Incentives make the world go round. In fact, they run it ‘more than laws, regulations, critiques or the ideas of researchers,’ notes internet seer and polymath Jaron Lanier. 

An exaggeration? Well, here’s the late Charlie Munger, Warren Buffet’s right-hand man at Berkshire Hathaway. ‘The iron rule of nature is that you get what you reward for,’ he said, adding later, ‘I think I’ve been in the top 5 per cent age cohort almost all my adult life in understanding the power of incentives, and yet I’ve always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.’

Incentives look simple, which is why people get them so wrong. They’re so obvious in concept – ‘do this to get that’ – that they are taken for granted. The idea that financial incentives are the prime drivers of performance is central to companies’ performance management systems, and via agency theory – the idea that managers, as ‘agents’, need to be incentivised, ie bribed, to serve the interests of shareholder principals rather than their own – embedded deep at the heart of Anglosphere corporate governance. Indeed, in a neat instance of self-fulfilling prophecy, it has been placed there by the very management opportunism that agency theory was designed to control. As economist John Kay remarks, this dry, ‘fundamentally financially driven view of the corporation would probably have had little impact outside the academic world had its applications not been so congenial to investment bankers – and to corporate executives themselves’. Not just congenial: so hooked on incentives have executives learned to be that Elon Musk now ‘has to have’ $56bn to keep him motivated and interested in Tesla, according to its chairman. She is careful to say that no one is holding a gun to her head – but many people might wonder how different that is from blackmail.

The giant problem with incentives is not that they don’t work. It’s that they do, only too well: in order to work, they routinely override anything that gets in their way, whether that’s common sense, ethics, or even survival. Pondering the key role of financial incentives in the Great Crash of 2008, Alan Greenspan lamented, ‘I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms… I discovered a flaw in the model that I perceived as the critical functioning structure that defines how the world works.’

Yet despite the piled-up evidence of their harm, belief in incentives is strong enough to ensure that they are routinely abused, including in the public sector, as the go-to solution to buy off almost any business problem, whatever its cause. Unfortunately, they are not a remedy for poor management or poorly designed systems, which they only make worse through the unfailing appearance of perverse unintended consequences. Intel’s Andy Grove, never one to shy away from a hard truth, noted dryly that for every incentive that the company implemented, another had to be swiftly brought into existence to counter the effects of the first. (Interestingly the phenomenon of unintended consequences was first investigated by the same sociologist Robert K. Merton who described the self-fulfilling prophecy, and the two are linked. By definition, incentives, as bribes, stop working when they are removed; as exemplified in spades by Musk, they condition people to expect incentives, even though in survey after survey for most of us money ranks well below positive reputation, appreciation, and interesting and important work as motivator.)  

At the level of the firm, incentives damage teamwork and cooperation, especially when they result in high differentials in pay. ‘When work settings require even modest interdependence and cooperation, as most do, dispersed rewards have consistently negative consequences on organisations,’ write Jeff Peffer and Bob Sutton in Hard Facts, Dangerous Half-Truths, and Total Nonsense. This goes for sports teams and academic departments as well as companies. They are a disaster in sales, responsible for countless mis-selling scandals. In fact, look hard enough and they wiill be found somewhere in almost any scandal. Grenfell, for instance. As for chief executives, depressingly few companies bother to ask themselves if they are really better off with a CEO who is focused outside the organisation, on money and shareholders, rather than internally on customers and the workers who serve them. Hired hands who come for the money will leave for it too. As Kay remarks, ‘there are people for whom money is an overwhelmingly dominant motivation…, but they are defective as human beings, and generally not suitable for employment in senior positions in complex organisations.’

Over time, the incentive pathologies at work in companies play out as corporate self-cannibalisation. The unintended price of self-interested CEOs maximising shareholder value to meet the incentives laid out in their compensation plans is falling investment in skills, technology, jobs and R&D that endangers their company’s future existence. At the level of the economy as a whole, as Greenspan belatedly realised, the same ideology-based incentives almost collapsed the world economy in 2008, just as on a smaller scale they brought down Enron a few years earlier. In the digital age, other unintended collateral damage from the incentive bubble includes the destruction of privacy, the plunging quality of public discourse, the ‘enshittification‘ of the internet (to borrow Cory Doctorow’s graphic term), the rise of inequality, and of course the distress of the planet.

Or take private equity and hedge funds, monuments to and perhaps the purest expression of what happens when people and organisations are single-mindedly focused on financial incentives. As value extractors on a massive scale, they skew the whole economy with their insatiable wealth appropriation and the magnetism they exert over the financially ambitious. ‘We have a higher percentage of the intelligentsia engaged in buying and selling pieces of paper and promoting trading activity than in any past era’, Munger pointed out, a lot of it reminding him of Sodom and Gomorrah. Lanier wonders how any society can hope to survive unless there’s at least some degree of alignment between society’s interests and economic incentives. Without it, we’re very close to the place where, as Charles Handy put it in The Empty Raincoat, ‘The incentives, which may have been the fertilizers to grow more wealth, ended up consuming all the wealth which they created.’