Show Me the Incentive and I’ll Show You the Behavior

By: Bradley Binversie

I’ve been thinking a lot about the power of incentives and how they shape our behavior and the world around us. I’ve been asking myself, what is the incentive behind (person,system, decision) ect? Just asking this question let’s me think about things a bit more rationally and clearly if I have an understanding of what is shaping the behavior of those around.

Rational decision making is vitally important, yet we are anything but rational. If we look deeply at human pyschology and behavior, we can see that the power of incentives is one of the largest driving forces shaping the world around us and even impacting our own thinking.
“The chains of habit are too light to be felt until they are too heavy to be broken.” – Warren Buffett

Incentives are incredibly powerful and potentially dangerous because of they shape systems or influence our own thinking in ways that not easily detected, difficult to predict, and almost impossible to change once the system is built. It can cause us to rationalize immoral behavior that in a stand along situation would thought to be grossly misguided.
The goal of this piece is to highlight how incentives are at work and by providing some examples. Perhaps by peeling back the layers and exposing incentives at work, we can understand how and why human behavior is how it is.

Corporate and Business Incentives
Incentive: Leaders of publically traded companies are judged by how well their stock performs. Stock performance is based upon the company’s ability to make money, which is reported in quarterly earnings. Seems like a logical incentive structure, encourage CEO’s to have their company do well on a regular basis. Good CEO’s and good company’s will be rewarded
Unintended Consequence: This can create the incentive for CEO’s to focus short term, neglecting long term investment necessary for the future of the business. It can also create intense short term pressure to “meet the numbers” quarterly, which might lead to questionable accounting practices or other immoral behavior… See Enron, GE, or any number of corporate cases where the numbers didn’t quite match reality.

Sales
Incentive: Salespeople are paid commission for the sale of products. They are motivated to make money and thus work hard.
Unintended Consequence: Can create the incentive for immoral behavior. Some examples: Wells Fargo employees opening fake accounts to meet their sales numbers. Countless cases of immoral Insurance salesmen on everything selling bad companies with higher commission to taking advantage of the elderly, ect.

Political System
Incentive: Politicians need to get re-elected repeatedly in the US or any democracy. This allows citizens to vote out bad politicians.
Unintended Consequence: It makes it difficult for politicians to make meaningful, difficult, long-term decisions because they are always involved in a popularity contest for their job. Would you do anything difficult or unpopular if your livelihood would end in 2, 4, or 6 years? This incentive creates lifelong politicians who do not accomplish much.
Politicians are also responsible for allocating tax dollars, if you had to win a popularity contest might you be tempted to allocate money to the causes that might help you win that popularity contest. Like a 6th grade class president candidate who promises unlimited recess and ice cream for lunch.

Investment and Finance Space
Incentive: Managers of Private Equity, Venture Capital, Mutual Funds are paid fees based on assets under management.
Unintended Consequence: Investment Managers are not incentivized to invest well, they are incentivized to “gather more assets”. More assets=more fees for the manager. This creates very average performance on the whole so customers don’t pull their funds and buy index funds to settle for averages. It can also encourage risky or reckless behavior because you get the money and are being paid to invest, whether you have a good investment idea or not.

Media
Incentive: Reporters need access to high profile people.
Unintended Consequence: Are they going to fair in their assessment? Or do they want to keep getting access to the high-profile people? They might not if they’re overly critical (even if it’s true).

Legal
Incentive: Attorneys are usually billed by the hour.
Unintended Consequence: Are they incentivized to conclude legal proceedings as quickly as possible? Or is the temptation to drag out billable hours?

We could exemplify any number of systems that horribly influenced by the power of incentives: Healthcare, Education, social services, …..Bottom line in systems is people show conscious or unconscious bias to those who employ, pay, or feed them. “Who’s bread I eat, his song I sing.”

On an Individual Basis
This also happens to us on the individual level. Incentives can influence our behavior and thoughts without knowing, or worse we rationalize it to ourselves. Examples:

-Instead of seeking truth. Most people spend the majority of their life, looking for information that rationalizes what they already believe to be true.

-The salesmen who sells a low-quality product, might justify it in his mind. Even believing that it’s a great product, when in truth it’s poor. “To the man with a Hammer, everything looks like a nail.”

– We look for reasons to justify the outlandish behavior of the candidate of our aligned political party. “He’s only doing that because the other party is so evil….”

-We talk ourselves into foolish financial, professional, or business decisions because we simply want them to be true. “Nothing is easier than self-deceit. For what each man wishes, that he also believes to be true.”- Demosthenes

-The person who behaves slightly immorally, will justify it to themselves to reach their incentive. “I’m entitled to the money, I embezzled.” “Everyone does this in corporate accounting.” “Everyone cheats on their homework and tests.” “All men behave this way….”

We should all take a step back and analyze what is the incentive behind this person, or system? Not all incentives are bad, but it’s incredibly important that we take the time to analyze them so we can approach decisions as rationally as possible.