The interactive effect of reward type and taxation on employee effort

Abstract

Firms are increasingly using performance-contingent tangible rewards (e.g., gift cards) to motivate employee effort. We use an experiment to examine whether the effort effects of tangible rewards versus cash rewards depend on whether the rewards are subject to taxation. Consistent with affective valuation theory, we find that the motivational disadvantage of tangible rewards versus cash rewards is greater when rewards are subject to taxation than when rewards are not subject to taxation. Specifically, while we find no difference in effort between the two reward types when rewards are not taxed, we find that participants exert more effort to earn cash rewards than tangible rewards when rewards are taxed. Our study informs compensation designers of the greater adverse effects of taxation on tangible relative to cash rewards, which highlights the usefulness of techniques such as ‘grossing up’ tangible rewards or using cash- tangible reward combinations to mitigate the negative effects of taxation on tangible rewards.