Incentive - Problems

Problems

Incentive structures, however, are notoriously more tricky than they might appear to people who set them up. Human beings are both finite and creative; that means that the people offering incentives are often unable to predict all of the ways that people will respond to them. Thus, imperfect knowledge and unintended consequences can often make incentives much more complex than the people offering them originally expected, and can lead either to unexpected windfalls or to disasters produced by unintentionally perverse incentives.

For example, decision-makers in for-profit firms often must decide what incentives they will offer to employees and managers to encourage them to act in ways beneficial to the firm. But many corporate policies — especially of the "extreme incentive" variant popular during the 1990s — that aimed to encourage productivity have, in some cases, led to spectacular failures as a result of unintended consequences. For example, stock options were intended to boost CEO productivity by offering a remunerative incentive (profits from soaring stock prices) for CEOs to improve company performance. But CEOs could get profits from soaring stock prices either (1) by making sound decisions and reaping the rewards of a long-term price increase, or (2) by fudging or fabricating accounting information to give the illusion of economic success, and reaping profits from the short-term price increase by selling before the truth came out and prices tanked. The perverse incentives created by the availability of option (2) have been blamed for many of the falsified earnings reports and public statements in the late 1990s and early 2000s.

Also there is the tradeoff of short term gains at the expense of long term gains or even long term company survival. It is easy to plunder the assets of a previously successful company and show spectacular short term gains only to have the enterprise collapse after those responsible have gotten their incentives and left the organization or industry. Although long term incentives could be part of the incentive system, they have been abandoned in the past 20 years. An example of an organization that used long term incentive programs was Hughes Aircraft and was highly successful until the government forced its divestiture from the Howard Hughes Medical Institute. Recently there has been movement on adopting the Benefit Corporation or B-Corporation as a way to change the trend away from short term financial incentives to long term financial and non financial incentives.

Not all for profit companies used short term financial incentives at levels below the president or very top executive levels. The trend to move financial incentives down the organization hierarchy started in the 1980s as a way to boost what was considered low productivity. Prior to that time the incentives were associated more with customer satisfaction and producing high quality products. Moving financial incentives down the corporate chain had the unintended consequences of subverting internal processes to save short term costs, forcing obsolescence at the lower levels as investment was deferred or abandoned, and lowering quality. Some of these issues are explored in the British Documentary The Trap (television documentary series). This idea of financial incentives and pushing them to the lowest level common denominator has led to a new company structure or Organization#Ecologies where essentially everything is a standalone profit center with the only incentive being short term financial incentives.