Perverse Incentives: public sector executive pay

Michael SandelMichael Sandel's new book "What Money Can't Buy: the Moral Limits of Markets" is particularly timely – coming as it does in the midst of the scandal over a get rich quick traders at Barclays and manipulation of the LIBOR that affects all of us. In the book, Sandel illustrates how financial incentives very often yield exactly the wrong results – they drive individuals to do things that are not only morally repugnant, they are also damaging to the organisation that designed the reward.

Morgan Stanley bank

it is said that in 2007 Morgan Stanley bank went to the US regulator and said "give us some rules". What they actually meant was " If you define what boxes, then we can tick them and get up to all sorts of underhand activity”. The rest, as they say, is history. Some people have got very rich, and many others have paid the price. We know how much we paid to bail the banks out using taxpayers money, but how much did it cost us in higher fees (UK banks typically charge around 3x the fees that banks in Europe and USA charge), or losses on investments?

As well as bankers, there is another group who are regularly incentivised with cash benefits. Salespeople the world over are given money for selling more.

Does it work?

I remember some particularly complicated pricing – only I was overruled by a sales director who sold it for 20% less. I pointed out that we would make a loss at this price, and was horrified to hear from his own lips "I don't care, I will have taken my bonus and moved on before they ever find out". If he said this so explicitly, I wonder how often it went on, hidden by politeness?

The public sector

In the public sector, executives and senior management are also offered bonuses, in the form of cash. What are the results?

The executives have gone back to their non-executives and remuneration committees, and to the Whitehall departments, and demanded a set of tick-boxes to tick to maximise their bonus. It’s Morgan Stanley all over again. They know that they can comply with these tickboxes, at the same time making themselves ludicrously rich from the public purse.

Payment by Results (PbR) was piloted in South Yorkshire for 12 months before it was rolled out to the rest of England. I had the fortune/misfortune to evaluate it. PbR is a system, and so easy to exploit, no matter how sophisticated it has become since. It is still possible to increase the income and profits but one organisation, at the expense of another, or to withhold payment for various "legitimate" reasons to benefit the second organisation at the expense of the first. We should expect our outstanding leaders to do the right thing; but we don’t, we wearily accept that they will play by the letter of the law not the spirit of the law.

Doing the right thing

The right thing is the action or attitude that leaves customers, or users, or the general population, better off. It's the one that makes a fair return, not an excessive one. It's the action that binds people together as a community, instead of spreading division and hatred.

We need regulators and politicians who can resist the temptation to regulate more and more, but rather set broad criteria principles which are common sense to us the population.  They need the power to act, to remove someone or even institute criminal proceedings for actions that are morally wrong, even if no law has technically been broken.  They need to be above reproach themselves.  We need incentives based on doing the right thing, incentives such as more responsibility, honour*, more freedoms (1)

My specialist area is evaluation. Of course it is best to design an evaluation from the start, but it is certainly possible to evaluate with hindsight. The disciplines of SROI  come to the fore here, as they provide a rigorous framework for evaluating when the results cannot be measured in pure financial terms. In the commercial world it’s often called Corporate Social Responsibility, in the public sector it ought to be “business as usual” – but unfortunately is often Business as Unusual.  Our evaluations can demonstrate transparency, weed out bad practice, and allow people to be proud of what they do.

And if you can be proud of what you do, then you can achieve great things.

Citations

1. Osterloh, M. and B. Frey (2007). Does pay for performance really motivate employees? in Business performance measurement : unifying theories and integrating practice. A. D. Neely. Cambridge, UK, Cambridge University Press: 443-448.

2. US Limbers up for LIBOR scandal - and UK slow to follow - FT.com/videos

Footnote

* Oh - it appears that honour can be purchased too!

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