Key Concept

Reference-dependent theories state that individuals evaluate outcomes as gains or losses, depending on a neutral reference point. Making 19 sales in a month is a loss when the goal — the reference point — was 20 sales a month. Data from 10 million marathon finishes provides a field test that confirms the behavioural expectations and implications of these theories, shedding a light on how milestone goals can push individuals to higher performance.

Idea Summary

The use of reference points — for example, a monthly sales quota of 20 sales — is at the heart of reference-dependent behavioural economic theories, the most influential being “prospect theory.” According to prospect theory, an outcome is evaluated based on a reference point. Failure to achieve the reference point (19 sales instead of 20) is considered a loss. Achieving the reference point (20 sales or more) is considered a gain. Since most people have an aversion to losing, they will work harder as they get closer to reach the goal.

Prospect theory has been applied to many different real-world field settings, from investment decisions or consumer behaviour to the issue of labour supply and effort provision (for example, the labour supply of taxis is reduced as taxi drivers reach their daily income goals). The application to field settings, however, can be problematic because it’s difficult to know the reference points for individuals. Aspirations, expectations, norms, social comparisons are just some of the factors that can come into play in an individual’s reference point.

For that reason, new empirical research using data from nearly 10 million marathon finishes offers important insight into the effectiveness of reference points; in marathons, the reference points are easily identifiable and clear of additional influences. The marathon data was also interesting because it eliminated the financial motivation involved in other field settings: the motivation is all intrinsic.

The reference point for marathons is in round numbers. Runners will try to beat a 3-hour time, or 3:30, 4:00, or 4:30 times, for example. The demonstration of the reference point in action is through the bunching of runners. For example, the number of runners finishing a race rises steadily between 3:01 hours and 3:25. Suddenly between 3:25 and 3:30, there is a spike in the number of finishers. At 3:31, the number of finishers drops off precipitously, only to start climbing steadily up to the 3:55 time, at which point there is another spike of finishers just before the 4:00 time. This pattern of spikes and drop-offs around the round numbers indicate that runners are using those round numbers as reference points.

The data from the marathons reflect the expected behaviour from prospect theory including planning and pacing; reference-dependent effort provision (runners speed up to beat the reference point time, and slow down immediately afterward); and spontaneous goal formation (runners who fall behind reset their reference points or goals but still speed up to beat the new goals). 

Business Application

In some ways, the evidence from the marathons offers a potential solution for managers who are seeking to motivate their employees to higher performance levels while recognizing the importance of motivation from within. Even when no monetary compensation is involved, as in the case of marathons, the research shows that individuals are motivated to meet the goals they have set. In the terminology of prospect theory, the simple creation of a reference point will suddenly introduce a sense of loss and gain that might not have existed before. Employees will strive hard (speed up) to meet their goals because they don’t want to lose.

The challenge, of course, is that prospect theory calls for a diminishing sense of gain after the reference point; in other words, once they meet their goals, people tend to “slack off” a bit since there is not as much to gain from expending effort at this time.

Another implication drawn from the marathon data, which looked at “splits” (intermediate times) as well as finishing times, is the importance of setting goals in terms of round numbers. It’s sometimes easy to backslide during the implementation of a goal. Partitioning the overall goal into rough or general sections (30-minute increments in the case of a marathon, for example) keeps employees focused and moving forward.

Daniel Kahnemann won a Nobel Memorial Prize in Economics for his work on prospect theory. Although the totality of the theory’s influence and implications are not covered here, the marathon data offers intriguing insight into helping employees to internally evaluate the losses and gains of their performance levels or achievements.