, it discourages engagement in EII that could contribute to the well-being of the organization as a whole. In contrast, fixed-pay employees have more autonomy to exercise creativity in areas unrelated to the immediate task at hand. Thus, our findings suggest that companies hoping to solicit organization-wide innovation from their employees must consider the spillover effects introduced by how they reward standard task performance.
KEY TAKEAWAY
Because creativity is an inherently personal trait, companies have long struggled to motivate and incentivize EII. Our finding that fixed-pay compensation significantly increases EII compared to variable pay provides a concrete mechanism that can be used to indirectly foster EII, especially in areas outside an employee’s standard tasks. Our results should remind managers that control mechanisms don’t operate in a vacuum and that compensation contracts designed to regulate employees’ efforts on their standard tasks can have far-reaching spillover effects on multiple dimensions of the workplace.
Our findings also call into question the idea that pay-for-performance is always beneficial to company success. While it may reward employees for delivering on their standard tasks, our study shows that it can discourage employees from proposing ideas that may improve efficiency in other areas. Managers, therefore, must consider the trade-offs between narrowly defined standard task productivity and other desired activities they may wish to elicit from their employees.
April 2023
