More generally when we talk about incentive systems,
there is a trade off.
Right? And the trade off is going to be for employees.
Ideally you want an incentive system to be based
on some measure of outcome that is within my control.
So, something about my job.
I do this, I get that.
Right? If you don't have that,
there's really no incentive,
I can't control how much I'm going to get from you.
Then, there's no incentive for me to do a good job.
I might do a good job anyway because I'm
a good guy but it's not because of the incentive.
And the problem in lots of jobs,
is it's very difficult to measure my output.
If I work at administration for example or work in a team or I work in
some context where I'm interdependent with people or with idiosyncratic problems,
it's very difficult to measure my individual output.
So, another possibility would be to say well,
let's make the output something big like
overall firm goal or overall organization performance, right?
The problem with that is it's beyond my ability to control that.
Right? And the problem with doing that is that I don't feel any incentive, right?
So, if you give me for example stock options and I work in a huge corporation,
I've got almost zero input into what happens to the share prices,
so I don't really have any incentive.
There may be other reasons for me to have incentives,
makes me feel part of the organization,
but it's not the incentive from those rewards that is making me perform a particular way.
Well, how about having that organizational goal anyway.
Right? Well, the other problem with having goals
that are maybe within my control and are pretty even if they're
pretty far up is that it's possible for me to do well
at my goal at the expense of the overall business.
So for example, if I'm a sales person and you say we want you to sell more stuff, okay?
I could sell a lot of stuff by giving customers a really sweet deal, right?
That's giving them low prices.
I could sell a lot of stuff and drive my performance up and my incentive pay up, right?.
So the problem with that is sub-optimization.
You know I'm doing well on my goal,
but it's at the expense of the overall business, right?
So, it's another example of rewarding A while hoping for B.
So, the best solution about most incentive based pay is to
not rely on it too much and to have incentives that are pretty simple.
So, if you try to design an incentive system that heads off
every incentive to cheat and every possible way somebody might go bad with this.
You don't have to have a rule book that people will have to look up to
decide what to do at work all the time and you really don't want that.
Now, one exception we see for incentive based pay is at the executive level for people
whose individual jobs we believe drive the entire performance of the organization.
And you might be able to tie their pay
to overall business outcomes in a way that wouldn't make sense for
lower employees because they got no control really over
the company's overall share price or overall performance,
the agency's performance right?
But even here you could get sub-optimization.
Right? We get executives for example
whose incentive pay is based on
relatively short-term performance and then there's a concern
that they are driving up the short-term performance of the firm at
the expense of longer term performance where they're not going to be around.
So, it's really hard to get away from these problems of incentives and so the idea that
we can simply manage people by incentives is unfortunately just not true.
Now, let's talk about more complicated models of management.
These are ones that are developed by psychologists.
So you might think about this as these are
more realistic models of how people actually behave.
But it's much more complicated to understand all these different effects and to
also think about how they might be bundled together in any given way of managing people.
So, let's start with the psychologists take on the agency theory story of economists.
The incentive story, we want somebody to behave a particular way,
let's pay them if they achieve that.
Right? Well, the psychologist added a wrinkle to this,
which they call expectancy theory.
Psychologists have a way of calling whatever they do theory.
And so, you'll hear that a lot through this program.
Expectancy theory basically means well,
what do I actually expect from the employer?
Right? And that might be this if I have got this incentive-based plan,
but I don't trust that if I actually
get the performance that I will really get the reward,
then my motivation falls to zero.
Right? So, it's important to have predictability and trust in these models.
You can't just hand somebody a contract and expect that that's
going to make it work, right?
And if you believe that something might happen, change in ownership,
change in goals, change in compensation structure,
then your motivation erodes.
Another complication created by
a different set of psychologists is when particularly by our former Wharton colleague,
Bob House, is something called Path goal theory.
And path goal theory says you could have all the incentives in
the world and you could even have a clear goal for people that's unambiguous.
But if they don't know how to get there,
the incentives aren't going to do you any good.
So for example, if you asked me to do something at work that's kind of complicated,
solve some particular algorithm or something and here's the reward I get if I do it,
but I don't know how to do that kind of math.
All the motivation in the world is not going to matter much.
So, it reminds us of the importance of people having the skills, having the training,
understanding what to do,
it's not just about incentives, right?
The third issue which is where we depart from the economists altogether,
begins with a series of what we might call
cognitive models that have to do with the way your brain processes information.
And the simplest one of these is behavior modification.
An employer or a supervisor let's say who goes around
a retail store and sees somebody
doing good stuff and gives them a spot bonus right there.
Right? That's the kind of behavior modification technique.
I got a spot bonus for behaving this way,
I start to anticipate that maybe I will get more bonuses if I continue to act that way.
But the beauty of behavior modification is
that you don't have to get those bonuses all the time.
In fact, some of the strongest motivation,
strongest learning about how to behave a particular way from this,
comes when you don't get them all the time.
When you get them almost kind of randomly for doing the right thing.
Right? And it teaches people to behave in a particular way which is unconscious.
It might look like incentives,
but the difference with incentives is you've got to know it's coming.
Somebody's got to tell you do this and you get the bonus.
With behavior modification you don't know it's coming,
and you don't know when you're going to get it.
And it causes you to learn in a different way which is not at the conscious level.
Let's talk about some other ways in which we can manage people to
get them to perform the ways we want them to perform.
And these are also of that kind of cognitive variety.
These are associated with social psychology and that
is how people behave in the context of other people.
And maybe the simplest one of these is the notion of conformity,
and that is particularly when there's uncertainty,
we look around to other people to see how we should behave.
Got a little video clip on this one as well.
So take a look at this and watch what you see the people doing in this video.
The gentleman in the elevator now,
is a candid star.
These folks who are entering,
the man with a white shirt,
the one with a trench coat and
subsequently one other member of our staff, will face the rear.
And you'll see how
this man in the trench coat tries to maintain his individuality.