Incentive plans that corrode integrity

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If profit related pay works for CEO’s, then why not have growth related pay for the Chancellor? History tells us why this is a bad idea

Most people agree that Gordon Brown has had five good years as Britain’s chancellor of the exchequer. But the pessimistic revisions of the pre-Budget statement give cause for concern. Could he be losing his grip? Paul O’Neill, in contrast, is lucky to hold on to his job as US treasury secretary after a lacklustre performance.

Perhaps it is time to incentivise the chief financial officers of our national economies. We could offer them 1 per cent of the amount by which the country’s average growth rate exceeds the average of all developed states. There could be thresholds and triggers, linked to unemployment and inflation. Those clever remuneration consultants would readily suggest a suitable formula for a suitable fee.

But we know immediately that this would be a bad idea. It would not make any difference to the energy or competence that these individuals bring to their jobs. We expect that those who hold posts such as chancellor will give everything they can. And this expectation is generally well founded: politicians often fail but not usually for want of trying.

And yet such a bonus scheme would not leave behaviour completely unchanged. If a finance minister were in line for a multi-million-dollar bonus based on what happened to gross domestic product, he or she would take a new and intense interest in exactly how national accounts were compiled. There is the same scope for judgment in compiling national accounts as is found in corporate accounts. It would require a very tough national statistician to hold the line against pressures to present data in the most favourable light.

Such an incentive scheme would also create a bias towards optimism and risk-taking. Its rules could never stipulate that if the economy went into recession, the finance minister would have to give some of the shortfall back. If it did, Bill Gates and Warren Buffett would be the only people who could risk taking the job. But if you take a bigger share of the upside than of the downside, you will be less cautious in your judgments.

There is a deeper reason for steering clear of such a plan. Centuries of experience show that financial incentives attract the wrong sorts of people to politics. History is full of people who saw political influence as a means to become rich, from Richelieu to Mobutu, and few of them are remembered as great statesmen.

When Winston Churchill became prime minister in 1940 he did not ask for a bonus if he pursued the war to a successful conclusion and if he had, it would have been wrong to appoint him.

Churchill was an inspiring war leader. But it was not Churchill who won the war; it was millions of soldiers and civilians. A good finance minister can make a little difference to the performance of an economy. But that performance mostly depends on the aggregate activity of thousands of businesses and millions of people.

For all these reasons, bonus schemes for politicians are a bad idea. And they are a bad idea for senior managers for the same reasons. If the chief executive needs a bonus scheme to ensure his 100 per cent commitment to the job, he is the wrong person to hold it. The scheme is unlikely to affect the intensity of his effort but it will affect the intensity of his interest in how numbers that report that effort are compiled. All incentive schemes reward good performance more than they penalise bad performance. The result is undue risk-taking and excessive readiness to claim credit when risky behaviour pays off.

Structures geared to performance attract individuals who are more concerned to enrich themselves than to develop the business. That can have a corrupting influence at the top of the business and a corrosive effect on the relationships between those at the top and the foot soldiers on whom performance really depends. As the evidence of 1990s corporate greed unfolds, that sounds like an accurate description of what happened.

I once ran a discussion between a group of MBA students and a retired chief executive. At the end of it he said: “These kids regard running a company as a prize, not a responsibility.” In the 1990s, too many people who saw things that way got to the top in business. Political history has taught us that the only way to preserve integrity and competence in politics is to emphasise that power and office are responsibilities, not prizes. Recent business history has been teaching us the same lesson.

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