The Incentives Curse



I’m sure you heard or even worse asked the question yourself:

What’s in it for me? What’s the benefit, the reward,

the incentive you offer me for doing something……

For “whoeveryoubelievein’s” sake – does everything have to be rewarded, remunerated or whatever term one wants to use for that largely financial “bribe” for action?

There is no incentive for breathing either, well some might say the incentive is life, I would say the consequence of not breathing is death.

Unlike many might believe the word incentive is relatively new and originates from late Latin as the dictionary snapshot below tells us. Not to mention all the twists we did to the meaning between the 15th or 16th century and today.

Having said so the word, or perceived importance of incentive has only been more closely studied since the 1940’s – 1950’s and considered fairly young given the economic history of mankind.

 

 











Even the famous economist Schumpeter (1954) does not mention the word "incentives" in his major work “history of economic thought”. Maybe Schumpeter's omission happened because, when he was writing, economics was mostly concerned with understanding the theory of value in economies and not of the individuals involved.

Sadly, for many economists and individuals today, economics is to a large extent a matter of incentives: incentives to work hard, to produce good quality, to sell more, to buy cheaper, etc.

Apparently incentives were introduced when delegation of a task to an employee or employee who has different objectives than the principal who delegates this task became problematic.  They are meant to insure the tasks are performed in the interest of the principle. This problem is the essence of incentive questions. If the employee or employee had the same objective and level of engagement as the principle, the principal could rely on the latter's actions to be what he would like to do himself in a world without delegation. Again, incentive issues would disappear.

Conflicting objectives and incomplete information are thus the two basic ingredients of incentive theory.

The information gap is relatively easy to understand as in large companies with thousands of people it is impossible for the principal or principals to know the individual employee not to mention having a personal relationship. Our human ability to manage personal relationships is limited to around 150 people and then we run out of time and probably emotion as well. We then unfortunately created management structures and hierarchy levels to handle teams or groups of certain sizes which should not have required the incentive program but yet it did as these managers are not the principles either but higher paid employees themselves falling for the same motivation trap.  

It is more complex to explain what drives the differences in objectives as one would think that both the principal and the employee would have a similar goal, the enterprise doing well should be in both interest. 

Clearly wealth distribution over the centuries between the landlords initially and the industrialists later and the employees has created an imbalance between the two classes. The working class always felt exploited by the capitalists as they got richer and the employees poorer plus the tenure and certainty of their engagement being subject to the principal’s mercy.

As much as unions and government reforms have improved the situation for the employees over the years, maybe too much so that the employee is in power more than the employer, the sentiment still remains. Many employees feel good if they can get away with some abuse of working hours or other perks a company offers, not understanding that they actually cause harm to the hand that feeds them.  Being that one particular company or companies in general.

To close the wealth gap, companies offer financial incentives, largely, to motivate their staff to perform better by having that carrot in front of their eyes all the time.  The issue is that this incentive does not align the objectives of the principal and the employee, unless they are purely financial as well. Where that leads to is another 2008 meltdown as the financial incentives for shareholders and employees are too great to stay within the realm of proper and responsible behaviour. The ones who got hurt most however are the working class people, the same who are looking for incentives that might destroy the greater good. The other issue with incentives is that they largely only have an upside and there are no disincentives when things go wrong or performance is simply poor.  

So shouldn’t pay be structured as a target pay with a reduction from or addition to that target pay. An incentive and a penalty like everywhere else in life?

Both issues above are typical for our modern economic and capitalistic few of the world. Schumpeter once claimed that capitalism might be destroyed by its own success and I think we are well underway to get there.

Many different interests and attitudes are at work these days, both on the employee and principle side. As greed and status do their deeds, we also lack trust, responsibility and sense of duty and if you want us to move “you gotta pay” whilst we want to enjoy safety and protection of our economic lives at the same time – no risk and always upwards.  This situation is not everywhere obviously as there are scandalous conditions in some countries when it comes to work but they are fuelled by the same ingredients, just with the power differently distributed.

To make a change to our economic live we need changes from both sides, the principles and the employees. We have to do away with bonus and commission plans which tends take ignited efforts down the wrong path, besides over time people take them for granted.

The employees need to get a mindset closer to that of the principle and vis a versa. They need to adopt more entrepreneurial thinking and behaviours as only that can create the trust and respect needed from the principle to operate autonomously or as a self-governed organization with everyone interests largely aligned. Organisations need to have more than making money at their hearts, other values that are relevant to the people working with them, values that motivate them beyond cash, values that unleash their own drive.

Andreas Hipp
 

 

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