Russell's Blog

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Executive bonuses are stupid

Posted by Russell on November 20, 2008 at 1:42 p.m.
This morning my dad sent me a New York Times op-ed by Dan Ariely, a professor of behavioral economics at Duke, on the total idiocy that is executive bonus pay. Here's the main bit :
Of course, there are many reasons to be disgusted with executive pay. It feels unfair that so many people make so much money managing our money, and it is often difficult to see how their talent and abilities justify their compensation. We find it particularly offensive when executives receive high bonuses after disastrous performances. But doesn't the promise of a big bonus push people to work to the best of their ability?

To look at this question, three colleagues and I conducted an experiment. We presented 87 participants with an array of tasks that demanded attention, memory, concentration and creativity. We asked them, for instance, to fit pieces of metal puzzle into a plastic frame, to play a memory game that required them to reproduce a string of numbers and to throw tennis balls at a target. We promised them payment if they performed the tasks exceptionally well. About a third of the subjects were told they'd be given a small bonus, another third were promised a medium-level bonus, and the last third could earn a high bonus.

We did this study in India, where the cost of living is relatively low so that we could pay people amounts that were substantial to them but still within our research budget. The lowest bonus was 50 cents — equivalent to what participants could receive for a day's work in rural India. The middle-level bonus was $5, or about two weeks' pay, and the highest bonus was $50, five months' pay.

What would you expect the results to be? When we posed this question to a group of business students, they said they expected performance to improve with the amount of the reward. But this was not what we found. The people offered medium bonuses performed no better, or worse, than those offered low bonuses. But what was most interesting was that the group offered the biggest bonus did worse than the other two groups across all the tasks.

My dad asked, "Surprised?"

Nope. Not surprised at all.

The whole theory of executive pay is based on a slightly different idea than motivation. Boards are not exactly trying to motivate their executives to perform, they are trying to attract what are invariably described as "the highest caliber" candidates. It works if you assume that ability is some kind intrinsic property of humans, and that if you dangle a big reward in front of a big group of people, the most able ones will triumph and seize the prize. It's naked social Darwinism. That's what people mean when they talk about people's "caliber," or whatever. It's sloppy thinking, and sloppy thinking usually gets the sloppy thinker into trouble. A gigantic, world-girding economic catastrophe, for example.

I think bonuses fail for an even simpler reason than Dr. Ariely suggests: In a strictly scientific sense, there is no such thing as a smart person. There is no way to rank human beings based on cognitive skill in any meaningful way. In fact, it's not even clear we can define "cognitive skill." It's a 19th century idea that has been so thoroughly debunked that it has become a kind of parlor game for psychologists.

There are a lot of reasons for this, but chief among them is that we do not, in any substantive way, understand the nature of intelligence. We may think we know it when we see it, but we have no way of measuring it.

Tests of intelligence are actually on worse scientific footing than those people you see on TLC videotaping empty hallways through osmium-doped filters in the effort to prove the existence of ghosts. At least the ghost hunters are usually honest about their total lack of evidence, and at least there is some reasonable expectation that if there were ghosts, that you would would see them on the tapes. The College Board, and ETS, and pretty much every professor engaged in teaching that I've ever spoken with lack even the intellectual honesty of crackpot ghost hunters.

Clearly, there is variation among people when it comes to performance of specific tasks. Some people are really good at memorizing sequences of numbers and repeating them back in some carefully jumbled order. This is usually taken as an indicator of mathematical ability. Nevertheless, I find that I cannot memorize sequences of numbers to save my life, but that doesn't stop me from doing quantum mechanics.

So, once we've measured everyone's performance on the regurgitating-numbers-test, and put everything in a big table and sorted the table by score, what have we learned? Well, not very much. We might be able to draw some conclusions about people in general, perhaps, by correlating performance on the test with choice of breakfast cereal, or whatever. But it doesn't tell you anything of significance about an individual test subject.

However, it is usually possible to tell a smart idea from a dumb one. Unlike people, ideas can be subjected to detailed analysis. They can be examined for internal logical correctness. They can be modeled by equations, or simulated, or tested empirically, or compared to historical data for similar situations and the results considered. They can be slotted into a multiplying zoology of ready-made intellectual frameworks, and poked and prodded and stretched and tortured in all sorts of interesting ways. They can be placed head-to-head with other ideas in the analysis gauntlet, and in many cases it is possible to pick winners, or at least to triage pretty good ideas from dumb ones.

It's more work to pick smart ideas ideas than to pick smart people because the techniques we have for picking smart people are a fraudulent mummery that can be conducted with hardly any work at all. And lo, we see that systems in which ideas compete work very well (e.g., science), and systems in which people compete are either totally artificial (e.g., sports) or tend to function worse than had you picked the players at random (e.g., business, politics).

If you dangle a big reward in front of a big group of people, all you really know about the person who seizes the reward is that you have found someone who is good at taking large amounts of money from people. If I were looking for someone to run my company, I would be suspicious of such a person.

A National Infrastructure Investment Fund

Posted by Russell on November 08, 2008 at 5:24 p.m.
There were a lot of remarkable things about Obama's campaign, but one of the most significant aspects is that it was funded by millions of ordinary people who could only muster small donations. I've been thinking a lot about how that model could be turned bigger problems. Here's what I've come up with so far.

Most people set aside part of each paycheck for a variety of things. 6.2% of each paycheck (up to $102,000) pays for contributions to Social Security, 1.45% goes to Medicare. Then there is income tax withholding, contributions to 401k plans, health plan co-payments, and so on. I think we should create an additional voluntary withholding item with a variable rate that would feed into a fund that invests in revenue generating national infrastructure.

The idea is to offer taxpayers an investment option with a risk profile somewhere between Social Security (which is designed to be a sure thing) and a 401k (which can be lost completely). Contributions would be invested only in critical national infrastructure projects, like transport and renewable energy. The investments would be structured so that they would pay dividends. For example, the fund could build wind turbines, and the dividends would come from the electricity revenue.

This would help solve three problems :

  • It would give taxpayers a relatively safe investment option. The dividends might fluctuate from year to year, but the investment could never be lost. This would provide a nice compliment Social Security and a 401k.
  • It would create a pool of money designated for projects of crucial national importance. The fund would be big enough that it could invest on a scale impossible for private equity. Also, the focus on generating long-term reliable revenue instead of capital gains would allow the fund to invest on a much longer time horizon than most private equity.
  • It would bring patriotism, volunteerism and ecological-mindedness into alignment with individual financial self-interest.
I suppose similar things exist in the private sector already, mainly in the form of green mutual funds and suchlike. I've never been very impressed with them. Mutual mostly seem to focus on capital gains, which seems like a crummy way of monetizing basic infrastructure like electrical generating capacity. These funds are also generally very small, which means they cannot invest directly in projects and they have high overhead expenses.

I'm not interested in yet another speculative investment option. The private sector does a good job there, and doesn't need to be duplicated. I'm thinking of a different sort of model, more like social entrepreneurism, but with mass-participation.

This One for That One

Posted by Russell on November 04, 2008 at 1:01 p.m.
A lot of people fought long and hard to give me the right to a secret ballot. This time around, though, I'm happy to show it to anyone who cares to look.

I like this ballot system much better than the InkaVote thing they have in LA, and much better than any kind of computerized bullshit. I spent four years using computers to design fusion reactors, but I sure as hell don't trust them with an election. Pen and paper, thanks.

The radio says

Posted by Russell on November 04, 2008 at 10:30 a.m.
Normally, I really, really hate mornings. When my radio clicked on this monring, it was in the middle of a country song. The first lyric that came up was, "I'm so tired of Mr. Wrong, I'm gonna find me a Mr. Right." That was the first time I've woken up laughing in years.

I'm going to fix myself a nice steaming cup of democracy.