Jason Punyon

Employee Referral Bonuses Are Pants on Head Stupid: Follow Up

In my previous post I outlined one reason why I think employee referral bonuses aren’t good: They distort the incentives for referring someone into the company in a way that can’t possibly be good. First off, my thanks go out to everyone who read that post. Some people refuted my argument in various ways and I thought I’d take a look at a couple of them.

Refutation The First: Bonus Size Matters

This is correct. I was working under the scenario of the miso article where the bonus was $10,000. The size of the bonus absolutely matters. The bonus can’t distort any incentives if it’s too small for people to care about. But that’s the problem then. It’s too small for people to care about. The promise of $500 ($350 after taxes?) six months from hire date is not enough to divert your employee’s attention from their primary responsibilities to do this recruiting work for you.

If you also use contingency recruiters (you shouldn’t, but I realize companies still do) another problem that might exist with relatively small referral bonuses is you can’t simultaneously have GIANT contingency recruiter fees that your employees know about. If a contingency recruiter gets $25K on a $100K salaried worker when your employee gets $500 or $1000 for the same kind of referral your employee is going to see the dissonance there and be unhappy.

Another dissonance your employees might see is that the company says things like “We are 100% dedicated to finding great talent. It is #1 with a bullet on our list of priorities” and then you pay out $500 for a referral. It just doesn’t jive.

Refutation The Second: Risk vs. Reward

Another popular thought was that referring someone to the company carries with it the inherent risk that the hire doesn’t work out. When the hire doesn’t work out it’s the referrer that would be “blamed” for the failure and that the bonus compensates them for that risk. This was interesting and I have to admit that I didn’t consider framing the issue like this at all.

Your employee who refers a potential hire doesn’t get the bonus until the potential hire is hired and stays for a honeymoon period of 3 or 6 months. The honeymoon period is there to protect the company from paying out a bonus and then having the new hire quit after 3 weeks. So when the new hire doesn’t work out during the honeymoon period, the referrer gets both the “blame” and no bonus. The bonus can’t possibly compensate them for any risk during the honeymoon period.

The honeymoon period simultaneously sends the message “Once the new hire makes it out of the honeymoon period, we’re happy with your referral performance. Let’s celebrate with some rewards.” If the new hire makes it out of the period, and then something doesn’t work out, the company can’t with a straight face blame the referrer for anything. It’s simply schizophrenic. If you’re doing it right, there isn’t any blame risk to compensate them for after the honeymoon period is over.

So during the honeymoon period the referrer can’t possibly be compensated for the risk, and after the honeymoon period there isn’t any risk for which to compensate the referrer if the company isn’t being schizophrenic.

Side note: This analysis was done under the pretense that there’s this blame game being played. If there’s any of this going on at all there is a serious problem that needs to be remedied immediately. The company can’t attach this nebulous liability to the referrer for a person the company hired. The company should still put the referred candidate through their paces in the interview process and prove to themselves that the recommendation was justified. In doing so the company can’t possibly place blame at the foot of the referrer for providing what is essentially an introduction.

Employee Referral Bonuses Are Pants on Head Stupid

So, I read this story yesterday about the employee who referred a friend and got screwed out of his referral bonus. People on Hacker News argued about “Name and Shame” and who was right and wrong but the first thought that popped into my head was “employee referral bonuses are pants on head stupid.”

Forget about this particular case and the collateral problems it’s causing. The employee referral bonus is just an intrinsically bad idea. Ostensibly the bonus exists to reward an employee for referring someone into a job. All it really does is distort the incentives in a way that can’t possibly be good.

Following is a list of reasons I want an employee of mine referring someone to my company:

  1. The person being referred is beyond awesome at what they do and we’d be fools not to hire them.
  2. Did you not read #1?

When I hold a $10,000 gun to the referrer’s head I’m distracting them from that one simple reason. When there’s no bonus involved there are people the employee will refer and people they won’t. With the money hanging out there a third category of people opens up: people the employee will refer if they can get $10,000. This third category is made up completely from the people the employee wouldn’t have referred if the bonus didn’t exist. I don’t want any of these people in the third category.

The absolute last thing I want to do is turn my employees into contingency recruiters and that’s exactly what the referral bonus does.

So if referral bonuses aren’t right how do you get your employees to refer great talent to the company and the company to great talent? Make your company such an awesome place to be and work that your employees naturally want to do that. Figure out what your employees want and then give it to them. Great health care, free lunch, 20% time…whatever. They’ll be so happy with you that they won’t be able to contain themselves when they find out a friend is looking for a job.

If you want to hear my thoughts on some of the responses to this post, read my follow up here