A person struggles to balance a seesaw representing the balance between fixed pay and performance-based incentives.

Fixed Pay vs. Performance: Are You Sabotaging Your Team's Potential?

Kai Mendoza in Business & Economy June 2025 • 5 min read.

"Uncover the surprising truth about mixed compensation schemes and how they impact employee motivation and effort."

In today's dynamic business landscape, attracting and retaining top talent requires more than just a paycheck. Companies are constantly experimenting with different compensation models to maximize employee motivation and productivity. While some advocate for purely performance-based pay, many organizations utilize a mixed compensation scheme, which includes both a fixed salary and variable incentives. But does this seemingly balanced approach truly unlock an employee's full potential?

Conventional wisdom suggests that fixed payments provide security, while performance-based bonuses incentivize hard work. However, emerging research in behavioral economics suggests that the way employees perceive these components can significantly impact their effort levels. The concept of "relative thinking," where individuals evaluate options based on their relative differences rather than absolute values, plays a crucial role in shaping these perceptions.

This article delves into the fascinating world of compensation psychology, exploring how fixed payments can inadvertently affect employee effort. By understanding the hidden biases at play, businesses can design incentive programs that resonate with their workforce and drive tangible results. Prepare to challenge your assumptions about compensation and discover strategies for building a more engaged and productive team.

The Relative Thinking Trap: How Fixed Payments Can Distort Effort

A person struggles to balance a seesaw representing the balance between fixed pay and performance-based incentives.

The human mind isn't always rational. Instead of objectively weighing the pros and cons of a situation, we often rely on cognitive shortcuts and biases. One such bias is "relative thinking," where we evaluate options based on their relative differences rather than absolute values. In the context of compensation, this means employees might not simply consider the total amount they earn but also how that amount breaks down between fixed pay and performance-based bonuses.

Imagine two employees, both capable of completing ten tasks. Employee A has a fixed salary of $10 and can earn an additional $1 per task. Employee B, however, has a fixed salary of $50 and the same $1 per task bonus. From a purely rational standpoint, both employees should be equally motivated to complete all ten tasks. However, relative thinking suggests that Employee A might be more motivated because the potential $10 bonus represents a 100% increase over their fixed salary, whereas it only represents a 20% increase for Employee B.

Anchoring Bias: Employees may anchor on their fixed salary, making performance-based bonuses seem less significant, especially if the fixed component is substantial.
Framing Effects: The way compensation is presented (e.g., emphasizing the bonus potential vs. the base salary) can influence how employees perceive its value.
Loss Aversion: Employees may be more motivated to avoid losing their fixed salary than to gain a performance-based bonus of equivalent value.

To effectively harness the power of relative thinking, companies need to carefully consider how they structure and communicate their compensation plans. Instead of simply focusing on the total compensation amount, they should emphasize the potential impact of performance-based incentives and highlight the relative value they offer. By doing so, they can tap into employees' intrinsic motivation and drive greater engagement and productivity.

The Future of Compensation: Leveraging Relative Thinking for a More Engaged Workforce

Understanding relative thinking is a crucial step toward designing more effective compensation plans that truly motivate employees. By considering how individuals perceive different components of their pay, companies can create incentives that tap into their intrinsic drive and foster a more engaged and productive workforce. As the world of work continues to evolve, embracing behavioral insights will be essential for attracting and retaining top talent and achieving sustained success.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: 10.1016/j.joep.2018.10.004, Alternate LINK

Title: Do Fixed Payments Affect Effort? Examining Relative Thinking In Mixed Compensation Schemes

Subject: Economics and Econometrics

Journal: Journal of Economic Psychology

Publisher: Elsevier BV

Authors: Ofer H. Azar

Published: 2019-01-01

Everything You Need To Know

What is 'relative thinking' and how does it affect employee motivation in mixed compensation schemes?

'Relative thinking' is a cognitive bias where individuals evaluate options based on their relative differences rather than absolute values. In the context of mixed compensation, employees may focus on the percentage increase a bonus represents compared to their fixed salary. For example, an employee with a lower fixed salary might perceive a performance-based bonus as more valuable because it represents a larger percentage increase than the same bonus for an employee with a higher fixed salary. This can impact motivation levels as employees with lower fixed pay may be more incentivized by the bonus. Understanding this bias is crucial to designing effective incentive programs.

How do 'anchoring bias', 'framing effects', and 'loss aversion' influence employee perception of compensation plans?

These three concepts are crucial elements of understanding the impact of compensation schemes. 'Anchoring bias' means employees may 'anchor' their perception of overall compensation on their fixed salary, potentially diminishing the perceived value of performance-based bonuses. 'Framing effects' refer to how the presentation of compensation—emphasizing the bonus potential versus the base salary—influences its perceived value. For example, if a bonus is framed as a significant percentage increase over the fixed salary, employees might be more motivated. Lastly, 'loss aversion' causes employees to be more driven to avoid losing their fixed salary than to gain a performance-based bonus of equal value. This means the fixed payment acts like an anchor and can decrease motivation to earn the bonus if the base salary is high.

How can companies use the understanding of 'relative thinking' to design more effective compensation plans?

Companies can use 'relative thinking' to design better plans by carefully structuring and communicating their compensation. Instead of just focusing on the total compensation, the emphasis should be on the potential impact of the performance-based incentives and highlighting their relative value. For instance, when communicating the plan, businesses should frame bonuses in a way that makes them appear significant relative to the fixed salary. Furthermore, by understanding that employees with lower fixed salaries may be more motivated by bonuses, companies can tailor plans to balance fairness and drive engagement. This also involves considering how the bonus is perceived and framed.

Why might a mixed compensation scheme with a fixed salary and performance-based bonuses not always unlock an employee's full potential?

A mixed compensation scheme, though seemingly balanced, may not always unlock an employee's full potential because of the cognitive biases like 'relative thinking'. Employees may perceive the performance-based component differently depending on their fixed salary. If the fixed salary is high, the bonus might be perceived as less impactful, reducing motivation. Furthermore, biases like 'anchoring bias', 'framing effects', and 'loss aversion' play crucial roles. Employees can 'anchor' on their fixed salary, which makes the bonus less significant. The 'framing' of the compensation plan affects how the bonus is valued, and 'loss aversion' might make the employees more concerned about protecting their fixed salary than earning extra through the bonus. In such cases, employees may not be fully motivated to increase their performance.

In what ways can businesses effectively communicate compensation plans to leverage the principles of 'relative thinking' for higher employee engagement and productivity?

To effectively communicate compensation plans and leverage 'relative thinking', businesses should focus on the relative value of performance-based incentives compared to the fixed salary. This can be done by clearly highlighting the percentage increase a bonus represents, especially for employees with lower fixed salaries. Emphasize how bonuses can significantly boost overall earnings. Use 'framing effects' by highlighting the potential gains of the bonus rather than just stating the fixed salary amount. Furthermore, make sure to regularly remind employees of the potential impact of their performance on the bonus, keeping the bonus at the forefront of their minds. This consistent communication helps employees understand and appreciate the direct connection between their work and rewards, thus boosting engagement and increasing productivity.