Book Me For A Speech

My Writing and Ranting

Press Room

Good Books

« On Failing to Notice | Main | Does Berkshire Hathaway Use The No Asshole Rule? »

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d83451b75569e2010535ccaa18970b

Listed below are links to weblogs that reference Washington Mutual and Perverse Incentives:

» Incenting Disaster at WAMU from Next Level Blog
Yesterday's New York Times featured a fascinating article on how financial incentives such as month long trips to Hawaii and negative incentives such as verbal abuse compelled mortgage underwriters at Washington Mutual to eventually tank the institutio... [Read More]

» Righter Incentivization from Curious Cat Management Improvement Blog
So incentive schemes to get people motivated seem to backfire often. Why cant we figure out to incentivize the behavior we desire and have it not backfire on us? What is the righter way to dangle incentives in front of our employ... [Read More]

» Im Marching to My Own Tune. Better Get Used to It. from .eduGuru
If youve read my posts on In Clear Text, youve already pegged me as some Bob Sutton fan-girl (among other things), but apparently were interested enough to keep reading me here on .eduGuru.  If Im new to you, well, certain Nikki-i... [Read More]

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

Alex

Yeah, it's not surprising that this happened. The incentives setup for governmental budgeting are especially perverse. Take CA's current budget crisis, for example. The Governator focused on short-term goals...times were great for a few years, but now we are strapped for billions. If CA can issue an IOU to me, can I pay my taxes with an IOU?

Kevin Rutkowski

Jay, I like your plan for paying trailing commissions as the loan is paid back. It seems to be a good incentive to give solid loans and to stick around for a while at a company. I wonder why a plan like that wasn't put in place.

I would guess that part of the issue is that Wamu was looking primarily at the fees they could generate up front. Perhaps the fact that Wamu sold the loans and didn't service them long term also would make it difficult to calculate that incentive.

Regardless, it seems like if banks could incent people in that manner, it would be good for the long term health of the bank.

Paul Hebert

Hate the player but don't hate the game.

Incentives - properly designed incentives - have their place in guiding and reinforcing behavior. Typically, though, the incentive is designed by someone with little experience in incentive program design and based on a too simple an idea.

Any professional who has put together more than a couple of programs will tell you there is always a possible "unintended consequence" - the key is to look for them - no different than a stress test on the heart, you must take the program or plan to the extreme and determine if there is a problem. Very often you only have to push a particular program a little bit before you see the issues - and adjust accordingly.

Citing Kohn as a reason to avoid incentives doesn't really translate, as his work was around intrinsic motivation and focused on school children. Incentives and rewards are required in business. To think you can manage a company culture and performance without them is akin to saying we should eliminate email because some abuse the technology.

Properly designed incentives work and pay big dividends.

Jay Godse

This WaMu story has all the hallmarks of front-loaded or transactional commissions. In such a case, the sales person or sales manager makes money on deal-flow, and not on long-term value. The fix here is pretty simple. Only pay trailing commissions on loans as they get paid back. That will encourage behaviour that is good for the bank in the long term.

One of the deeper problems in the North American equity markets is that over the last 30 years, shareholders have consolidated and/or banded together. In the past, individual shareholders held small chunks of equity, and didn't have any real say how the company was run. Professional managers could act in the long-term interest of the company with impunity because that led to improved personal compensation through long tenure. That was the best way to make money because CEO salaries were not as high back then in relation to average worker salaries.

Over time, shareholders consolidated into mutual funds and pension funds. These funds could now put the managers' "feet to the fire" at every shareholders meeting. Over time, they insisted on more and more business performance, and offered management teams more and more money for their services. Of course, business performance is hard to measure if there are no profits, so other metrics were needed. Boards of directors compelled management teams to implement the latest fads such as raising market share, increasing capacity in anticipation of booming markets, improving revenues, improve "operating margins", lower fixed and variable costs, outsource, etc, and measured these with numbers.

So, given that most management teams could not turn lead into gold, or squeeze blood from a stone, they proceeded to ensure that they "made the numbers". Unfortunately, this lead to lots of perverse behaviours such as sandbagging sales, creatively booking revenues, incurring "one-time charges" every quarter while "growing" operating margins, and so on. As the management teams made their numbers, the consolidated shareholder proxies gave them lots of money, even if the companies were not profitable.

Unfortunately, most companies are not star performers such as Cisco, GE, Microsoft, etc. Most only grow at the rate that populations grow. As a result, the average company paid too much for their management teams and didn't have any results to match. It's easy to blame the archetype of a greedy money-grubbing CEO, but in reality, a lot of this was driven by consolidated shareholder proxies such as mutual funds and pension funds trying to get more than was reasonably possible from most companies.

The solution to this problem is harder. I believe that paying management teams from long-term profits will encourage the right long-term behaviour. Other remedies would be to find "numbers" that better reflect company needs such as profits, margins, and long-term growth. That is a hard problem...

Kevin Rutkowski

One of the biggest problems seems to be that the incentives all reward short term behavior at the expense of the long term. It is very difficult to measure the long term performance of a loan at the front end.

I agree that many of these types of incentives should simply be done away with. Instead, interesting work and a compelling vision for a company should result in people looking at what's best for the company.

The way companies throw away employees and the way employees leave companies, many people don't feel any reason to help build anything long term at a company.

The latest book from the book club that you wrote about earlier this year is Extreme Leadership by Steve Farber. I think that the principles that he discusses in his short, compelling book would well serve a company for both the short and long term: cultivate love, generate energy, inspire audacity, and provide proof.

Jan

I think we are hardwired to game the system. It's a survival mechanism since 100 000 years. We simply must understand what make the system tick, and manipulate those levers. Some of us have more of this in our DNA, some less. So what can we do about it? I'm as lost as everybody else. One thing we could do, is to stop designing systems from singularities, i.e. the extreme cases that will always occur. Design the system from the normal case, and deal with the extreme cases on an individual basis. Does that make sense?

Bob Sutton

Rick,

What you say makes complete sense to me -- but it mystifies me why so many smart people fall prey to the same damn thing over and over again!

Rick, Brennan, and John -- thanks for he great comments,

Bob

John Hunter

The problems of individual incentives seem to far outweigh any potential benefit. Deming was against them decades ago (along with short term quarterly profit focus) and I agree. Scholtes and Kohn (among others) do a good job of explaining why it is a bad idea. Douglas McGregor was right, managers need to eliminate de-motivators of employees not try to find better carrot dangling schemes to somehow make the carrot dangling incentive produce the desired behavior.

Brennan

It's hard coming up with an incentive structure that promotes the long-term goals of a company. This post reminds me a lot of Levitt's Freakanomics.

I think this is a "the medium is the message" problem. Where everything your company does should be congruent with its long-term goals.

rick

But in the case above incenting the right behavior would be easy. First, though, you need to decide what that behavior is. In the case of WaMu it could have been a loan amount where the portfolio had certain performance characteristics. And instead of looking at how many loans were written per month, look at it over a year. Basically... what loan policies would have meant that the bank was building a stable, growing business? Once you have those, reward them. But you simply cannot build incentives for good behavior when executives want bad behavior.

Of course, we can ask what was incenting execs to want bad behavior - and in most cases it's short term rewards. Is the stock price up this quarter? Bonus!! Is it off a penny? Your stock might drop 10, 15 or 20%. But there are no incentives to build a consistently profitable, stable company. Too often, the Street rewards current quarter performance with no eye to the medium or long term, executive compensation is structured around that and... if the exec is fired? Here's a few million on the way out. If I'm only going to be there 4-7 years and have the choice between doing things that might mak me millions and others that won't...

The comments to this entry are closed.

Scaling up Excellence

Good Boss Bad Boss

No Asshole Rule

Hard Facts

Weird Ideas

Knowing -Doing Gap

http://bobsutton.typepad.com/.a/6a00d83451b75569e20168e878040d970c-pi

The No Asshole Rule:Articles and Stories