Hello everyone
Legendary investor Charlie Munger said:
show me the incentive and I’ll show you the outcome
As a business rule-of-thumb, it’s good. But this maxim explains much more about humanity, and in particular, why we so often get the results we don’t expect and don’t want.
And of course, the incentives are what drive characters in fiction.
Corporate pay
One of the most obvious incentives occurs with pay in connection with employment. This was probably the context in which Munger offered his insight.
Often an element of pay, for instance a bonus, will be contingent on performance. For instance, an employee may be rewarded for making a certain number of sales. A clearly defined reward such as a sales target provides an unambiguous incentive to sell.
However, a sales target does not provide an incentive to sell well. And this is why we find companies who sell inappropriate products or sell products to minors.
not my catastrophe
But it’s not just sales where the incentives are misaligned with the public good. Look at the Enron scandal as one example (which brought down both the company and the auditor, and lost considerable amounts for shareholders).
This didn’t begin as an attempt to be fraudulent, but rather started as a bunch of executives looking to make money. The incentives from all involved—the executives, the auditors, the investors—were too compelling to stop and wonder whether they were doing the right thing.
It’s not just money…
So what creates an incentive? What motivates someone to act?
I’d suggest there are three main drivers. There are more incentives, but these three are the main ones:
- money (which we’re already talked about)
- power, and
- status
Now, clearly, there is an overlap here, and both “power” and “status” are somewhat nebulous concepts.
At its most thuggish, power is the ability to exert one’s will over another. No one wants to be the less powerful, and the desire not to be the underdog is one reason why the pursuit of power is so alluring, especially in the criminal world. Clearly, having money allows one to “buy” power, but power can be achieved in other ways (which typically involve a lack of squeamishness about violence).
Status is one of those notions that is earned, rather than being taken (although people will seek to acquire status). Status is about one’s standing, professional or social, in regard to others.
The notion can imply qualification, for instance, becoming a lawyer gives a status, that status being dependent on the public’s view of lawyers as a whole. Status can also follow from actions (a benevolent or a wise/thoughtful person will have a status). Status can also, of course, derive from wealth (or more, how that wealth is displayed and applied).
But having status, and therefore the incentive to pursue status, is largely only relevant in relation to how one is perceived by others.
Which leads us back to money…
Power and status can flow from money, and for many, money is the most straightforward pursuit and the most clear incentive.
But the pursuit of money isn’t always about acquiring more money.
the money isn’t about money…
Acquiring the first billion is probably quite fun. But no one spends the second billion or anything that comes after. So why is there still an incentive for a billionaire to acquire more money?
In short, the money isn’t about the money—it’s about keeping score.
…the money is how they keep score
In some ways, more money equals more power or more status. But fundamentally, having more money is about being able to rank on a scoreboard as being “better” than someone else. And not just better, but many times better.
Fear
Incentives aren’t only about gain. Behavior is often driven by the fear of loss.
Losing money is bad. Losing status or power is worse. And especially for those who have pursued money, power, and status, and have made the successful acquisition of these three central to their own personality. Even the potential of loss is enough to create a furious drive to prevent that loss and to accumulate more power, money, and status.
not losing status can matter more than gaining money
And there’s the combination: the thrill of acquisition coupled with the fear of loss, which can lead to truly toxic brew of incentives to act.
Until October
So was Munger right? Do the incentives reveal the outcome? I’d suggest, both in fiction and in real life, that Munger comes as close as you can get to a perfect rule of thumb. If you want to know what’s going to happen, look to the incentives.
That’s me for this month. I’ll be back in October. You can be sure of that—I’ve got an incentive not to look flaky now I’ve made that undertaking.
Until then
All the best
Simon