How to Pay People

In the midst of the recent alleged scandals in politics, and the reminders of past (almost literally) hushed scandals, the issue of pay may now seem passé, but I'd like to share a short article on behavioral responses to incentive schemes.

In a way, it tangentially supports a past contention that KPIs, if they are used, should be cognitively complicated to game. Yet, there is also support for "I think he/she did well" type of bonus schemes. (For those, reports should be published justifying the bonuses awarded.) Anyway, on to the main event.

Bloomberg Businessweek (Sep 26 - Oct 2, 2011)

How to Pay People

by Dan Ariely

Most of the time, when you hire people you don't want to specify exactly what they do and how much they would get paid -- you don't want to say if you do X you will get this much, and if you do Y you will get that much. That type of contract is what we call a complete contract. Creating one is basically impossible, especially with higher-level jobs. If you try to do it, you cause "crowding out." People focus on everything you've included and exclude everything else. What's left out of the contract tends to drop out of their motivation as well. You are taking away from their judgment and goodwill and teaching them to be like rats in a maze.

It's like the difference between asking someone to help you change a tire and offering them $5 to do it. The moment you introduce money, you change how the person views the exchange. They say, "Oh, this is work. I don't work for $5, give me $150 and we can talk." When I was at MIT, they told us we had to teach 112 points per year. They a complex formula for how many students and how many hours and so on would translate to teaching points. Basically, MIT was conditioning me to put the least effort into getting the most points. This became the game. I was quite good at it. And I taught very little.

It happens with all kinds of compensation. A consulting company once told me that if you stayed until 8 in the five, you could order food and use the car service to get home. So what happens? A ton of people are there at 8. Nobody's there at 8:05. It's the same with pay: If you're hiring the right people, you don't want to include anything too specific in the contract. You want people to buy into the objectives of the company. Be specific about those, and then trustpeople to quickly understand how they can help maximize the objectives at each point in time. People actually know to a high degree which actions are good for the company and which are not -- regardless of what you pay them for.