How many people work just for the money? Fewer than we, or our bosses, might think. Economists assume people behave rationally towards money. But they couldn't be more wrong, and the power of money to demotivate is much higher than its power to motivate.

Let's begin with the simple belief that money brings happiness. Using data from the US, plotting personal income over the past 50 years produces a satisfyingly ascendant 45-degree line. But over the same period, the percentage who describe themselves as very happy is completely flat. Personal income (alone) has little effect on personal happiness.

We have a fair idea what brings happiness: being physically and mentally fit and healthy; having good relationships at home and work; feeling in control of your life; feeling good about yourself; and having a satisfying job that plays to your talents.

So, where does that leave money? Extra money can motivate people to do extra work, but it does not always work. For highly paid employees (and defining that is a problem), money can lose its power to motivate. They want other things. Think of all the problems connected to performance-related pay. Few people are happy with the way it works in their organisation: it can increase conflict and jealousy, which ultimately wrecks satisfaction and productivity. It is more likely to upset people than to motivate them.

And money sure demotivates people if you get it wrong. Fail to pay people equitably and you end up with a disenchanted workforce, however much they are paid. Take a trip to the City of London during bonus time to see what I mean.

There are three forms of equity: first, that people are rewarded proportionally according to their effort (input must relate to output). The more you give the more you get. Thus two people in the same job, with the same experience and job title, need not, and should not, be paid the same if their output is different. We have known since the 1920s that, as a rule of thumb, the best worker (in the same job) produces about 2.5 times as much than the worst worker. To pay equitably they should be paid 2.5 times as much. But they never are - except perhaps in commission-only sales jobs.

Second, they must be rewarded equitably relative to each other in the same organisation: more effort, more output, more reward - irrespective of experience or job title. People are rightly sensitive to the "costs and benefits" of promotion. This is why it may be difficult to persuade people to accept promotion to certain jobs (typically supervisor level). The financial rewards simply do not match the stress.

And third, they need to be paid equitably in relation to market forces. People can suddenly desert companies that do not keep a keen eye on what is happening in the market. Previously happy and contented workers can overnight become sullen, malcontented and underachieving if they feel they are underpaid compared with others doing similar work in different organisations.

Money can have other curious effects. Some jobs - say, a painter or potter or actor - are more intrinsically motivating than others. The reward is primarily in the nature of the task itself and people are therefore prepared to "trade off" money for the joy of the activity. But if you pay people for something they like doing you can easily reduce their intrinsic motivation. They may feel they are now doing it only for the money, which is an extrinsic factor.

Money can trivialise work. It can demean what you are doing and offering. Pay creative people for their creative ideas and they can dry up. Pay children to get better exam grades and they think they are studying only for the money. You diminish and demean the joy of the activity, of learning for its own sake. Money often makes the intrinsic extrinsic: it can make motivation more dependent on money. So, paradoxically, money has to be the motivator.

There is simply no evidence of a linear relationship between motivation - to work harder and smarter - or even satisfaction and money. There are four reasons why.

1. Adaptation: people very soon "get used to" the increase in salary. The positive effect goes away quickly. Yes, money works to some degree, but you need a lot of it because of its drug-like properties.

2. Social comparison: The single best predictor of a person's satisfaction with their salary is their knowledge of how much others are paid in the organisation. Best keep it all secret to stop comparisons. In fact, you can make people happier with their salaries by decreasing everyone else's as much as raising theirs. The motivational power of money is relative, not absolute.

3. Alternatives: This is all about trade off, time versus money, title versus money. After a certain point, money loses its power to stimulate and motivate in comparison with other rewards.

4. Worry: The more you have the more you worry about keeping it from the tax man, from burglars and for your old age and children.

So, how do you motivate people at work? Start by selecting energetic, stable, happy people; then pay them what they are worth. Understand and take into account individual differences in age-and-stage, personality and so on. Make each person's work as meaningful as possible, giving them feedback on how they are doing and rewarding development with praise. Keep salaries confidential but give everyone a share of the profits. Make salary differentials reflect skill, responsibility and effort.

If you want loyalty and commitment from your employees, you must show them yours first.

What makes your world go round?

Rank the following elements relating to your employment in order of their importance to you:

· Bonus (how much, how often, how it is calculated)

· Feedback (how accurate, helpful, regular, who from)

· Holidays (how many days a year)

· Interesting work (how intrinsically satisfying, joyful, engaging)

· Other benefits and perks (travel, housing, products)

· Respect (from peers, customers, society)

· Responsibility (for personal success)

· Retirement package (in its entirety)

· Salary (how it is calculated, how much)

· Training (how useful, how frequent)

Your boss would probably guess that you have put them in this order: salary, bonus, holidays, retirement and other benefits.

Most employers assume that people are really extrinsically motivated. But they are deluded. Most workers would actually prioritise motivating factors in this order: interesting work, responsibility, feedback, training and respect. Intrinsic motivation works best.

The trouble is, poorly informed bosses create self-fulfilling prophecies. By their ignorance, employers can make people extrinsically motivated and at work just for the money.

· Adrian Furnham is professor of psychology at University College London and co-author of Just For The Money (Marshall Cavendish)