Norms and pay

One of things I was trying to get at in my last post was that it might be useful to look at executive pay from different perspectives. Over the last two or three years I've read quite a bit about the psychology of incentives (principally, but not exclusively, financial ones) though I also think sociology can help.

To recap, my basic argument is that executive pay as currently structured (and as advocated by many shareholders) is implicitly based on certain economic and psychological views of motivation that are worth exploring further. The economic perspective is pretty clear - individuals are self-interested and rational, and hence execs will maximise their own utility in ways that may not align with shareholders unless pay is structured sensibly. The (implicit) psychological perspective is that properly designed financial incentives can focus attention on the right issues and enhance performance (through reinforcement presumably).

Seen from this perspective, the post-crisis reform effort on pay makes sense. If pay in the banking sector was a contributory factor, this wad because the incentives were poorly designed. Therefore the logical conclusion is to redesign the incentives with, for example, better targets, more emphasis on the long-term, ownership etc. It is simply a design problem, the underlying assumptions do not need revisiting.

There is a nascent discussion about those assumptions, and some emerging interest in whether we ought to amend them. However, having spoken to a few people, including rem comm members, about these questions there are some (somewhat contradictory) counterpoints made that are worth noting. one is that, yes, in experiments you might well find that incentive pay either doesn't work well or backfires. But real life executives are not the type to choke under performance pressure. Another is that incentive pay might not 'work', but it provides feedback to executives (the 'keeping score' point). (finally some simply argue that whilst performance pay may not be great it's difficult to shift course now.)

On the first point, I think we are getting closer to the point where we can directly challenge it. The recent PwC report was useful because it was based on surveys of actual executives. A striking finding was that only a small minority fit the model of risk-taking 'entrepreneurs' (ignoring the question of whether this is who we want running PLCs anyway) who might be more likely to be incentivised by performance pay. Most, like the rest of us, value a safe bet much more than a possible reward. (Another important finding was that attitudes to incentive pay vary by country, even amongst executives.)

The second point, for me, has more going for it. From this view pay is less about motivation, more about recognition and status. From this perspective odd decisions like making awards despite performance targets not being hit (Shell) or trying to get high increases in base salary through (WPP) make a bit more sense. But it also hints at the possibility that we could approach executive motivation, and standards of behaviour, from quite a different direction.

Pushing this point a bit further, we may have (created) a situation where the emphasis on performance pay means executives expect to be judged/valued in terms of cash, even if it doesn't motivate them in the way the rationale behind incentive schemes assumes. This in turn may create a culture in which a focus on self-enrichment, as opposed to fiduciary duty, becomes seen as normal (a point made in Identity Economics).

More broadly this feeds into the idea that an emphasis on market solutions can mean that social norms are displaced by market norms, a big concern of Michael Sandel, for instance. This might explain, for example, why attitudes to performance pay differ by country. In some markets there is still an expectation that executives have a duty to the company (and its stakeholders?) that over-rides their own financial gain.

Once again, I can already hear the voices of people in the City dismissing the idea we can appeal to other norms. I am not misty-eyed about the motivations of executives. Indeed I think an important one is the desire for power and influence. However, I do question whether an incessant focus on financial incentives as a way to "bond" executives, or align their interests with those of shareholders, is a sensible strategy. I would also point to the (isolated, as yet) example of Sir Michael Darrington as a successful business person who thinks executive pay has badly wrong.

What really strikes me when looking at the corporate governance world's response to the financial crisis is a general lack of curiosity about the importance of norms and values. In the pay debate the overwhelming effort is expended trying harder to get executives to follow the money, not to make them think about how they are expected to behave in return for any reward, even their salary. If there is a problem with displacing a professional norm with one of self-enrichment then many people are not only doing nothing to address it, they are arguably making it worse.

Performativity, self-interest and pay

A while back I burbled about how 'self-interest' might in part/for some people be a norm, and Charlie commented that this was getting close to performativity. Well in Michael Callon's piece on the performativity of economics in the book I mentioned below he makes the same point (though he says this isn't performativity):

Neoclassical theory is based on the idea that agents are self-interested. If I believe this statement and if this belief is shared by other agents, and I believe that they believe it, then what was simply an assumption turns into a reality. Everyone ends up aligning himself or herself to the model and everyone's expectations are fulfilled by everyone else's behaviours. To predict economic agents' behaviours an economic theory does not have to be true; it simply needs to be believed be believed by everyone.

The other thing I have toyed with is whether performance-related pay works a bit like this. And wouldn't you know it Callon has covered this too in the same piece:

Enforcing incentives inspired by economic theories and their assumptions about human or organisational behaviours causes these behaviours to fit the theory's predictions. When workers are paid on the basis of performance, they end up complying with the anthropological models that fit the incentives imposed on them. If we consider the firm is a nexus of contracts, and we set up procedures to make these contracts explicit and to ensure their enforcement, the firm does become a nexus of contracts.

Performativity, corporate governance, responsible investment etc

I've spent a couple of hours this weekend reading a few of the pieces in Do Economists Make Markets? which I bought last year but have only recently got around to looking at. It's broadly a collection of papers looking at the idea of perfomativity in respect of economics - how economic techniques not only capture market behaviour, but also influence it. The biggest claim in this area is in respect of option pricing where the proposition is that that economic models used to price options made the market behave the way the model predicted. Interesting stuff indeed.

It's less clear to me that there are necessarily lots of other instances where something has occurred that backs the claims of performativity as well as the option pricing example. Also I can't shake the feeling that perhaps there's actually not much new here. So some of what follows sounds a bit negative, but this is largely because I'm still thinking this stuff through

First I'll go back to home turf. There are quite a few studies that claim a correlation between pro-shareholder governance, or reforms to achieve it, and financial performance. I read something quite recently that suggested that there is an immediate uptick in share price at US firms where resolutions are passed introducing a pro-shareholder reform (I think the example was resolutions seeking to get rid of poison pills). It would be interesting to look at these kinds of studies over the long term because it may be that there is now a premium for pro-shareholder governance where there wasn't before. This might in turn suggest that the increasing adoption of a view amongst investors that corporate governance does matter to shareholders has led to prices reacting to governance-related information as if it does matter. But (making all the assumptions required above!) is this performativity? The option pricing example is much more detailed, and there was, of course, a specific formula that became accepted that particularly influenced the market. But in principle is there a difference?

Similarly, in the dot-com bubble there were some arguments deployed along the lines that 'traditional' models of valuing companies no longer applied, and historical PE ratios were no longer relevant. Of course we now know that some of those using these arguments to put very rosy valuations on companies (or IPOs) were essentially fraudsters. But there were plenty of true believers out there too, and for a while TMT stocks behaved as if they had a point. Now one might counter that the TMT bubble was short-lived so not really an example of an analytical approach changing the behaviour of a market. But in return a) you might still get away with arguing it as a weak form of performativity b) some of the TMT bubble era predictions about the impact of technology may yet come true (or at least have a bigger influence) and c) in the options pricing example there have been periods when markets haven't behaved like the model. Most importantly, if we can get away with a) then I'm not sure what is really new.

Having said all that there is something in here that rings true for the wrong reasons, which is probably best illustrated by a quick example. A few years ago I listened to an SRI fund manager give a presentation about how they constructed portfolios and the returns they generated as a result. I asked if they had looked at whether their approach had an impact in the other direction - were their views significant enough or shared widely enough that they could have a noticeable effect on prices. The answer was, as you might expect, no - they hadn't even looked at it - but in a way I wouldn't have found it surprising if they said yes.

What I mean by that is that it strikes me that many people in the responsible investment world are actually (whether fully aware of it or not) trying to make this happen. There is a view that current financial markets and the prices that emerge in them do not accurately capture everything that matters. That's why we see a huge emphasis on the disclosure of more information on social and environmental issues, and the development of 'enhanced' analysis that incorporates it into valuations. Rest assured this effort would not be expended if many of the people involved did not believe that, at the end of the process, markets would behave differently. ie they don't only think that prices would be more 'accurate' or whatever, they think they could be quite different, and markets might behave quite differently too. (Someone put it to me once that the objective seems to be to put up the cost of capital for 'irresponsible' companies.) At the moment a major effect on prices seems a long way off. But you can see that in an area like climate change, where there's a bit more of an overlap between people trying to amend the system to bring about change and those simply wanting to ensure the right information is available to assist price formation, that it could happen.

It's a funny turn of events. Performativity is quite an enjoyable idea to knock about because it suggests that economics can cross the boundary between describing and creating behaviour. And, if true, that's something that can potentially be used to whack neoliberals over the head with - you (at least in part) create the behaviours and relationships you say are already there and that you claim you are merely making explicit. (Hey, you could even say it's that favourite of conservatives, an unintended consequence). But at the same time we make this attack 'progressive' (sorry) types are trying to develop new analytical processes and models precisely because they expect it to change market behaviour.

PS. Albert Hirschman (yes, him again) pointed out that there's a less talked about mirror image of the unintended consequence - the unrealised expectation. In other words what is expected to result from a given reform does not occur. Sometimes I wonder whether the results of much of the activity undertaken in responsible investment might end up under this label.

Performativity

This is an idea that has cropped up a few times in posts on here. There's a really simple take on it here. Interesting stuff.

Interesting blog alert

Come across this one via Charlie. Economic sociology seems to be a major focus. Interesting stuff.

The sociology of financial markets

I took a punt on this book and it looks like it will be rather good. Just read the chapter 'Emotions on the trading floor' which has a lot of interesting stuff in it. No surprise to hear that emotions are a significant element of traders' involvement in markets, and what they enjoy about participation, and that newbies are keen to experience the most extreme market events.

There's a great table with a list of expressions traders use to describe feelings they experience in the market. Alongside the obvious sport/competition and combat/violence metaphors there are quite a lot of sexual ones. And there's a bit of speculation that this might be an expression of disconnection with the underlying economic reality. A good quote from a trader along these lines:

"You can't think about what each trade means financially... if you did you couldn't last."

It also made me wonder what kind of expressions might come up if you talked to institutional investors about ownership activity, and what kind of things they would consider good experiences.

ho hum. will no doubt be posting up a few chunks of text...