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The main political parties have achieved near-consensus that something needs to be done about executive pay. There is an argument that Government has no role in this area, and that private firms, with all their incentives to seek greater profits are the ones best-placed to design pay schemes that work. Except, that apparently, they’re not very good at doing just that. There is a growing body of research that shows that the link between pay and performance is simply not clear-cut. Studies by psychologists such as Dan Ariely have in fact shown that paying people to do things often makes a task less enjoyable and makes them spend less effort on it.
 
So, we have a problem. If pay and performance aren’t so closely linked after all, then many firms simply aren’t properly incentivising the best people for the job to do the best job they can. It means that firms are likely to have higher costs, which feed into higher consumer prices, for no extra benefit. We aren’t putting resources to their best possible use, because we aren’t getting the performance we are paying for.

Much of the political debate has stemmed from a feeling that pay is too high, ignoring the more fundamental issue of whether firms are properly incentivising employees and executives to perform. The different parties have therefore set out solutions on how to restrain pay. David Cameron has suggested increased transparency and giving shareholders binding, rather than advisory, votes on remuneration packages. Meanwhile, Vince Cable as well as Labour leaders have expressed some support for having employees on remuneration committees. But both of these options have flaws.
 
Taking an informed view as to whether an executive pay package is appropriate takes effort and analysis. What are other companies doing? What is the risk of losing an employee to a competitor company? What is the right balance between a fixed salary and a performance based element? How should performance be measured? Crucially, are there other ways of compensating employees that might work better? Those with only small shareholdings in a company don’t have a strong incentive to properly monitor pay structures, or answer these questions. Those with large shareholdings and strong vested interests already do have an incentive, and arguably already have sufficient clout to be able to place pressure on companies to change pay schemes, should they wish to do so. So it isn’t clear that changing shareholder rights is going to make a big difference.
 
On the other end of the spectrum, employees within a company are certainly likely to have better information about how the company operates, and better understand what drives performance in their organisation. But do they know what alternatives are available? Do they know what works well in other companies? And can they be relied on, in the interests of fairness, to vote against better pay packages which they themselves might benefit from one day? 

Ultimately, we need to focus on better understanding what works. We need to understand what incentivises people to perform and what doesn’t. For employees generally, autonomy, the freedom to be creative, and ensuring people have a sense of purpose have all been shown to be important in driving motivation, as discussed in Dan Pink’s book Drive. Chuka Umunna was right to note in his recent speech that pay alone does not drive incentives. From this we need to learn that measures like increasing pay transparency, and trying to encourage better shareholder engagement in voting on pay packages is just tinkering with the edges of the problem at best. At worst, it can be counter-productive: regulatory measures in the US in the 1990s to increase transparency in executive pay arguably increased the ratchet effect, whereby benchmarking of executive salaries led companies to continually attempt to pay above average to be sure that they were getting the best talent.
 
We need to fully realise that motivation isn’t just about money. We need to better understand what practices work, and what don’t – for employees earning the lowest wages to the executives at the top. The public sector could take the lead in this area: undertaking research and restructuring public sector workplaces to better increase motivation without necessarily raising overall pay.

In the current climate, surely it’s worth doing even if just for the potential to reduce long-term costs. The executive pay “problem” isn’t going to be solved until we know what works.

This article was also published on Left Central

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A recent study by behavioural economics academics Konstanze Albrecht, Emma von Essen, Juliane Parys and Nora Szech suggests an interesting division between the behaviour of men and women assessing the likely performance of individuals in tasks that men are traditionally good at – in this particular study, mental rotation tasks. They find that women tend to be over-influenced by the average performance of a group of people rather than the specific attributes of an individual. So, for example, women assessing other women for a role that men tend to perform better at focus too much on the average performance of most women, rather than the actual performance of the woman they are assessing. But this effect is not specifically about gender discrimination in favour of men. The study shows that even in an entirely neutral context, where you have two groups of people, divided on some other arbitrary lines, women will tend to be over-influenced by average performance when assessing an individual: even if it is entirely clear how good the individual is, so that any information about the group they belong to is entirely irrelevant.
 
For men, the tendency to take into account irrelevant information about group performance is there, although it is stronger when groups are divided along gender lines. Interestingly, the most self-confident men tend to overvalue male performers specifically – perhaps because they tend to project their own self-confidence onto other men.
 
Conclusion: If you’re a woman applying for a job in a male dominated sector, you want to be interviewed by a man with low confidence.

The paper, Updating, Self-Confidence and Discrimination is here.

1) Make your resolution public. If you care about what people think of you, you probably won’t want them to see you fail. So, tell your friends and family what you’re aiming to do. See psychology expert Robert Cialdini’s work on public commitments for more details, or take a look at his book, “Influence” for a summary. 

2) Make it costly to fail. If it will cost you money to fail, you may be persuaded to try harder. But beware: paying up-front for, say, a gym membership might not work as well as you think. Economists Stefano DellaVigna and Ulrike Malmendier looked at gym members at US health clubs and found that people overestimated how much they would use the gym, and were therefore paying for expensive gym contracts that they weren’t using. Instead, try making a commitment to paying out a certain amount contingent on not achieving your chosen goal. For example, make a bet with a friend that you’ll achieve your goal (unless your resolution is to gamble less in 2012). Or commit to giving a certain amount of money to charity if you fail on your goal.  Websites like StickK allow you to make these types of commitments.

3) Remember it gets easier once you get into the habit. Behavioural economics experts like Daniel Kahneman, Richard Thaler and Cass Sunstein all use “System 1″ or the “automatic system” to describe the type of human thought that happens automatically or instinctively – for example, quickly withdrawing your hand from a hot surface. If you can manage to get into a routine, gradually your preferred behaviour will turn into a habit – it starts to become a bit more like a System 1 process. For example: the habit of getting off one station early and walking home from work. After a while of concerted effort, you’ll (hopefully) find yourself doing it without thinking much about it.

Good luck!

Got any other tips? Post them below.

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Jack and the beanstalk
Jack is sent off to market to sell a cow. On the way, he meets a man who convinces him to swap the cow for magic beans. Jack’s mum is unimpressed and throws the beans out of the window. Overnight, a beanstalk grows in the garden. Jack climbs the beanstalk, meets a giant. Fee fi fo fum etc. Jack steals gold and various other items of value from the giant, and cuts the beanstalk to stop the giant climbing down after him.

Mr In Fo: A big problem here is information asymmetry between Jack and the man who sells him the beans. Jack has no idea whether the beans are magic or not, and naively does not even consider that the seller has an incentive to exaggerate the magic quality of the beans. Luckily for Naive Jack in this instance the seller is on the wrong end of the asymmetry, not realising how valuable the magic beans really are.

Ms Yoosta Bea Banker: You haven’t thought about the ex-ante risk. I suggest that the seller knew all about the power of the magic beans, but when taking into account the high cost and risk of failure, decided they were only worth as much as the cow. God knows what Jack was thinking at the time. This is risk-seeking behaviour, of the like I’ve never seen since the Lehmans Brothers 2006 Christmas party.

Dr Roolo Flaw: This story does not have a fairytale ending. What I see here is the complete disregard for the enforcement of property rights. Where is the incentive for giants to engage in productive behaviour if idiot bean swappers are allowed to come along and steal hard-earned profits? “Jack and the Beanstalk” is anti-capitalist propaganda, and it’s shocking that we’ve been feeding our kids this nonsense for so long.

Cinderella
Poor Cinderella lives with ugly stepsisters and an evil stepmother. Her fairy godmother takes pity on her and says Cinderella will go to the Ball. The fairy godmother ingeniously makes a carriage out of a pumpkin, and turns Cinderella’s rags into a beautiful gown and glass slippers. The catch is that Cinderella must get back before midnight, when the magic wears off. Cinderella meets the prince, but has to rush off, leaving her slipper behind. The prince uses the glass slipper to find his Cinderella among all the ladies of the land. 

Mr Ogre Nised: Cinderella has a classic overconfidence problem, thinking that she had enough time to speak to the Prince, get a proposal in the bag, and leave before midnight.  Luckily for her all turned out well, although after much costly fuss which could have been avoided if she had planned enough time to have a proper conversation with the Prince about who she was. But then studies have shown that we’re all over-confident, apart from people who are clinically depressed. So that’s something for Cinderella to be pleased about.

Rumpelstiltskin
A miller tries to impress the King by telling him his daughter can spin straw into gold. King shuts miller’s daughter in room and demands she spins straw into gold. Rumpelstiltskin appears and offers to help in return for the girl’s first-born child. King is happy and marries girl. The new queen gets out of her promise to Rumpelstiltskin by guessing his name.

Ms D’Emmo Crassey: What is so surprising about this case study is that the media and public have never been particularly interested in the amoral behaviour of the father. This type of lobbying behaviour has clear parallels to our current problems, when we have powerful companies promising Governments all sorts of things in return for special treatment. The King was right to try to test out this lobbyist’s claims: too many politicians today accept all sorts of unevidenced assertions from companies at face-value.  

Mr Sent Ralbank: That is slightly surprising. But not as surprising as the fact that, having discovered a technology for turning straw into gold, the King did nothing about it. I would have expected him to attempt to drastically raise gold production. Of course, in a country where gold was the basis of currency, this would have simply increased the money supply and inflation without actually increasing economic growth. But it would have been a way for an unscrupulous King to pay his debts. This King shows remarkable self-restraint and infinite wisdom for this period in history. It’s possible he may have been an early economist.

Want more economics posts with a Chrsitmassy feel? Check out Five Minute Economist’s Guide to a utility maximising Christmas

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Want to encourage people to do something? Give them a monetary incentive: pay them to do it, or fine them if they don’t. This is the traditional economic answer. But over the years, various studies have shown that it isn’t so simple.

A recent paper by Samuel Bowles and Sandra Polania-Reyes at the University of Siena is a great attempt to bring together the results of different studies in the area and try to draw out some implications for Government policy. In doing so, they summarise some particularly interesting examples:

Haifa day centres: Imposing fines on parents who arrived late to pick up their children from day centres in Haifa, Israel, entirely backfired. The number of late pickups doubled after the fines were introduced.

Irish bag tax: A small tax on plastic bags had the desired effect, resulting in a 94% drop in plastic bag use in two weeks.

Swiss voting: When authorities removed fines for people who didn’t vote, voting turnout fell, as you might expect. However, monetary incentives might not be the only thing at play here, because reducing the cost of voting by allowing postal votes had no effect  on turnout.

The authors of the paper argue that it isn’t so much the fine itself that is important, but what the imposition of a fine says about the different parties involved. They say that: “Fines deployed either to exploit or to control the target (or that give this appearance or that have this effect) are likely to be less effective… and may even be counterproductive. The reason, we think, is that they activate the target’s desire to constitute himself or herself as a dignified and autonomous individual who is treated fairly by others.”

They also recommend that monetary incentives are accompanied by explanations that emphasise how people’s actions will be socially beneficial, so that people are more likely to endorse the purpose of the policy, rather than be offended by it, or think it is unjust. For example, the Irish plastic bag tax was preceded by a publicity campaign, which emphasised the social obligation to use plastic bags wisely. In contrast, no explanation was given to parents for the Haifa day centre fines.

I think the simple message here is that people just like to be treated like grown-ups.

The paper, “Economic incentives and social preferences: substitutes or complements?” is here. The paper also contains references for the Haifa day centre, Irish bag tax and Swiss voting studies summarised above.

Earlier this week, the UK’s Office for National Statistics (ONS) published findings from its initial investigation into the UK’s subjective well-being. It tested out various types of questions, asking people about their satisfaction with life, whether they felt that the things they do in their lives are worthwhile, and whether they felt happy on the previous day and whether they felt anxious on the previous day. The answers to these questions were related, but there wasn’t an exact correlation, for example, in general, people tended to be more likely to give higher scores when asked about how worthwhile their lives were rather than how satisfied they were. 

The ONS also showed that you would get different results depending on whether you ask people if they were happy rather than joyful, and even if you asked them if they were calm rather than relaxed or peaceful.

Is there one definition of happiness or do we all experience happiness in different ways? Previous studies have shown that what people think of as happiness varies across culture and age. For example a study by Cassie Mogilner, Assistant Professor of Marketing, suggested that the meaning of happiness steadily shifts over the course of life from excited-happiness when one is young to peaceful-happiness as one gets older.

In a more recent paper, researchers Cassie Mogilner , Jennifer Aaker and Sepandar Kamvar explore the idea that the reason why the meaning of happiness appears to change with age is because young people are more focused on the future – and therefore equate excitement with happiness, whereas older people are more focused on the present – and therefore equate calm with happiness. Now, I don’t know about you, but this doesn’t seem immediately obvious to me.

Does this excite you?

But they do in fact show that getting younger people to focus on the present leads them to equate calm with happiness, and getting older people to focus on the future leads them to equate excitement with happiness. And what people think happiness means influences what they think will make them happy, and therefore can change their buying habits. For example, young people were more likely to choose a “calm” herbal tea (Sweet Dreams, a relaxing blend of chamomile and mint) , when they were primed to focus on the present – rather than the more “exciting” option (Peppermint, a refreshing peppermint blend). I don’t tend to think of any types of herbal tea as “exciting”, but maybe that’s just me.

All these different meanings of well-being and happiness mean that there are lots of questions we need to answer if well-being is to become more useful in helping Governments make better policy. Luckily it’s something advertisers are interested in too. There’s nothing like commercial incentives to advance human knowledge.

The full paper, “How Happiness Impacts Choice” is available here: http://gsbapps.stanford.edu/researchpapers/library/RP2084-1.pdf

The ONS study is here: http://www.ons.gov.uk/ons/dcp171776_244488.pdf

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“By 2035 the top 0.1% will take home 14% of the national income. Equivalent to that seen in Victorian England.” So proclaims the final report of the High Pay Commission, which was set up to look at the inequality in pay in the UK and what to do about it. They had to do a bit of extrapolating at both ends to come up with this conclusion, as they only had data from 1913 to 2007, and the Victorian era ended in 1901. But subsequent eras such as the Edwardian era and World War 1 have less of a whiff of the workhouse and Oliver Twist about them, so you can see why the Commission were keen to stretch the data out a bit.

The Occupy London protests are still going strong with the protesters having seized an empty building belonging to UBS to create an “Ideas Bank”. Nice idea. The Occupy protests do have an important message, so it is unfortunate that so far, its main victim has been accidental – the Church of England, which descended into confusion over whether any of the protesters had valid points to make, and if so, did it justify the fact that they were making it difficult to get to the St Paul’s Cathedral gift and coffee shop?

 It hasn’t helped that the protesters’ aims have been slightly vague so far. According to their website, they are “in agreement that the current system is undemocratic and unjust.” More specific grievances are listed under their “initial statement”, and among other things include:

“We refuse to pay for the banks’ crisis.
We want regulators to be genuinely independent of the industries they regulate.”
 
Worry about lobbying is a valid concern. It is difficult to know for certain how much lobbying goes on by different interest groups, and how effective they are. Theoretically, there is nothing intrinsically wrong with different interest groups (including firms) talking to politicians and regulators about their views on different policies. But it is a concern if different members of society are better able to access and influence compared to others. And it is a fairly safe assumption that some groups (particularly large companies) have a lot of resources to throw at talking to politicians and regulators, even going as far as funding Government special advisers, as was apparently the case in the Adam Werrity affair. 
 
How do you solve the lobbying problem? One option is to go down the regulatory rules route, for example, having register of lobbying organisations and making sure that there is transparency around meetings that go on between politicians and lobbyists. But it’s pretty difficult to go round policing who’s meeting who and what people say all the time – what do you do about informal meetings between people who know each other in a social context? News of the World had a go at policing what people say (albeit for slightly different reasons), and look where it got them.

So what about turning to that amazing process by which private firms are turned into enterprises that work for the social good: competition.
 
Ah the magical alchemy of competition, whereby firms compete for consumers by providing good, value-for-money products and services. (Caveat: like all magical spells, competition has the potential to go wrong if there are other problems in the market. The classic example is firms competing to reduce prices by skimping on health and safety, or environmental protection. The answer, of course, is not to get rid of competition altogether, but to have health and safety requirements, and ensure there are incentives not to pollute, like pollution taxes. Competition, like magic in the hands of an untrained wizard, doesn’t always deliver what you expect if you don’t properly understand the market and different firms’ incentives. I’m rather warming to this competition/magic spell metaphor. It may warrant a future blog post.)
 
But, I hear you cry, you are simply an economist who has ignored the politics of the whole thing. You’ve blabbed on about free markets (I didn’t actually) and competition until we thought you were Alan Greenspan, and completely ignored the fact that you were trying to solve the problem of lobbying by big corporations.
 
Patience. I was just getting to that. (Am I sounding too smug? The competition/magic metaphor may be going to my head. I must remember that being an economist does not actually make me a wise old sorcerer).  In a competitive market, with many different firms, it is far more difficult for firms to coordinate – this makes it trickier to lobby as one large industry body. It also makes it more difficult to lobby when firms don’t have huge resources to throw at it.

A recent research paper shows that the level of competition in a country’s financial sector has a significant impact on politicians’ ability to force reforms related to financial regulation through. The paper, by Susie Lee and Ingmar Schumacher, shows that financial instability tends to be followed, as one might expect, by more regulation: but significantly, this increase in regulation is less likely to happen in countries with low levels of competition and strong lobbying.  

Now, of course, big firms will probably lobby against competition reforms. That’s where Occupy London could come in with some additional public pressure to get reforms through more quickly. It’s a concrete idea to campaign on, it could contribute to solving the problem, and crucially, just like any good lobbyist, it speaks in the same language of government and regulators in the UK, surely none of whom could possibly argue that more competition is a bad thing – especially in the wake of reports such as the Independent Commission on Banking, which concluded that there are long-standing competition issues in UK retail banking, with high levels of market concentration, made worse by events since the financial crisis, such as bank mergers. Helpfully, the report also sets out ways of increasing competition, including divestiture of assets and making increasing transparency and switching.

Occupy London: what more could you want?
 
The paper by Susie Lee and Ingmar Schumacher , “When does financial sector (in)stability induce financial reforms?”, is here.

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Last week, I read the following newspaper headline: “MPs deride Lansley’s ‘nudging’ deal with food and drink firms“. The story was based on a report by a committee of UK MPs on the effectiveness of UK Government health policy, and in particular its “Responsibility Deal” with food and drink companies, which came in for a fair bit of criticism.

Somehow, in the public consciousness of the UK, “nudging” has become synonymous with some form of self-regulation, where Government takes a step back and relies on the private sector to do what’s best. So, for example, under the Responsibility Deal, various food and drink companies have signed up to “pledges” in the form of various actions designed to have a positive impact on the nation’s health. A very large proportion of these include providing more information to consumers, or donating money to health charities and programmes.

Most of these pledges are not really nudges at all. The occasional one is perhaps, at best, an elbow twitch, quickly suppressed as the firm concerned (unsurprisingly) remembers that it’s there to make a profit. For example, there is Heineken offering to distribute glasses that display information and alcohol units – and that are branded with the Heineken logo.

Creating a good nudge requires understanding what influences people when they make decisions and tweaking the setting in which they make choices to guide them to the better outcomes. For example, putting the healthy food at eye level in shops. It is more libertarian than banning things, in that it does not restrict people’s choices. But actually, it can require some quite interventionist Government policy, whereby Government tells firms how to market and sell products. And every good nudger knows that just providing information to consumers, which forms the basis of many of the Responsibility Deal pledges, is, unless carefully designed and managed, doomed to fail.  

Nudge fans: I fear that unless something is done to salvage its good name, nudging is headed for public relations failure.

Consistent with other research, a new working paper by Italian economists Vincenzo Carrieri and Maria De Paola finds that there is a positive correlation between height and economic and health conditions, which means that taller people tend to be happier. One reason for this positive correlation may be that height is an indicator of good nourishment and health early on in life, which also drives cognitive ability and good health in later life. Other reasons include the possibility that taller people have an advantage in the job market as they are perceived as being successful and good at what they do, and the advantage (particularly for men) in the marriage market.

These effects have all been looked at before, but what is particularly interesting about this paper is that the authors look at specifically look at different age groups. They find that for young Italian men, height has a positive effect on happiness, even after controlling for health and economic status. By contrast, for other age groups, once health and economic status has been taken into account, there is no remaining effect of height on happiness.

They say:

“We speculate that the beneficial effect of height on young males’ well-being may be related to the fact that in some countries, such as Italy, and especially for men, height is considered as a proxy for handsomeness.”

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Perhaps for young men who have yet to achieve their career potential and life aspirations, height and handsomeness is especially important for social status.

But if you are a short man living in Italy, take heart from the fact that Berlusconi isn’t, as far as I can tell, especially tall or economically competent. Yet, even the Eurozone crisis can’t seem to stop him grinning.

The paper is here.