More Money Less Performance? Not from me!

Jon links here and asks if CEO pay will be improved by more money. The economics in this video has one major problem, a couple of things I would quibble about, and one solid challenge to the conventional economic view, which can be salvaged, but at the risk of seeming less plausible than alternative explanations.

Dan Pink explains some recent discoveries in behavioral economics that show that when people are given excessive future monetary incentive they will tend to under perform. This is true particularly when the task requires thinking. He claims that people are motivated not by profit per se, but rather by doing the interesting work. He gives several examples of people doing things that aren’t for pecuniary reward, but are instead hobbies. These include Linux and Wikipedia. I’ll note as an aside that these types of ventures, which improve the lives of virtually everyone in the US, are one of the reasons that inequality inequality measures aren’t very useful. They don’t capture improvements that can’t be recorded in monetary terms.

The major problem with this video is that standard economics doesn’t posit that people are solely motivated by profits and money. Economics posits that people are seek to maximize utility. Many times value is converted into monetary measures for ease of comparison, but it should always be understood that people are choosing to maximize their utility, or at least they are being modeled as choosing to maximize their utility.

There is no way to directly measure utility, so generally economists will assume that individuals are utility maximizers and follow that postulate where it leads.  When a person chooses to edit wikipedia article rather than work another hour of overtime, they are revealing that they value editing wiki’s more than they value the monetary compensation that they would have received. Since the monetary value can be measured, we can determine how much they value that hour of contributing to wikipedia. This is a consequence of the persons revealed preference. If you were to ask the person whether they would rather have more money or fix a wikipedia entry, they may claim that they would rather have the money, but their revealed preference is that they value the time editing wikipedia more.

The quibble is more my lack of knowledge of all the data used in the study. Pink claims that people underperform when too much is on the line, but I’m guessing that is on average. I’m guessing that some people perform better when there is more pressure on. I knew people in grad school who couldn’t even start to think about doing a project until there was only a day left. Michael Jordan was clutch. Some folks just work better under pressure. Some people probably do better when they’re given a huge monetary incentive that is just waiting to be had. Not most, but I’m sure that some people do. I’m not sure, but it’s possible that these are the types of people who become CEO’s.

The big challenge for the utility theory approach is from the expectation that money is a positive good. If people are utility maximizers, and money is a positive good, then we should expect people to perform better when they are offered more monetary compensation for better work. One way to salvage the utility approach is to posit that subconsciously most people self-sabotage in some sense. Our subconsciousness isn’t completely open to us, so maybe people don’t really want the higher reward. Maybe deep down they think they don’t deserve it. Just based on self-reflection, that doesn’t seem like the right answer to me, but it is possible.

I do hope that more companies look at this research and companies use it to improve their incentive process. In any case, I trust the market to find better incentive far more than I trust the government to find them.

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