Thursday, 3 January 2013

Motivational assumptions

I've argued before that, given the failure of various rounds of remuneration 'reform', it would be helpful in future if those proposing new incentive schemes set out the motivational assumptions behind them. At present this doesn't happen, and I think this is a big problem since incentive schemes must be based on some ideas about how and why the recipient will respond to them.

Well funnily enough I was reading through some of the written evidence to the Parliamentary Committee on Banking Standards (massive PDF here) and I came across Fidelity's submission, which is focused on  remuneration. Specifically it argues for longer timescales to apply to LTIPs and for a portion of awards to be career shares. However what caught my eye is that they seek to make the case in part by drawing on the PwC research on the psychology of incentives:
We would also like to refer you to work which has been carried out by Pricewaterhouse Coopers which shows that recipients of shares under LTIPs place a high value on certainty with highly conditional awards being valued at a material discount. In the case of Career Shares or ex-ante performance vesting, once shares are awarded they really do belong to the recipient and hence it should be possible to achieve the same motivational effect with a lower quantum of shares. This could make a contribution to reining in the overall size of awards which is another area which needs attention.
As I've written before, the PwC work is really starting to have an influence, even though if you've read any of the behavioural stuff about pay it shouldn't come as any surprise. It's all about who has said it, and here we see a mainstream asset manager citing it. Clearly the ground is shifting.

The only problem is I don't think what they say is quite right. The point about incentives is that the theory behind them (which, I never bore of repeating, is challengeable) is that they reinforce behaviour. As such the awards need to be made around the same time as the behaviour they are seeking to reinforce if they are to have any effect. The further we push the reinforcer away from the behaviour, the less likely it is to have an impact. This is exacerbated by hyperbolic discounting, which puts a lesser value on the award the further away it is. These are the core motivational problems that need to be addressed (as I noted previously, at least BlackRock's emphasis on short-term rewards is consistent with this even if we might not like it).

Fidelity seem to arguing that once the awards have been made there would be no more conditionality (no clawback?) so they would have a strong motivational pull then. But, that whole 'once the awards have been made' is a problem. If it's too far away from the behaviour it is supposed to reward I really do question how much of an influence it can have - even if we can crack the other problem of how to define what the behaviour is that should be rewarded. 

I think we ought to be a bit honest about all this stuff. It may simply be the case that we can't use financial rewards to incentivise people over the long term, perhaps they just don't fit together (we could, of course, use a series of short-term incentives, if we think the long-term is just a series of short terms). For the delivery of long-term objectives we might be better off trying to find other ways of ensuring commitment to them. I think I'm basically convinced incentive schemes are a dead end.

No comments: