“All that we do is done with an eye to something else.” – Aristotle (Nicomachean Ethics, 4th century B.C.)

If you’ve spent any time managing a business, you’ve spent time wondering about compensation and performance: What is the best way to pay employees?

If you want to get the most from your employees, do you create a compensation program that is primarily incentive-based? Or do you pay them big salaries and forget about bonuses?

I’ve tried it both ways and in-between. I haven’t discovered the perfect formula, but I am developing opinions. Thus, I’m always interested in learning about the experiences of others. One set of relevant experiences was reported in the Harvard Business Review. A consulting group broke a team of workers into five groups, each with a different compensation structure:

1. The Communist Program (the HBR called it “the pay equality group”): Under this plan, all members of the team received the same pay regardless of experience, effort, etc.

2. The Sovereign Society Program (the “pay equity group”): Every member of this group was paid according to his individual performance.

3. The Free Market/Group Threshold: After the team as a whole reached a certain target, members’ pay rates rose relative to their individual performances.

4. The Free Market/Individual Threshold: Once every member of the team hit an established target, pay rates for each rose according to his individual performance.

5. The Controlled Market Program: Team members were paid based on their individual performances — but once the highest-paid employees earned twice as much as the lowest-paid, some of the high performers’ subsequent earnings were transferred to the low performers to reduce the gap.

So what happened?

As you might expect, the Communist Program depressed individual performance. So did its cousin, the Controlled Market Program.

The Sovereign Society Program was great at getting individuals to excel but fell short in getting people to act as a team.

The two programs that provided a free market for individual performance plus some extra incentives for achieving, as a group, certain defined thresholds achieved individual performance plus teamwork and teaching.

The Controlled Market Program produced the worst of all possible worlds: negative competition, resource hoarding, and the  withholding of information.

What do I take from all this?

Let’s start with the obvious:

* If you reward individual performance, you will get more of it.

* If you don’t, you’ll get less of it.

So it seems to me that the most important thing you should do in business is pay people more who contribute more.

Your strong performers are going to lead your business. Although they will comprise 20% of your work force, they will produce 80% of your most productive work. So pay them well. I’m not sure it matters how you structure that pay. It can be fixed, incentive-based, or some combination of the two.

As for the other members of your work force — they will pretty much follow the lead of the top 20%. Most people will make some attempt to keep up but feel comfortable lagging somewhat behind. A smaller group will try to do as little as possible.

Let your top people set the pace, trust the middle group to follow, and seek out and cull the ne’er-do-wells. That’s pretty much all you can do.

If you provide strong incentives to your best people, you will have their strongest work. If you try to stiff them, you will lose out.

Other than that, I’m not sure you can get anything done by compensation. Getting your people to cooperate, share resources, plan together, and so on — most of that stuff comes out of the business culture you create. And the business culture is derived from your leadership, not your compensation plan.