Financial reward schemes in microfinance

We evaluate the effect of incentive schemes (bonuses) on the performance of credit officers working for a large microfinance institution. Specifically, we compare between a bonus scheme based on individual performance and a bonus scheme based on team performance.

Individual behavior is largely driven by incentives, yet those faced by employers and employees are often misaligned - the classic principal-agent problem. A large theoretical literature is concerned with the design of contracts that provide solutions to the agency problem. One commonly proposed tool for addressing agency problems is the provision of financial reward schemes, or bonuses. In organizations with a social mission, or where agents are expected to perform on both measurable and non-measurable tasks, such schemes may perform worse because only certain tasks can be rewarded in this way, and these tend to be the non-social tasks (Holmström and Milgrom, 1991, Holmström and Milgrom, 1994). Earlier research findings also suggest that financial rewards risk to crowd out employees’ intrinsic motivation to “do good”. Such motivation is of particular relevance to the public sector and in organizations with a social mission, including those in the microfinance sector. Despite these potential risks, financial reward schemes are pervasive in organizations, and only a number of recent experiments from developing countries have evaluated such schemes.

This study adds to the literature on financial reward schemes in organizations. The microfinance setting is an interesting one in which to evaluate bonus schemes as credit officers are in frequent contact with the borrowers and social factors can affect their decisions regarding loan granting and the repayment collection. When individual reward schemes are introduced, a credit officer may need to trade off monetary rewards against social expectations and rewards. Bonuses based on individual effort, as compared to team based bonuses, reduces free riding and may thus incentivize certain credit officers to work harder. At the same time, key aspects of the job require teamwork between credit officers, and a monetary incentive based on the individual level performance might negatively affect effort on these components.

The study is carried out in collaboration with BRAC Uganda, currently one of the largest development organizations and micro finance institutions in the country with more than 200,000 active borrowers (see www.brac.net/uganda). We collaborate with BRAC to evaluate the effects of a move from a reward scheme for credit officers based on team performance to a scheme based on individual performance. We use a randomized control methodology with randomization at the branch level, and ask how individual level as compared to team level bonus contracts affect outcomes such as credit officer effort, measures of team work, staff well-being and borrower pool characteristics.