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Incentives in the dock

Sun, 7th Apr 2013

Pay, both low and high, is a sore that is always about to erupt into an open wound. Last week it did once more, and rarely have its complaints and lessons been so clear: an object lesson in the destructive power of financial incentives.

‘High pay fed ethical “vacuum” at Barclays,’ shouted the FT’s splash on 4 April over an article on lawyer Anthony Salz’s report on the bank, commissioned after its three senior managers had resigned in the wake of the Libor fixing scandal. The report detailed how ‘warped pay levels’ at the top led to an ‘entitlement culture’ that twisted the bank’s entire approach to business, favouring ‘transactions over relationships, the short term over sustainability and financial over other business purposes.’ Salz noted that the bank’s 70 top managers earned well above the industry average and in 2010 pocketed 35 per cent more than peers at other banks – a wholly unjustifiable premium in an already overpaid industry. ‘Some bankers have appeared oblivious to reality,’ says the report, adding: ‘Elevated pay levels inevitably distort culture, tending to attract people who measure their personal success principally on compensation.’

Just the day before, there were equally indignant headlines over the £10.5m fine imposed by Ofgem, its largest ever, on energy supplier SSE for ‘prolonged and extensive’ mis-selling in which many customers who were told they would save money by switching ended up with more expensive contracts. Customers were exposed to misleading statements, inaccurate and misleading information on SSE's charges, and misleading comparisons between SSE's charges and costs of other suppliers, Ofgem said. A former SSE salesman told the BBC that colleagues ‘would do almost anything’ to meet their targets and make their commission, including scouring local obituaries in order to sign up the recently deceased on fake contracts. Since sales auditors were on commission too, they had no incentive to stamp down on bad behaviour. It wasn’t just doorstep and telesales that failed customers, concluded Ofgem in justifying the record fine, but a management that had no effective control over its sales effort.

 

Salz’s 244-page report apparently cost a truly staggering £17m. Yet like all the others it signally fails to draw the only conclusion possible from the evidence so expensively collected. Despite the clear evidence of guilt, no one is ever actually found to blame and the authors are reduced to impotent scolding of the ‘culture’ of entitlement, greed or making the numbers which has swept everything else aside.

 

Well, you can read the missing bits here for (almost) free.

 

The guilty parties are those at the very top that have put in place and maintain a self-serving pay and performance system that might have been designed to produce perverse if not criminal results. And they are still doing it. The problem with incentives is not execution – the way they are done – they are the problem. 

 

Ironically, it's all there in the reports which spell out in black and white everything you need to know about why. It’s simple. Incentives change behaviour – as they are supposed to. They motivate people to think about the money and do what it takes to make it. It’s no use managers (or ministers) saying, ‘Yes, but of course they have to think about the job too’. Incentives both legitimatising and demanding self-interest, systematic self-interest is unsurprisingly what you get. You can either use incentives or not. You can’t switch them off for part of the time (which part?) and on again for the rest.

 

Incentives vampirise the organisation’s purpose, sucking the heart and soul out of it and leaving the shell of the numbers. Making the numbers (meeting the incentives) becomes the de facto purpose, which is why it produces perverse results, in turn giving rise to a whole industry of remuneration consultants and business academics dedicated to devising new and better ways of implementing them. But the perverse results are inherent, and the more complex the scheme, the perverser they become.

Again, the reports spell it out. Incentives don’t attract the best; they attract people who measure their success by what they are paid and will do anything to get it. How much more evidence of their effects do we need? Bending purpose grotesquely out of shape, they have palyed an increasing role in every scandal of modern times, culminating in the wholesale corruption of the financial sector which almost brought down the global economy in 2008 and with whose effects we are still ineffectually struggling.

As John Kay puts it: 'We have dysfunctional structures that give rise to behaviour that we don't want. We respond to these structures by identifying the undesirable behaviour and telling people to stop.' The only way of making bankers and salespeople stop putting their own interests before those of their customers is to get rid of what caused them to do it: incentives – all of them, commissions and all.

 

 

 

 

 

 

 

 


 

 

 

 

 

 


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