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What is incentive-caused bias? How do you prevent reward bias?
Incentive-caused bias is the tendency of people to maximize their rewards within any incentive scheme. When people gain rewards for acting in a certain way, they will find it difficult to act otherwise, even when doing so would violate the intent of their obligations. You can prevent reward bias by designing incentive schemes that cannot be easily manipulated.
Read on to learn more about incentive-caused bias.
What Is It?
Self-interest drives human behavior. If someone receives rewards for doing a behavior, they will do that behavior again and again.
Research shows that once a behavior is conditioned, a random distribution of rewards keeps the behavior in place the longest—think a slot machine rather than a fixed, predictable payment like a salary.
Rewards are also known as incentives. Common incentives include money, friendship, sex, and advancement in social status.
People, institutions, and society often design incentive schemes to promote certain behavior. However, incentive-caused bias happens when people start to game incentive schemes to maximize rewards for themselves, even if it violates the intent of the incentive scheme and comes at the expense of the system.
Why It Evolved
The brain has a simple algorithm: “Repeat behavior that works.” Here, what works is what gives the person rewards. Why would the brain evolve any differently?
How Can Incentive-Caused Bias Be Harmful
Incentive-caused bias happens consciously or subconsciously. If you have an incentive to think a certain way, you will find it hard to think any other way.
Because people will maximize their rewards within any incentive scheme, poorly designed incentives cause bad behaviors.
- For example, if a surgeon is financially rewarded for each gallbladder she takes out, she’ll tend to take out gallbladders, regardless of whether the patient actually needs it taken out.
If people start acting badly because of an incentive scheme, they won’t see themselves as bad people. Instead, they’ll rationalize the bad behavior in a way that preserves their integrity.
- For example, the surgeon above won’t think, “I’m getting easy cash by fraudulently excising gallbladders.” Instead, she’ll think gallbladders are the source of all evil, and any doctor who loves her patients will take out every gallbladder she can.
Bad behaviors become intensely habit-forming when they are rewarded.
Examples
Munger cites a number of cases where properly designed reward schemes prevented incentive-caused bias and encouraged the right behavior:
- Package shipper Fedex had trouble getting all their packages processed in late night shifts. They tried a lot of management tactics, to no effect. Finally, they changed the pay model from pay per hour to pay per shift (workers wouldn’t get paid until they finished processing all the packages). Magically, the productivity problems disappeared and all the packages were processed on time.
- Government contracts used to be awarded on a “cost-plus” basis—whatever the vendor quoted, the government would add a percentage to allow for profits. Naturally, this caused vendors to embellish their quotes. The government switched to fixed-fee contracts, where vendors are paid a fixed amount regardless of their costs—immediately, the costs for each contract plummeted.
- Munger discussed a native European tribe that killed the last warrior to line up in his place. “No one enjoyed fighting this tribe.”
There are also cases where warped or missing incentives cause bad behavior:
- Expert advisors often recommend things that benefit themselves. Says Munger, “I have never seen a management consultant’s report that didn’t end with the same advice: ‘This problem needs more management consulting services.’”
- Munger notes that the capitalist free market promotes brutal competition between participants, which allows the smartest, most efficient participants to survive. In contrast, non-profit or government environments have employees paid fixed amounts with no incentives to be more efficient, causing a steep loss of efficiency.
Antidotes
Don’t reward behaviors you don’t want. Don’t design incentive structures that are easily manipulated.
To prevent incentive-caused bias in any reward scheme, apply audits to check for good behavior.
- Cash registers deter employee theft.
- Misbehaving employees should be publicly punished to deter future misbehavior.
When getting advice from advisors, be healthily skeptical, especially of advice that benefits the advisor.
- Learn the basic elements of your advisor’s trade so you can sniff out bad advice.
- Double check, disbelieve, or replace much of what you’re told.
Employers can behave poorly as well. To limit employer bad behavior:
- Allow formation of unions to protect workers.
- Apply regulation to rein in bad behavior.
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- A collection of Charlie Munger’s best advice given over 30 years
- Why you need to know what you’re good at and what you’re bad at to make decisions
- Descriptions of the 25 psychological biases that distort how you see the world
