Wednesday, February 4, 2009

Only $500k?

That’s the cap on compensation that the Obama administration wants to impose on top executives whose companies get big bailouts from the government. No doubt, some will say this is a mistake – that these companies won’t be able to attract and retain talented workers without paying the enormous bonuses of the past.

Quite a few studies in recent years have analyzed the way financial incentives affect human behavior, at least the kinds of human behavior that can be observed in a lab. The most common result from these experiments is that incentives do not affect average performance. There are, of course, exceptions. On mundane tasks, like filing or other clerical work, money does make a difference. Money will also induce people to endure pain. In one experiment, for instance, students were asked to keep their hands submerged in a tank of ice water for as long as possible. Those who got paid kept their hands submerged nearly 3 times longer, on average, than those who weren’t.

But most of us aren’t interested in enduring more pain -- or more mundane tasks. Neither are economists. On the kinds of sophisticated tasks that economists are most interested in, like trading in markets or choosing among gambles, the overwhelming finding is that increased incentives do not change average behavior substantively. Generally, what incentives do is prolong deliberation or attention to a problem. People who are offered them will work harder on a given problem, (in one experiment, their pupils actually grew larger) though they will not necessarily work any smarter. Typically, they will pound away at whatever the prevailing strategy is rather than coming up with a new one -- and a new one is clearly what we need.