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experimental economics: don't pay those creeps so much
Source Jim Devine
Date 08/11/21/07:17

www.nytimes.com
What's the Value of a Big Bonus?
By DAN ARIELY
Durham, N.C.

BY withholding bonuses from their top executives, Goldman Sachs and
UBS may soften negative reaction from Congress and the public if their
earnings reports in December are poor, as is expected. But will they
also suffer because their executives, lacking the motivation that big
bonuses are thought to provide, will not do their jobs well?

Of course, there are many reasons to be disgusted with executive pay.
It feels unfair that so many people make so much money managing our
money, and it is often difficult to see how their talent and abilities
justify their compensation. We find it particularly offensive when
executives receive high bonuses after disastrous performances. But
doesn't the promise of a big bonus push people to work to the best of
their ability?

To look at this question, three colleagues and I conducted an
experiment. We presented 87 participants with an array of tasks that
demanded attention, memory, concentration and creativity. We asked
them, for instance, to fit pieces of metal puzzle into a plastic
frame, to play a memory game that required them to reproduce a string
of numbers and to throw tennis balls at a target. We promised them
payment if they performed the tasks exceptionally well. About a third
of the subjects were told they'd be given a small bonus, another third
were promised a medium-level bonus, and the last third could earn a
high bonus.

We did this study in India, where the cost of living is relatively low
so that we could pay people amounts that were substantial to them but
still within our research budget. The lowest bonus was 50 cents
equivalent to what participants could receive for a day's work in
rural India. The middle-level bonus was $5, or about two weeks' pay,
and the highest bonus was $50, five months' pay.

What would you expect the results to be? When we posed this question
to a group of business students, they said they expected performance
to improve with the amount of the reward. But this was not what we
found. The people offered medium bonuses performed no better, or
worse, than those offered low bonuses. But what was most interesting
was that the group offered the biggest bonus did worse than the other
two groups across all the tasks.

We replicated these results in a study at the Massachusetts Institute
of Technology, where undergraduate students were offered the chance to
earn a high bonus ($600) or a lower one ($60) by performing one task
that called for some cognitive skill (adding numbers) and another one
that required only a mechanical skill (tapping a key as fast as
possible). We found that as long as the task involved only mechanical
skill, bonuses worked as would be expected: the higher the pay, the
better the performance. But when we included a task that required even
rudimentary cognitive skill, the outcome was the same as in the India
study: the offer of a higher bonus led to poorer performance.

If our tests mimic the real world, then higher bonuses may not only
cost employers more but also discourage executives from working to the
best of their ability.

We later did a variation of the same experiment, at the University of
Chicago, to look at a different kind of motivator: public scrutiny. We
asked 39 participants to solve anagram puzzles, sometimes privately in
a cubicle and sometimes in front of the others. We reasoned that their
motivation to do well would be higher in public, and we wanted to see
if this would affect their performance. But we found that while the
subjects wanted to perform better when they worked in front of others,
in fact they did worse.

So it turns out that social pressure has the same effect that money
has. It motivates people, especially when the tasks at hand require
only effort and no skill. But it can provide stress, too, and at some
point that stress overwhelms the motivating influence.

When I recently presented these results to a group of banking
executives, they assured me that their own work and that of their
employees would not follow this pattern. (I pointed out that with the
right research budget, and their participation, we could examine this
assertion. They weren't that interested.) But I suspect that they were
too quick to discount our results. For most bankers, a
multimillion-dollar compensation package could easily be
counterproductive. Maybe that will be some comfort to the boards at
UBS and Goldman Sachs.

Dan Ariely, a professor of behavioral economics at Duke, is the author
of "Predictably Irrational: The Hidden Forces That Shape Our
Decisions."

Copyright 2008 The New York Times Company

COMMENT: I think there's a good chance that these experiments miss the
role of _relative_ salaries. If the standard pay for a CEO is $1
billion/year, then paying a CEO less than that hurts his or her
motivation. ("How can I afford the diamond-studded champagne
glasses?") Paying more than that standard would raise motivation --
but, as Ariely points out, only up to a point. This reinforces
Ariely's point: we should lower the standards of CEO and other big-wig
pay.

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