The power that incentives and disincentives hold over our actions, causing even decent individuals to fall into immoral behaviour
25-Aug-2015 •Mohammed Ekramul Haque
What is it? On a very basic level, it is the tendency to respond to rewards and punishments. Simple as it sounds, Munger cautions that even though we tend to think that we recognise the importance of incentives and disincentives in changing cognition and behaviour, that is often not the case.
"If you would persuade, appeal to interest and not to reason. This maxim is a wise guide to a great and simple precaution in life: Never ever think about something else when you should be thinking about the power of incentives."
An extreme side of the incentive superpower brings about the 'incentive-caused bias', because of which even decent individuals, consciously or unconsciously, fall into immoral behaviour to get what they want by rationalising bad behaviour.
Often found in: Cases of persuasion and providing incentives.
In Life: Money is one of the biggest incentives that drives people's habits, says Munger. "A rich person will often, through habit, work or connive energetically for more money long after he has almost no real need for more. Money rewards are also intertwined with other forms of reward. For instance, some people use money to buy status and others use status to get money, while still others sort of do both things at the same time."
There are other rewards that act as incentives: sex, friendship, companionship, advancement in status, and other nonmonetary items. They act in a similar fashion to change or influence behaviour.
And then there is 'Granny's Rule', which, according to Munger, provides an example of reward superpower that works with astounding success. What is it? "The requirement that children eat their carrots before they get the dessert." According to Munger, "You can successfully manipulate your own behaviour with this rule, even if you are using as rewards items that you already possess!"
In corporations: The most important rule in management, according to Munger, is to get the incentives right. That, as Munger illustrates, FedEx found after trying all tricks in its books.
"One of my favorite cases about the power of incentives is the Federal Express case. The integrity of the Federal Express system requires that all packages be shifted rapidly among airplanes in one central airport each night. And the system has no integrity for the customers if the night work shift can't accomplish its assignment fast. And Federal Express had one hell of a time getting the night shift to do the right thing. They tried moral suasion. They tried everything in the world without luck. And, finally, somebody got the happy thought that it was foolish to pay the night shift by the hour when what the employer wanted was not maximized billable hours of employee service but fault-free, rapid performance of a particular task. Maybe, this person thought, if they paid the employees per shift and let all night shift employees go home when all the planes were loaded, the system would work better. And, lo and behold, that solution worked."
What happens when you or corporations ignore 'the incentives are superpowers' concept? You get what the Soviet Communists used to get from their labour: "They pretend to pay us and we pretend to work."
The power of incentives is also most visible in owner-run companies compared to public-sector companies. Whereas owners survive brutal competition by preventing all wasteful operational expenditure, that incentive is often absent in a public-sector unit whose employee functions with the incentive-caused bias to determine "what service he will give in exchange for his salary and how much he will yield to peer pressure from many fellow employees who do not desire his creation of any strong performance model."
In Investing: The lessons are often direct in investing. Should you trade more on the tips that your stockbroker provides regularly? Do you sell your stock that has made gains only because it has met your broker's target price? What is your portfolio manager's incentive behind churning your investments?
Munger advises how we can arm ourselves. "Widespread incentive-caused bias requires that one should often distrust, or take with a grain of salt, the advice of one's professional advisor. The general antidotes here are: (1) especially fear professional advice when it is especially good for the advisor; (2) learn and use the basic elements of your advisor's trade as you deal with your advisor; and (3) double check, disbelieve, or replace much of what you're told, to the degree that seems appropriate after objective thought."
You just read about one of the misjudgements people generally make while investing. Read 25 ways to (Not) make mistakes to get an account of Charlie Munger's twenty-five typical misjudgements, along with our commentary on how they fit into Indian businesses and Indian investments.